Market volatility and fewer alternative low risk asset classes is strengthening demand for REITs globally. A real estate investment trust (REIT), is a legally recognized business structure that makes money by owning or financing property. REITs have fully transferable shares.
Generally, two categories of REITs exist based on the type of investments they make and their sources of funds; equity REITs and mortgage REITs (mREITs). MREITs are more prominent in developed countries and they are mainly involved in the business of offering mortgages to commercial real estate interests, or trading in mortgage-backed securities and similar financial instruments originated in the industry.
Equity REITs on the other hand are mainly concerned in the development or acquisition and management of income generating real estate. Equity REITs can be further classified into Development REITs (D-REITs) which focus on property development and sale, and Income REITs (I-REITs) which focus on income generating properties.
Equity REITs often focus on apartment complexes, commercial office and retail property but they can just as easily involve hotels, healthcare facilities, utilities etc.
In African markets, traditional equity REITs are more common since the continent’s capacity to absorb real estate capital is still limited owing to risks and generally low purchasing power. In addition, most African markets are yet to experiment with the level of financial instrumentation available in leading global markets since financial markets here are less sophisticated.
Changes are fast in coming however and a handful of African countries now have REIT legislation and REITs. South Africa, the most developed REIT ecosystem of them all, has in fact been the most yielding REIT market globally for some years. Nigeria, Ghana, Mauritius, Kenya and Tanzania are also developing their REIT markets.
There is also a difference between publicly listed REITs and Private REITs. These relate to transparency, costs and liquidity. First, listed REITs are subject to the same disclosures required of public companies, unlike private REITs.
Also, cost wise, private REITs usually outsource property management and advisory services at a fee while listed REITs rely on in-house professionals. Thus, when you buy into a listed REIT, these expenses are already factored in.
And on liquidity, it is notable that private REITs are less exposed to market volatility since investors don’t have to worry about price movements. But this comes at a cost that is less liquidity. While investors in publicly listed REITs can liquidate their shares instantly, private REIT investors will face considerable constraints in redeeming their investments. This may take days, weeks or even months to realize liquidity.
According to Stanlib, ‘the illiquid nature of a private real estate fund’s investment assets often makes the open-ended structure unworkable since it presents the fund with the dual problems of establishing a fair value for each contributing and withdrawing investor.’
One of the key factors affecting the performance of REITs is the types of commercial property they own and operate, in addition to certain regulations in the local jurisdiction which enable and restrict the operations of REITs.
In Kenya for instance, the following restrictions apply;
REITs cannot invest more than 5% of total asset value with one issues of bonds, securities or other financial instruments.
Another restriction is that they can only invest 10% or less of total asset value, in a company wholly owned by the REIT Manager.
On borrowing, I-REITs can borrow up to 35% – 40% of total asset value while D-REITs can borrow between 60% – 75% of total asset value. Trust documents impose a limitation the purposes for which borrowings can be undertaken.
In Kenya, REITs are required by law to a maintain minimum float of 25% of the REIT security, to persons not associated to Promoter or REIT Manager, unless funding is required for unscheduled cost overruns
Investors in restricted REITs need a minimum of KSh. 5 million or $50,000 to get into the game.
On income distribution, I-REITs in Kenya are required to distribute least 80% of the net income after tax other than realized capital gains on the disposal of real estate assets. However D-REITs have no mandatory distribution requirements.
Realized capital gains are distributed depending on scheme documents. Usually, they are to be distributed within 2 years or re-invested to retain tax status.
REITs cannot dispose more than 50% of total asset value unless the REIT is being wound up or approval has been obtained from REIT Security Holders.
Kenya as in most jurisdictions, does not require REITs to pay corporate tax.
In conclusion, REITs offer several benefits to investors including hedging from inflation, liquidity, diversification, dividends, professional management and tax transparency.