The (Outdated) Persistence of REITS and Trust Structures in Real Estate Funds
Introduction: real estate fund structures
Real estate funds in Singapore, whether listed or unlisted, have conventionally been constituted as unit trusts. A unit trust is a type of collective investment scheme that is based on a trust over assets (in this case, real estate and real estate-related assets) held by the trustee, and of which beneficial interests are vested in the holders of ‘units’ in the said trust.
That said, the launch of the variable capital company (‘VCC’) structure in Singapore in January 2020 provided a new alternative to structure real estate funds. Briefly, a VCC is a corporate entity that can be used to hold one or more collective investments schemes over any form of property, including real estate and real estate-related assets. It can be structured in a variety of ways, most notably as an umbrella VCC with several sub-funds, each having its own separate and segregated investment objectives, assets and liabilities.
Despite the establishment of over 540 VCCs as of mid-2022, as of the date of this article, there are no real estate funds listed on the Singapore Exchange Securities Trading Limited (‘SGX-ST’) that are constituted as VCCs – most have adopted the unit trust structure. Anecdotally, we have had many clients who request for their real estate funds to be structured as unit trusts, and view VCCs with some degree of unfamiliarity or suspicion.
Borne out of this context (and perhaps a little frustration), we want to delve into the reasons underlying the persistence of the unit trust structure for real estate funds (instead of VCC). Ultimately, we argue below that the VCC offers greater advantages over a unit trust structure and should be the structure of choice for listed and unlisted real estate funds going forward.
The history of unit trust structures in Singapore
Much of the preference for unit trust structures in Singapore for real estate funds can be traced to the widespread use of real estate investment trusts (‘REITs’). REITs were first conceptualised in 1960 by the United States (‘US’) Congress to give all investors, particularly small retail investors, opportunities to invest in real estate without incurring significant capital outlay. Such real estate funds were not corporatised (i.e. they were constituted via trust structures) primarily because of a prohibition on corporations from qualifying as REITs under the US tax laws in force at that time. As such, trust structures have, by reason of precedent, been used to house REITs in the US, although (since certain amendments made to the US tax laws in 1976) the trend in the US has been to corporatise REITs as state law corporations.
Locally in Singapore, market players have followed the trailblazing precedents set by the US, Australia and other foreign jurisdictions. The first listed Singapore REIT (‘S-REIT’), CapitaMall Trust, was constituted as a unit trust and listed on the SGX-ST in 2002. Over the years, the S-REIT landscape has matured, with 43 S-REITs and property trusts having a total market capitalisation of SGD111 billion as at June 2022. A quick sampling of these S-REITs reveal that almost all of them are set up as unit trusts. So prevalent are unit trust structures that the rules of the SGX-ST relating to real estate funds are drafted assuming that the real estate fund is constituted as a unit trust, even though there is no strict requirement to be constituted as such. Therefore, it remains to be seen how such listing rules, requirements and procedures will be applied to a real estate VCC in the future.
Anecdotally in the private unlisted real estate fund industry, we note that clients often have a strong preference for unit trust structures, as documentation is widely available on the SGX-ST and in other exchanges. Such structures are well-understood and ingrained into the public consciousness.
Aside from familiarity, what advantages do unit trusts have over other structures and in particular the VCC? We compare these two structures– and on a balance, argue that the VCC is actually much more suitable to house real estate funds than trusts.
The VCC versus the unit trust structure for real estate funds
One of the often-cited advantages of constituting a real estate fund as a unit trust is the tax transparency treatment of certain specified income distributed by the trustee. Tax transparency means that the specified income will not be taxed at the trustee level, but in the hands of the unitholders. However, while that is true for REITs, we have had to explain to some clients that REITs have a specific meaning – being a trust investing in real estate and real estate-related assets that is constituted as a collective investment scheme authorised under section 286 of the Securities and Futures Act 2001 (‘SFA’) and listed on the SGX-ST. As such, for many of our private clients, they will not be able to avail themselves of the automatic tax transparency treatment and income tax will be levied in the trustee’s hands at the prevailing corporate tax rate. This outcome is therefore similar to a VCC for income tax purposes, as a VCC is treated as a company incorporated under the Companies Act 1967 and subject to the prevailing corporate tax rate. In both cases, downstream distributions from a unit trust to its unitholders or a VCC to its shareholders are exempt from another separate tax.
In addition, while the tax incentive schemes generally available to real estate funds, being the Offshore Fund Tax Exemption Scheme, the Singapore Resident Fund Tax Exemption Scheme and the Enhanced-Tier Fund Tax Exemption Scheme, are applicable depending on its legal structure, similar economic benefit is accorded under these schemes. In each case, the real estate fund must fulfil the specific conditions to prove that its ‘specified income’ is derived from ‘designated investments’, and therefore is exempt from tax. Thus, there is no inherent benefit in constituting a real estate fund as a unit trust. Conversely, certain qualifying expenses incurred in the incorporation or registration of a VCC may be defrayed by the VCC Grant Scheme offered by the Monetary Authority of Singapore (‘MAS’), capped at SGD150,000 per VCC. As at the date of this article, the VCC Grant Scheme is still available.
From a regulatory perspective, the managers of VCCs are required to be regulated by the MAS, and are excluded from relying on the exemption relating to immovable assets under the SFA from holding a capital markets services (‘CMS’) licence for fund management. Accordingly, the additional time and effort involved in the application of a CMS licence for fund management may deter the utilisation of VCCs. In contrast, a manager of a unit trust can invoke such exemption and be deemed to be a ‘restricted scheme investing in non-capital markets products’, provided that (i) the fund invests solely in immovable assets or in securities issued by investment holding companies whose sole purpose is to invest into real estate development projects and/or real estate properties, and (ii) the units in the fund are offered only to accredited investors. The adoption of the unit trust structure therefore appears to be a relatively quicker path to establish a real estate fund.
