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Saturday, 20th April 2024 |
| Range of property investment structures offers variety of advantages and disadvantages |
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| John Walsh surveys the legal structures commonly used and sets out the pros and cons of each. |
The surge in property investment over the past number of years has resulted in more unusual investment structures being adopted in lieu of the ‘traditional’ property investment structures.
The principal property investment structures include:
• Direct personal
• Group personal
• Direct corporate
• Property funds
• Equity sharing arrangements
Each mode of investment carries its own particular benefits and drawbacks.
Direct personal
The advantages here include direct control over the property and the ability in the case of commercial property to claim a deduction for income tax paid on borrowings incurred in connection with the investment.
The disadvantages of direct personal investment include lower yields and limited choice due to smaller lot sizes as well as over-reliance on a particular tenant.
Group personal
This structure usually involves a number of private investors coming together through means of a co-ownership arrangement to invest in specific properties. A co-ownership agreement is entered into to regulate the respective rights and obligations of the parties.
Amongst the advantages of group personal arrangements include a wider choice of properties, spread of tenants and somewhat higher yield arrangements than would apply to smaller sized investments. Interest incurred on borrowings for the purpose of investments in commercial property can be offset against each individual’s tax liability. A manager is usually appointed by the parties for the purposes of managing the investment and preparing the necessary tax returns for each of the owners in respect of the investment.
Amongst the disadvantages of this form of investment include lack of control and lack of liquidity. The co-ownership agreement will usually regulate assignments and will frequently incorporate a pre-emption right on the part of the remaining owners to acquire a proposed vendor’s share for the open market value less the proportion of borrowings attributable to the share. In default of agreement on the open market value, the matter will be determined by an independent chartered surveyor or valuer. It is generally accepted that the valuation should not be depressed on account of the fact that a share only of the property is being disposed of, although in reality on the open market, it would seem reasonable to assume that there may be some diminution in value due to the fact that the interest is a fractional one.
Co-ownership agreements will usually prevent the parties from charging their interest under the co-ownership agreement to a bank to raise finance. This can be a substantial negative where the investment carries a large element of equity which cannot be leveraged against unless all co-owners agree to increasing borrowings against the properties.
Direct corporate investments
This is a traditional type of investment approach where the investors become shareholders in the company and the company in turn acquires the property beneficially.
The obvious advantage of this method is the limit on liability. The company can act as a ‘shield’ for the shareholders, which does not exist with personal type investments. In the latter cases, bank finances are usually procured, if possible, on a limited recourse basis, the recourse being to the property only and not to the other assets of the investors.
This approach also facilitates confidentiality in that the names of the investors do not appear on the face of the title documents (and occupational leases which have to be granted) as they do with personal investments, unless a nominee company is interposed for the personal investors.
A further advantage is a stamp duty saving of up to 5% (and possibly as much as 8% in cases of residential property) where the property is ultimately disposed of by means of a sale of shares in the company and property investments are sometimes established through special purpose companies with this objective in mind.
The disadvantages of this mode of investment are primarily related to taxation. In cases where a purchaser wishes to purchase the property directly rather than by way of shares in the company, the company will pay tax on the disposal. A further taxation liability may arise on the distribution of the net sale proceeds to the shareholders. Thus in some cases a double charge to tax can arise.
Property funds
A number of the larger investment companies have created specific property funds on behalf of participating personal investors who provide the finance to acquire unspecified properties. It is possible to establish a property fund regulated by the Central Bank as a unit trust, an investment company or an investment limited partnership. The investment objectives and policies of a property fund of this nature are subject to the approval of the Central Bank and will depend on whether the fund is a retail fund or a fund marketed to professional or qualifying investors under the Central Bank rules.
Amongst the benefits of this type of investment are the fact that the investment decisions are usually made by a professional fund manager who may be a chartered surveyor, and will certainly be on the advice of an independent chartered surveyor. This type of investment also benefits from advantages similar to those associated with the group personal investment vehicles on account of size and spread of properties. In addition, the transfer of units and property funds does not require consent.
A disadvantage associated with this type of investment is the right of some managers to delay exit by encashment or switching for a specified period in the event of outflows from the fund.
Equity sharing leases
This a property structure which is being increasingly used with large property investments. It can be particularly useful where a developer obtains a favourable planning permission for the development or redevelopment of a particular site. It may make sense for the developer to introduce an investor to share the development risks and benefits. In such a case, the developer would agree to dispose of an agreed share of the site to the investor for an agreed consideration on foot of which the developer would grant to the investor a lease obliging the investor to pay to the developer the agreed percentage of the rental income from the development with the investor retaining its agreed percentage. This structure can also be used for forward fund development works, with the investor having the right to an agreed percentage of the occupational rents paid by the tenants.
An advantage of this investment structure for the developer is to realise a gain on the development (hopefully at the rate of 20% if the receipt is treated as a capital gain) whilst at the same time retaining a stake in the development going forward. An advantage for the investor is that it has an equity-sharing lease of the property from the developer/freeholder and therefore is in direct contact with the occupational tenants and is entitled to receipt of the entire of the rents from the tenants (part of which must be passed on to the investor under the equity-sharing lease) and thereby controls the investment. This structure is also particularly useful in the context of large property investments as it results in each of the developer (who will usually also be the freeholder) and the investor having the right to independently deal with their respective interests by means of assignment (subject to any agreed conditions in this respect) and mortgagabilty of their interests.
A disadvantage of this structure is the fact that a large investment is resting in one particular property, although this could presumably be balanced against an institutionally acceptable tenant of good financial strength.
Weighing up
Clearly there is a number of advantages and disadvantages associated with each particular form of property investment structure. In some cases the nature of the property will dictate the structure proposed; however, potential disadvantages should in each case be balanced against the advantages having regard to the investor’s particular requirements before finalising any particular structure. |
John Walsh is a partner in the Commercial Property Department of Arthur Cox.
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| Article appeared in the May 2000 issue.
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