REITs are regulated investment vehicles that enable collective investment in real estate, where investors pool their funds and invest in a trust with the intention of earning profits or income from real estate, as beneficiaries of the trust. REITs source funds to build or acquire real estate assets which they sell or rent to generate income.
The income generated is then distributed to the shareholders at the end of a financial year. They operate income-producing real estate or related assets which may include among others, office buildings, shopping malls, apartments, hotels, resorts, and warehouses.
Kenya’s property market has seen exponential growth over the years. However, financing costs for developments are still high despite the market being undersupplied especially in housing for the lower segment of the market.
The high financing costs associated with real estate development and the undersupply of housing have proven to be a challenge towards the further advancement of this sector.
To remedy this, the government sought to encourage investments in real estate through REITs, which are traded like stocks and investors can buy and sell shares and are regulated by the Capital Markets Authority (CMA).
REITs enable fund-raising for development or purchase of real estate from multiple investors. Examples of REIT managers in Kenya are; Stanlib, UAP Investment, Nabo Capital and CIC Asset Management Limited. However, currently, Kenya has only one listed REIT i.e. the Stanlib Fahari i-REIT, which started trading in November 2015.
With REITs, the Trustee acquires the Property and holds it on behalf of beneficiaries, usually the Investor. The Trustee is responsible for the appointment and supervision of the Manager and also ensuring that the assets of the scheme are invested in accordance with the Trust Deed and the Offering Memorandum. They also ensure that distributions from the assets of REIT are made in accordance with the Offering Memorandum.
There exist three types of REITs namely;
Income REITs (I-REITs)
This is a form of REIT in which investors pool their resources for purposes of acquiring long-term income-generating real estate including housing, commercial and other real estate. Investors gain through capital appreciation and rental income. The appreciation is usually distributed to unit-holders at the agreed duration.
Development REITs (D-REITs)
D-REITs is a type of REIT in which resources are pooled together for purposes of acquiring eligible real estate for development and construction projects. This may include housing or commercial projects. D-REIT can be converted to an I-REIT once the development is complete where the investors in a D-REIT can choose to sell, reinvest or lease their shares or convert their shares into an I-REIT.
An Islamic REIT is a unique type of REIT that invests primarily in income-producing, Shari’ah-compliant real estate. A fund manager is required to conduct a compliance test before investing in real estate to ensure it is Shari’ah compliant and that non-permissible activities are not conducted in the estate and if so, then on a minimal basis.
The advantage of REITs is that they are exempted from double taxation; REIT schemes are exempt from corporation tax and are also exempted from income tax except for the payment of withholding tax on interest income and dividends. Other benefits include;
1. Capital Access & and Access to investments: REITs enable mobilizations of savings from individuals and groups- this means groups and cooperatives will be able to invest in the market. This offers investors especially the middle-income class, easier access and ownership in the growing real estate sector in a manner which is not as capital intensive as a direct purchase of property.
2. Higher Yields and returns -REITs offer predictable income streams because of long-term lease agreements with tenants thus rental income and management expenses are predictable in both long and short time frames. Notably, the Real estate sector generates positive returns, attaining yields of 10.0 percent, 8.9 percent and 5.6 percent for commercial, retail and residential respectively in 2017.
3. Liquidity -Unlike direct investments in property which are generally illiquid, investments in I-REITs may easily be converted into liquid cash by selling the units in the market or offering them for redemption in the case of open-ended funds.
4. Portfolio Diversification -Investors -in REITs have the advantage of investing in a variety of real estate e.g. shopping malls, residential projects industrial projects among others.
5. Professional Management -REITs provide investors with access to professionals such as property managers and fund managers who understand the industry and the business and can take advantage of opportunities.
6. Transparency – REITs are listed and traded in the public domain making them sufficiently transparent. Additionally, REITs must disclose financial information to the respective investors on material risks and business developments on a timely basis
7. Simple Tax treatment – Unlike other partnerships, tax matters for REIT investors are straightforward. REITs are exempt from VAT and stamp duty and for tax purposes its dividends are allocated to capital gains, ordinary income and returns on capital. REITs do not pay taxes at the corporate level and hence investors pay taxes at individual tax rates for the ordinary income portion of the dividend. The portion taxed as capital gains emerges only when the REIT sells assets.
However, REITs, like any other venture, have shortcomings. They include;
1. The decrease in rental income as a result of the termination of lease agreements or non-renewal of lease agreements and failure to secure to secure replacement tenants in good time.
2. For close-ended REITs, the investor is not able to access their investment before the end of the investment period. The investor cannot seek to redeem his investment before expiry of the investment period unless there is an arrangement with the Trustee’s consent for the sale of the Investor’s units.
3. Economic and political situations that could lead to depreciation in the value of the property.
4. Change in taxes – While REITs are currently exempt from VAT and stamp duty taxes, these benefits may change depending on the regime in place
5. Competition from other assets classes e.g treasury bills and stocks.
6. Limited pool of investors especially institutional investors like pension schemes who are only allowed investment to a tune 30 percent of asset of trustees.
REITs are a good option to raise funding as they give people an opportunity to participate in real estate projects. Investors are thus encouraged to go the REIT way and enjoy the benefits it presents.
In Kenya, REITs are at nascent stages with only Fahari i-REIT being listed, and trading at Kshs 11.10 as at 30th November 2017 that is a 44.5 percent drop from its issuance price of Kshs. 20.
For its first year in operation ending 31st December 2016, Fahari I-REIT declared dividends of Kshs. 0.5 per unit that translates to an annual dividend yield of 2.6 percent on its issuance price.
The poor performance is as a result of a significant portion of rental income going into professional fees and thus there’s a need for service providers to consider cutting down their fee drawings to boost investor confidence in the product.
With returns of up to 25.0 percent and rental yields of up to 10.0 percent and 8.9 percent in the commercial office and retail sector, REITs in Kenya has a potential for growth with increased government support, public sensitization and REIT service providers aligning their interests with those of investors to improve returns.