Yet from a legal perspective, there are benefits in having clearly defined statutory rules governing the segregation of assets and liabilities of the sub-funds of a VCC, that the sub-trusts of a unit trust do not have the advantage of. This is most relevant in considering the protection of the unitholders during insolvency or winding up of the real estate fund. Such segregation laws are statutorily enshrined in the Variable Capital Companies Act 2018 (‘VCC Act’) which states that the assets of a sub-fund of a VCC cannot be used to discharge the liabilities of the umbrella VCC or of another sub-fund. Third party creditors of a sub-fund are therefore ring-fenced into recovery against that sub-fund’s assets by the operation of clearly defined legal rules. In comparison, the unitholders of a sub-trust are not conferred similar protection and must rely on contractual provisions set out in the trust deed to segregate the assets and liabilities of each sub-trust. Legally speaking, such segregation is contractual and only binding on the trustee and unitholders inter se and may not be entirely effective against third party creditors who are not privy to the trust deed and have had no notice of the same. As such, protection of the unitholders afforded by a unit trust is weaker than that rendered to the shareholders of a VCC.
Finally, from a conceptual perspective, it must be highlighted that trust laws do not mandate a limitation of liability between unitholders and their trustee, and therefore theoretically unitholders may be exposed to unlimited liability incurred by the trustee. Unless otherwise agreed, trustees have a right to be indemnified against the trust assets and where insufficient, against the unitholders personally, insofar as the trustee is not in breach of its statutory duties under the SFA. On the contrary, given that the VCC is a company, the liability of shareholders is limited to their subscription into the VCC, and the directors and/or managers of the VCC do not have direct recourse against the shareholders. This is however a conceptual point because to our knowledge, the limits of such personal recourse by a trustee against its unitholders have never been tested in Singapore courts.
In summary, it appears that the VCC has several clear legal advantages over the unit trust structure, and generally enjoys similar tax treatment to a unit trust (which is apposite for unlisted real estate funds). However, a real estate fund constituted as a trust and which is deemed as a ‘restricted scheme investing in non-capital markets products’ need not have a licenced manager, which a VCC is statutorily required to have. This may deter smaller real estate funds from adopting the VCC structure.
The way forward
Having considered both the advantages of the VCC as well as its limitations relative to the trust structure, we set out our thoughts on possible enhancements to the VCC framework going forward to better suit real estate funds.
An important step forward would be to extend the exemption relating to immovable assets under the SFA from the requirement to hold a CMS licence for fund management, to the fund managers of real estate funds constituted as VCCs, subject to the satisfaction of the requisite conditions. By doing so, it would bring the VCC on par with the unit trust structure in this respect. While we acknowledge that the rationale for mandating that fund managers of VCCs be regulated by the MAS is to maintain supervisory oversight and prevent any abuse of the VCC structure, safeguards may be implemented via the introduction of more stringent requirements under the corporate governance framework of VCCs. Nonetheless, it remains a curious case as to why a real estate fund constituted as a trust and which is deemed as a ‘restricted scheme investing in non-capital markets products’ need not have a licenced manager, whereas a real estate fund constituted as a VCC must have a manager that is regulated by the MAS.
Moreover, as noted above, the present rules of the SGX-ST pertaining to the listing of real estate funds are drafted in trust language. By providing express guidance as to the applicability of the rules of the SGX-ST in relation to the listing of real estate funds constituted as VCCs, this will provide clarity and aid the decision making in structuring real estate funds as VCCs.
On this note, it is hoped that subsequent revisions of the VCC framework will progressively bolster Singapore’s position as a leading asset management and fund domiciliation hub, in addition to its status as a global REIT hub.
 Thompson and Priest, ‘Singapore: Wider Adoption Greater Goal For Singapore VCC’ (Mondaq, 5 September 2022) <https://www.mondaq.com/directors-and-officers/1227428/wider-adoption-greater-goal-for-singapore-vcc-> accessed on 27 October 2022.
 Lee and Foo, ‘Real Estate Investment Trusts in Singapore: Recent Legal and Regulatory Developments and the Case for Corporatisation’ (2010) 22 SAcLJ at 37-38.
 Ibid at 38.
 SGX Research, ‘Chartbook: SREITs & Property Trusts’ (SGX, June 2022) <https://www.reitas.sg/wp-content/uploads/2022/06/SGX-Research-SREIT-Property-Trusts-Chartbook-June-2022.pdf> accessed on 27 October 2022.
 Rule 404(8) of the Mainboard Rules of the SGX-ST.
 Section 43(10) of the Income Tax Act 1947 (‘ITA’).
 Section 13D of the ITA.
 Section 13O of the ITA.
 Section 13U of the ITA.
 Paragraph 5(1)(h) of the Second Schedule to the Securities and Futures (Licensing and Conduct of Business) Regulations.
 Paragraph 6A of the Sixth Schedule to the Securities and Futures (Offers of Investments) (Collective Investment Schemes) Regulations 2005; MAS, ‘FAQs on the Licensing and Registration of Fund Management Companies’ (MAS, 30 March 2022) at 5.
 EC Investment Holding Pte Ltd v Ridout Residence Pte Ltd  4 SLR 123 at .
This alert is for general information only and is not a substitute for legal advice.