Real estate is an important and a growing asset class especially in emerging economies. For general public (small savers), however, it is essentially inaccessible particularly in our part of the world where mortgage finance is virtually nonexistent. Real estate demands a large fund size to take exposure in and is illiquid, in case, one wants to reconvert the asset into cash. Other challenges of investing in real estate include lack of transparency, high cost of due diligence and post acquisition management.
In Pakistan the desire for owning real estate ranks at the top amongst investment objectives of nearly all individuals. However, modest average income levels and high inflation makes it difficult to achieve this desired objective. The need to design an investment instrument which protects savings against inflation and links investment return to escalation in real estate prices has been felt for quite some time.
Real Estate Investment Trusts (REIT) provide a perfect combination of inflation hedge, liquidity and real estate-linked returns. In Pakistan they have an added advantage of being proximal to Shariah prescriptions. REITs allow an average investor to take exposure in real estate with limited amount of money and have the ability to encash the investment by selling units in the capital markets. REIT regulations were introduced in Pakistan in 2008 making it the first country in the region to offer REITs. These regulations and the approval process at SECP are singularly focused on protecting the interest of minority unit holders / small savers. A lot of work has been put in since then to bring this instrument to the market. It is expected that the first REIT scheme will be launched within this fiscal year. SECP is in the process of amending REIT regulations to make these more practical and viable.
In Pakistan, REITs are structured as "closed-end" funds whose units are to be listed on the stock exchange. REITs in Pakistan can be either Developmental REITs (where a real estate is acquired for development and subsequently sold or rented out) or Rental REITs (where a developed real estate is acquired to generate rental income for the unit holders). The management company launching and managing REIT fund is to be a public limited NBFC (Non-Banking Finance Company). Three REIT management companies are already established which are active to varying degrees. Like all other collective investment schemes, REITs are tax pass through vehicles and are exempt from income tax provided they distribute 90% of their income to unit holders.
To ensure all aspects of the real estate are handled professionally, the Regulations involve the services of a Trustee, Unit Registrar, Quality Assurance Manager, Valuation Company and Property Manager, each of which has clearly defined roles to ensure optimal investor protection and real estate operations.
When an investment is made in a real estate through the REIT structure, the real estate is transferred in the name of a Trustee, which can be a AA rated financial institution or CDC. Trustee holds the asset on behalf of unit holders who proportionately own the real estate and its related earnings as per their unit holding. This provides security and transparency to the transaction. This is in addition to the oversight and diligence provided by the SECP.
The biggest impediment for the success of REITs in Pakistan is the exclusion of real estate development activity from the formal sector. Real estate investment and development is undertaken mostly by the informal sector where tax evasion is rampant. This tax evasion coupled with violation of building and construction rules makes the business highly lucrative and comparatively makes the business model unviable if someone wants to undertake the business while being compliant with the prevailing rules and regulations. Transfer duties and taxes alone put REITs at a crippling disadvantage as compared to the prevalent market practices. REITs have to pay transfer duties and taxes at the actual transaction value. The informal sector on the other hand pays transfer duties and taxes as per the "valuation table" or "Collector" rate, which are lower by more than 8 to 10 times as compared to the actual transaction value at prevalent market prices. Although, the Government of Sindh and Punjab have announced lower rates for transfer duties and taxes when applied to REITs; these concessions are highly inadequate and need to be revised downward to match the "valuation table" or "Collector" rate.
Bringing the real estate business within the fold of formal/regulated economy and creating an opportunity for small investors to invest in real estate could prove to be a major game changer. This has the potential of increasing our savings and investment rate, addressing the problem of housing, commercial and other infrastructure shortage, creating employment for millions and enhancing government's tax collection significantly. REITs are playing their due role in other developed and emerging countries. India has also promulgated REIT regulations in 2014 and has attracted significant interest from large local and international players. It is hoped that with the right set of policies and incentives, Pakistan can also join the rank of countries benefiting from the adoption of international best practice in terms of real estate transactions, design, execution and management of the developed real estate.
In order to enhance REITs potential of success all participants including the Provincial and Federal Government, Regulator, REIT Managers, Developers and Financial Institutions should play their collective role in making REITs successful as an investment vehicle, mode of development and a means to meet the nations demand for quality real estate.
(The writer is currently serving as Chief Executive Officer at Arif Habib Dolmen REIT Management Limited)
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