Yves Moreau, France Englebert and Anton Cox of Linklaters explore the success of the Real Estate Certificate in Belgium as an investment mechanism.
When, in November 2011 – in the middle of the financial crisis – the Belgian prime minister launched a bond loan initiative to try to limit Belgium’s recourse to bank financing, the government expected subscriptions to reach about Ä200 million, taking into account the Belgian people’s natural preference for saving.
The bond loan initiative was a huge success and had to be extended. By the end of the offering period, subscriptions had reached an amount of approximately Ä2 billion, ie, 10 times greater than expected.
How can such success be explained? Quite simply, because the Belgian population no longer knew where to invest its savings. The stock exchange was seen as being far too risky, while investing in real estate requires a significant amount of money (particularly taking into account Belgium’s level of transfer taxes on real estate) and does not necessarily offer the expected return in terms of flexibility and liquidity.
Another mechanism exists in Belgium which seems to be advantageous as it combines the best of both worlds. This investment tool, the Real Estate Certificate, blends the security and stability of a real estate investment with the flexibility of a stock exchange-based transaction.
Initially appearing in the 1960s, using general principles of law to meet the financing needs of promoters willing to develop shopping centres and other commercial premises, Real Estate Certificates were very popular at first but recourse to them soon decreased when, as a result of the introduction of new and very severe laws on new commercial premises, the construction and development of such premises dropped drastically.
Real Estate Certificates can nevertheless be seen today as an attractive investment vehicle for those who are looking for investment opportunities in a relatively secure and tax-favourable environment, but who also want to retain a certain level of flexibility and liquidity.
Moreover, Real Estate Certificates are useful given today’s costs and the scarcity of bank financing, and because equity funds tend to invest only in prime and fully secured real estate. For more average-sized and/or local developments, Real Estate Certificates could thus also be the remedy for certain financing difficulties.
When using the Real Estate Certificate mechanism, a real estate investment is made by specialised companies that (re)finance the acquisition or construction of one or more specific properties (commercial properties, but also office or logistics properties) by issuing a certain number of Real Estate Certificates to be subscribed by investors. The Real Estate Certificates issued by the property-owning company (or by a company that has a partnership with the property-owning company, the latter being in that case the so-called “managing company” in charge of the realisation of the real estate project and the management of the properties concerned) are thus securities representing a debt against the issuing company (or against the partnership to which the issuing company is party). Real Estate Certificates are subscribed by way of private or public issues (in the case of public issuance, the transaction is then supervised by the Financial Services and Markets Authority or FSMA).
Contrary to a Belgian Sicafi/Vastgoedbevak (similar to a Real Estate Investment Trust (REIT) in the US), which owns a portfolio of assets and may sell part or all of these assets to reinvest in others, a Real Estate Certificate is intrinsically linked to a limited number of real estate properties, the sale of which will trigger the liquidation of the issuing company and the reimbursement of the holders. As such, a Real Estate Certificate can be viewed as a more stable, less fluctuating, real estate investment.
With Real Estate Certificates it is possible to make, with a limited amount of capital, an indirect real estate investment in the form of debt securities offering higher negotiability and liquidity as well as lower transfer costs. Real Estate Certificates can be transferred fairly quickly, without any particular formality being necessary (for instance, such a transfer does not require the execution of a notarised deed). Similarly, tax, fees and costs charged as a result of a property sale do not apply to the sale of a Real Estate Certificate. For these reasons, Real Estate Certificates also offer the advantage of allowing more investment diversification and, as a result, can help to reduce risk exposure for investors.
A Real Estate Certificate entitles its holder to a proportional share in the net income derived from the properties concerned (rents less expenses) and, ultimately, a proportional share in any net proceeds resulting from the sale of those properties (sale price less costs, including the reimbursement of any loan relating to the properties). The coupon to be paid to Real Estate Certificate holders is broken down into portions which correspond to the repayment of the principal amount and a portion which corresponds to the actual return.
Such holders are not, from a legal and tax perspective, considered as owners of the property (the property belongs to the issuing company or the managing company) nor as shareholders of the issuing company (the company belongs to its shareholders and not to the Real Estate Certificate holders).
A holder’s right is equivalent to that of a creditor having a debt claim against the issuing company (or against the partnership formed by the issuing company and the owning company).
However, from an economic point of view, the Real Estate Certificate holder is in the same position as the owner of a rented property. The Real Estate Certificate holder bears the risks of the investment (such as vacancy or capital loss). Indeed, unlike with ordinary bonds, whose return is generally fixed, the return on Real Estate Certificates depends on the net income generated by the property. As far as the repayment of the Real Estate Certificate is concerned, this also depends on the capital gain/loss realised on the later sale of the property. On the other hand, the Real Estate Certificate holder, in contrast to the owner of a property, will not be involved in the management of the underlying properties. The whole transaction (including the rental, rent collection, property maintenance and, at a later stage, the sale of the underlying properties) is managed by the issuing company or, in case of a partnership, by the managing company. Those specialised companies are acting, in effect, as a trustee which owns and manages the underlying properties for a Real Estate Certificate holder’s account, even if the Real Estate Certificate holder only has a debt claim against them and no right over the properties.
Although it is true that the Real Estate Certificate holder’s rights are conditional (in the sense that they depend on the income generated by the property), a Real Estate Certificate remains a relatively secure investment compared with other forms of investment. Real Estate Certificate holders are, for instance, protected against inflation due to the fact that the rental income is index-linked.
As far as Belgian tax aspects are concerned, Real Estate Certificates qualify as debt securities: every sum paid by the Real Estate Certificates’ issuing company above the principal amount of such securities therefore qualifies as interest under the Belgian Income Tax Code.
The above means that both the income component in the regular coupons and the income component in the final coupon (ie, the capital gain on the property) will, for Belgian tax purposes, quality as interest.
Arm’s length interest payments are, in principle, fully tax-deductible in the hands of the Real Estate Certificates’ issuing company.
As regards Belgian tax in relation to the holders of the Real Estate Certificates, a 21 per cent withholding tax needs to be levied by the Real Estate Certificates’ issuing company (or its paying agent) on the interest income paid to the holders of the Real Estate Certificates.
On top of that, an additional tax of 4 per cent on investment income is due by Belgian natural persons.
On the basis of the above, it appears clear that Real Estate Certificates offer numerous advantages over real estate or stock exchange investments. Real Estate Certificates indeed combine the flexibility of stock exchange-based transactions with the security and stability of a real estate investment. However, as income deriving from Real Estate Certificates is directly linked to the performance of the underlying assets, subscription to them requires a thorough prior examination of the relevant real estate assets, together with an in-depth knowledge of the real estate market.