It’s a brave finance director who, with a tax liability of £642.5m, says he
has absolutely no intention of paying it. But this is exactly what Aidan Smith,
FD of FTSE-100 property company Liberty International, does within minutes of us
meeting. “We would never have paid that £640m. We never had any intention of
paying it,” he says.
Happily, Smith isn’t stark raving mad – the liability is a deferred capital
gains tax charge and, not surprisingly, is something he would be happy to defer
“pretty much indefinitely”.
That was, however, until the government recognised it was missing a trick in
the listed property sector. Capital gains tax was beginning to resemble a ball
and chain to the industry, making companies less agile, less attractive to
investors and with the result that many decisions were being made for tax
reasons rather than business ones.
So, while expecting the Treasury to wipe out CGT may seem unrealistic, it’s
exactly what Gordon Brown plans to do. Well, almost. In return for allowing
property companies to convert to real estate investment trusts, the Treasury is
demanding a one-off charge equal to 2% of the gross assets of the company in
question. In Liberty International’s case, this is around £146m. Should all five
FTSE-100 property companies convert – which is the expected outcome – the
Treasury will be about £850m richer overnight.
In return for this one-off charge, property companies are freed from the
constraints of CGT on their portfolio, with the responsibility for tax being
passed on to the shareholder.
But why would Brown settle for just £850m when Liberty International’s CGT
liability was almost £650m alone? “Because we run our business on a very
long-term basis, and because of the way we’re financed, rather than sell a
shopping centre we can take big loans on the centre and take 65-70% of the value
out without having to sell it,” Smith explains. “And if we keep doing that, why
would we ever want to sell it? We can pretty much defer that game indefinitely.
So, from the Treasury’s point of view, it can collect £140m, or so, for
Smith refers to the contingent capital as being treated by the company as an
interest-free loan. “You can flip it the other way round and ask, ‘why would we
want to pay £140m to pay off an interest free loan?’ And the answer is that it
gives us a lot more flexibility,” he says.
In fact, if ever there was a policy change in which everyone involved appears
happy, the Reits regime could well be it. The government is happy because it
gets a substantial guaranteed cash payment; the companies are happy because they
are freed from the burden of CGT; and everyone else should be happy because it’s
likely to result in a far more active property sector – which is good news for
As Smith says: “In the Reit world, all sorts of deals and transactions will
become possible that, because of the tax, we couldn’t contemplate at the moment.
It’s going to become a much more interesting and dynamic world. I think there’s
going to be a lot more M&A activity.”
Reits have long been mooted, but it wasn’t until Gordon Brown’s spring Budget
that an announcement was finally made giving the go-ahead for property companies
to convert themselves into Reits from 1 January 2007. Liberty International was
one of the first to confirm its intention to do so and some analysts are
expecting the listed property sector to double in size. “We are being freed from
a shackle that meant we were a less attractive way of investing in property than
going direct,” says Smith.
There has been a lot of talk about whether or not Reits will be of any use
for the corporate which owns a large amount of real estate, but whose main
business isn’t necessarily property – such as a high street bank or retailer.
Smith doesn’t think so, saying the Treasury doesn’t want what it calls the
“op-co, prop-co model” – where operating companies would use Reits as a way to
finance their property portfolio. “Once it’s established, and once it’s been
seen that it can work, I think some of those fringe rules – which I think are
there in case, rather than for good reason – [may be removed],” he says.
One such fringe rule, which has many property professionals slightly
perplexed, is the exclusion of Aim-listed property companies from becoming
Reits. Whether this is because the Treasury sees the tax advantages offered by
an Aim listing as enough of a tax advantage for one company, or whether the
light regulation of Aim is seen as too risky while the rules bed down, is
unclear. But the small cap London market is one of the only stock exchanges in
the world on which the companies listed do not qualify to convert to Reit
status. “This seems crazy because you can be on any of the stock exchanges in
the world, as long as it’s reputable, but not one of the main ones in London,”
The Reits regime has been keeping Smith extremely busy. From being a “vague
possibility” just 12 months ago, this completely changed in the past nine
months. So quickly has it happened that he fully expects some of the rules only
to be finalised in the new year – after the regime has come into effect.
In fact, the past year or so has been incredibly busy – something which isn’t
always the case in a profession as slow-moving as property. The vast bulk of
Liberty International’s assets are4 in the retail sector – it owns several
regional shopping centres such as Lakeside in Essex and the MetroCentre in
Gateshead. “The big shopping centres are in a life-cycle – from conception to
actually making money – of anything up to 15 years,” he says. “I suppose in that
sense I’m still a new boy – I’ve been here 20 years.”
So, it’s no surprise that a year in which he has had to prepare for a new tax
regime, bed in IFRS (see box, previous page) and successfully negotiate probably
the highest profile acquisition in the company’s history, that of Covent Garden,
was always going to keep him on his toes.
The purchase of Covent Garden for £421m in cash was completed in August and
gave Liberty International more column inches in a month than it’s probably used
to in an entire year. “It has a unique value as a landmark,” says Smith. “I
think in a few years’ time we’ll be known as the company that owns Covent
Liberty International has some very large assets, and this influences investment
and borrowing strategy to a large degree. To minimise risk, Smith funds
acquisitions by borrowing against those individual assets rather than the entire
company. “All of our finances are effectively like individual mortgages on the
properties,” he says. “So we take the finance, secure it on something like a big
shopping centre and all of the finance conditioning relates purely to that
property. So, in extreme cases, if something goes wrong, only that property goes
– there’s no recourse whatsoever [back to the group].”
But financial risk is one thing, coping with cultural risks quite another.
The purchase of Covent Garden has handed Liberty International a property asset
with a hugely delicate cultural mix. High street names rub shoulders with market
traders selling scented candles. Making sure that all are well catered for,
while at the same time creating value and increasing earnings, could cause
problems – especially when the rents go up.
Smith’s words probably won’t assuage too many Covent Garden supporters who
love its hustle and bustle and alternative feel. “It is the nearest thing you
can get to a shopping centre in the heart of London,” he says. “And the
opportunity is to manage that property in the same way as we manage our large
shopping centres and to see it as one continuous piece.” While the last thing
that Smith will want to do is drive the more colourful aspects of Covent Garden
away, Liberty International hasn’t paid £421m for an asset that it doesn’t see
potential to improve and squeeze more earnings from.
Currently, the rent from Covent Garden tenants tops £17m. But this will
surely be increased over time. “We’re only interested in acquiring assets where
we think there are substantial opportunities to grow the income,” says Smith.
“There will be room for some of the high street names, but it has to be a
premier location. In the main piazza area the units are quite small so there’s
always scope for boutiques. It’s a matter of getting that balance between the
uniqueness and getting the right bigger-space users paying the right rent. You
can’t turn it into a Lakeside – it’s a different animal.”
Although Smith is one of the first to admit that the property sector can be
relatively slow-moving, it’s been quite some year for Liberty International.
Coping with reporting standards primarily designed for airlines and banks and
moving to a new Reit regime, despite a lack of clarity over how the final rules
will look, certainly doesn’t help.
But Smith is clearly buzzing about the challenges ahead – only time will tell
whether that will see him through another 20 years.