REIT Under the Civil Law

 What is the Civil Law, and How Does it affect REIT?

Their world has two main legal structures, the civil law and the common law. In simple terms, civil law is a pre-written legal code that was made by the lawmakers; judges simply apply these codes rather than interpreting past decisions (Basically, judges don't make decisions based on old court cases or interpreting them in any way, but rather based on a pre-written rule book).

Property law under the civil law saw property as a bundle of rights over lots of things, including ownership over property, usufruct (right to use property and earn income from it), lease, servitudes (right of land), and mortgage. Under civil law, property ownership is absolute, held by only one party, and it does not recognize the 'splitting' of ownership.

REIT, on the other hand, is structured with two separate legal entities owning a piece of property. The trustee (REIT company) holds the legal title to the property, and the investors (unitholders) are the beneficial owners, although they do not own the building; however, they still get income from it. Therefore, generally, a traditional REIT would have two parties involved in holding it, which under civil law, is not recognised. 

However, that does not mean that REITs do not exist in civil law countries; in fact, Asia's first REIT, J-REIT, is under civil law. France, South Korea, and Germany REITs are also under the same structure, and this is how they did it:

Case Study of REIT under Civil Law: J-REIT

J-REIT, the first ever Asian REIT IPO'd in September 2001, despite being in a civil law country which does not recognise trusts the same way common law does.

The success of J-REIT must be studied, knowing the context it was in. Japan faced a real estate crisis in the 1990s, followed by the 1997 Asian financial crisis, leaving the banking sector with lots and lots of non-performing loans (NPLs). To resolve this issue, the government passed the Investment Trust and Investment Corporation Law in the year 2000.

As they are under civil law, a trust is not recognized; therefore, J-REIT companies must be flexible in their implementation of it. They treated REIT as a fund (or in Japan, its legal entity was called an 'Investment Corporation') with an external asset management company, following a triple structure: The REIT firm itself owns the real estate (legally), the asset management company runs the operation of it, and the custodian (middleman) holds the assets and monitors the compliance. This set-up allows a REIT-like behaviour, but is still within the civil law framework.

To go into further details, the investment corporation is a legally incorporated entity; it is not a trust. It owns real estate directly and is listed on the Tokyo Stock Exchange and is governed by its own articles of incorporation. The asset management company is a separate licensed company and is appointed by REIT to make all the investment decisions. This asset management company must be independent but acts on behalf of the REIT, getting paid by performance or asset under management (AUM). Custodian is a regulated financial institution that holds the title to the real estate. They ensure legal compliance, transparency, and asset protection of the REIT.

J-REIT governance mechanism consists of the board of directors and supervisory officers. Like any other listed companies, J-REIT must disclose all its financial statements to the public and will be checked by an independent auditor. 

Case Study under Civil Law: France SIIC

France took a very different approach from Japan when it comes to their REIT, also under the civil law, but rather than a trust-based structure, France kept it relatively simple. SIICs were introduced to the French market as listed real estate companies with a REIT-like tax exemption. They essentially are a regular corporation, not a fund or an investment corporation like Japan; however, they still get special tax treatment. 

Also, unlike Japan with the triple structure, SIICs are self-managed real estate companies without any external asset managers or custodians. They are governed by the French Commercial Code and corporate governance law and are not under any special fund laws, despite that they still get tax treatment if they meet certain requirements.

In order to be qualified for SSIC, the company must be listed, have a minimum capital of 15 million euros, and have to distribute 95% of its rental income, 60% of capital gains, and 100% of dividends from subsidiaries; in return, they do not need to pay corporate tax.

Case Study under Civil Law: K-REIT

Again, South Korea follows civil law, meaning trust law is not recognized in the system. REITs popped up as a solution in response to the 1997 financial crisis. Like other countries, there was a surplus supply of real estate that needed to be liquidated, and REIT came up as a way to revitalize the real estate market and reduce reliance on corporate real estate ownership. South Korea they were also very fortunate in that the government passed through Real Estate Investment Company Act in 2001 (REICO Act) to introduce REITs under the Korean law. 

Despite that, Korean REITs are not a trust, but rather a corporation, similar to France and Japan. REITs are registered as legal entities, and the ownership of REITs is direct in that REITs hold full legal and beneficial title to all their assets. However, the law does allow for many different types of REITs in terms of ownership and operational models. The 3 main types are as follows:

1. Corporate REITs (CR-REITs)

A normal listed REIT corporation managed by an external asset management company (similar to Japan). It, like any other stock, must meet listing rules, disclosure and governance standards, and they are allowed to raise capital from the public. 

2. Entrusted-Management REITs (EM-REITs)

These REITs entrust their asset management to a REIT management firm but still own the real estate. The great thing about this is that the regulator is the Ministry of Land, Infrastructure and Transport; therefore, it is highly suitable for public-private partnerships. This REIT structure is often used for projects involving public housing, urban development, or government property monetization.

These REITs can still be listed on the stock exchange; listing them does allow for more transparency and capital; however, it does require more regulation and cost; this depends on the REIT's strategy.  

3. Self-Managed REITs

These REITs self-manage their asset internally without an independent investment team. However, these REITs are quite rare and often are not that successful due to most investors and regulators prefer to have an external management firm. 

K-REITs receive partial tax benefits, unlike the US or Japan, and are exempt from corporate tax; they must distribute at least 90% of their taxable income, qualify for tax pass-through (based on their structure), and meet other requirements. 

However, in order to operate a K-REIT, it is not simple. K-REIT receives strong oversight by the Ministry of Land, Infrastructure, and Transport (MOLIT), REIT managers must be licensed and have a specific capital requirement as well as track records. Publicly traded REITs must also follow the capital market laws and corporate governance codes. 

Conclusion

In conclusion, civil law does not recognize REITs; however, it does not mean countries under civil law can not establish one. Like Japan, the triple structure, France's SIICs, or Korea's REICO Act, there will always be a way around if a REIT is needed in an economy. 

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J-REIT.jp - The Information about Real Estate Investment Trust in Japan

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