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Hong Kong Issues REIT Guidance

Tuesday, April 12, 2011

Hong Kong’s Securities and Futures Commission (SFC) has published an investor education article explaining key features and risks related to latest real estate investment trust (REIT) products, particularly to those denominated and trading in renminbi (RMB).

The article, entitled “Understanding the latest REITs in Hong Kong” highlights, among other issues, important risks and features of REITs investing in real estate located in mainland China. As for REITs traded and settled in RMB, investors, it says, should also take into account the additional risk factors associated with RMB fluctuation and convertibility.

In Hong Kong, a REIT, a collective investment scheme in a portfolio of income-generating real estate, may borrow up to 45% of its gross asset value and has to distribute at least 90% of its after tax net income in the form of dividends. Investors are urged to study offering documents and consult, where appropriate, professional advisers before making any investment decision in relation to REITs.

Currently, for example, the article points out that, while foreign interests in property located in mainland China are generally held via a joint venture with a finite term, the value of the REIT's investment in such real estate will decrease over time and there will be no residual value at the end of the term. Therefore, any suggestion that any single interest in real estate held to the end of the term would still provide value, because of the expectation that the real estate would appreciate in value over time, may be unsupportable.

In addition, the dividend income of a foreign corporate investor received from an entity established in mainland China is subject to 10% withholding tax on the Mainland. Depending on the availability of any tax treaty between the foreign corporate investor's jurisdiction and mainland China, such withholding tax may be subject to a preferential treatment where the taxation rate may be reduced.

In any event, it is said, such taxation charge could reduce the profit available for distribution of a REIT holding real estate in mainland China. The offering document of a REIT should be checked to understand the impact of the withholding tax, and, furthermore, it should be remembered that the tax rate and policy are also subject to change.

The units of an RMB REIT are denominated, traded and settled on the Stock Exchange of Hong Kong in RMB. In general, distributions from an RMB REIT will be made in RMB rather than HKD, and non RMB-based investors will be maintaining a currency conversion risk.

It was also stressed that an investment in an RMB REIT should not be used to bet on the appreciation of the RMB. In addition, as the RMB is not freely convertible and is subject to foreign exchange controls and restrictions, the liquidity and trading price of the units of an RMB REIT may be adversely affected given the limited availability of RMB outside of China.