By Saeed Khan Baloch
The Securities and Exchange Commission of Pakistan (SECP) has finally launched regulatory framework of Real Estate Investment Trusts (REITs), which has been widely welcomed by the public and private sector stake-holders. The launching of REITs is a pioneering effort. It is for the first time that an emerging market has launched a modern financial product in a sector, which so far was the undiluted domain of the developed countries.
This has been done despite a number of very prominent property scams and lack of transparency in Pakistan. SECP held a wide-ranging consultative process with critical public and private stakeholders before going for formal launch of REITs. According to Dr Salman Shah, an important economic manager in Shaukat Aziz-led regime, “high quality individuals and groups will be seeking to set up REITs and will set good standards of corporate governance. This process will negate the negative perceptions of the past,” he says.
REITs are two types of schemes providing opportunity to the general public to pool funds for investment in real estate sector. REITs in Pakistan are introduced in the form of a trust where the property itself will be invested in the name of the trustee and REIT Management Company (RMC) will look after the real estate on behalf of the unit holders. RMC will have a minimum 20 percent stake in the scheme and will receive a management fee for providing services. People will be allowed to invest through units of the REIT Scheme, which will be listed on the Stock Market as a closed end mutual fund. The REIT, in fact, will be a specialized investment vehicle, whose development in Pakistan will ensure enabling fiscal and legal environment conducive to reduction in transaction cost, simplification of procedure, transparency in real estate transactions and tax incentives for all stake holders and investors, sponsors and real estate participants.
“Since domestic investors usually do not take a long-term view of the investment in real estate and are by and large looking for short-term speculative gains, therefore, success of REITs requires changing the mindset of local investors”
Under the regulations, REITs are foreseen as Development and Rental: in a development REIT, the RMC will undertake a construction project and after selling the property the sale proceeds will be distributed among the unit holders; in case of Rental REIT, the RMC will buy a portfolio of properties and rent it out, and the unit holders will get returns through annual dividend out of the rental income. As announced by the SECP, REITs will be initially introduced in Islamabad, Lahore, Karachi, Peshawar and Quetta and later their scope will be extended to other cities and towns.
REITs, though new to Pakistan, were introduced in other jurisdictions over four decades ago. Globally REITs is a rapidly growing asset class whose market capitalization increased by 26 percent during the year 2007. Experts believe that total Real Estate owned by REITs globally is USD 1.273 trillion. Now Asia has been widely regarded as the new REIT tiger in terms of high yields and stock premiums. In the year 2007 the REIT markets across the Asian region performed very well, particularly in stock prices, total returns and dividend yields. The total number of REITs in Asia has increased more than in any other region. The year 2007 also witnessed two countries, namely UK and Turkey commencing REITs. Philippines and Germany have also recently adopted a REIT regime, whereas Italy is in the process of doing so.
Recently, India has issued the draft REITs Regulations for public comments. REITs are usually considered as transparent, tax efficient income producing, professionally managed collective investment schemes that make investments in real estate ventures. Internationally, REITs are viewed as exciting and attractive investment opportunities because of higher yield and lower volatility. As an alternate asset class, REITs will provide the people of Pakistan in general and small and middle class investors in particular, an opportunity to benefit from real estate advantages. REITs, undoubtedly will broaden and diversify the supply side of securities and will provide depth to the capital markets.
The Federal Board of Revenue (FBR), through amendments and regulations in Income Tax Ordinance, 2001, have proportionally provided concessions and incentives required for the evolution and success of REITs in Pakistan. “REITs regulations are comprehensively formulated to safeguard the interests of the general public on one hand and facilitate the business community on the other,” says SECP Chairman Razi- ur- Rehman Khan. For him, the two pronged strategy for implementation of REITs serves to create an enabling environment for a robust growth in the sector.
The prospects of REITs look good in Pakistan due to availability of significant amount of untapped real estate in different cities for scrutiny and channeling bank funds, insurance and pension funds in real estate. However, since domestic investors usually do not take a long-term view of the investment in real estate and are by and large looking for short-term speculative gains, therefore, success of REITs requires changing the mindset of local investors. As regards impediments in the way of success of REITs in Pakistan, experts believe an enabling legal framework is the first and foremost element for facilitating, deepening and broadening of housing finance in Pakistan. Thus, there is need to bring about reforms in the various laws affecting transfer, tenancy, rent control and acquisition of immovable properties so that the present uncertainty in the legal system could be removed for establishing efficient real estate market in Pakistan through greater provision of credit from the financial system.
Tenancy laws create difficulties in the housing market and in Pakistan there is no single statute that governs landlord and tenant relationship. Likewise, lack of transparency in local property market and high transaction costs of properties are other critical impediments for the promotion and development of REITs in Pakistan as contrary to the presently practiced property development process, all the transactions under a REITs structure are required to be properly documented so as to reflect the actual money considerations paid, i.e. Market price for land, construction materials and labor. However, despite all such difficulties and problems, the government is hopeful that REITs structure will help in regulating the existing fragmented and informal property development mechanism and bring forth efficiency in price discovery mechanism of real estate and yield improved market valuation of property prices, besides enhancing the liquidity of the real estate market.
Saeed Khan Baloch is a freelance writer with vast experience in the field of print media. He also contributes to foreign media and his expertise is in business, economics and related issues.
This article was originally published in the print edition of Valuemag, issue 1, May 2008.