Nelly Gitau | Lena Onchwari

Introduction

Real Estate Investment Trusts or REITs as they are commonly referred to, have become the new frontier in the investment sector in Kenya. This is despite the fact that they have always been available as an investment option but for one reason or another, REITs have become more popular and increasingly attractive, even to the average investor who had always seen REITs as a niche investment for a select few. For most people, the possibility of owning property as expansive as Garden City Mall in Nairobi for instance, was next to impossible. This has been bolstered by a growing real estate market and advancement of earning power and net worth of individuals in Kenya. These changes, coupled with the access to information and the increasing interest in other forms of investment have resulted in the attractive allure of REITs today.

What is a REIT?

REITs are regulated investment vehicles that enable collective investment in real estate. Investors pool their funds and invest in a trust that is divided into units with the intention of earning profits or income from real estate, as beneficiaries of the trust. A REIT is an entity that owns and typically operates income-producing real estate or related assets which may include among others, office buildings, shopping malls, apartments, hotels, resorts and warehouses.

A REIT is a vehicle through which investors earn a share of the income produced through commercial real estate ownership without actually having to go out and acquire commercial real estate. REITs also allow the investor the opportunity to have its properties managed by a professional real estate team that knows the industry, understands the business and can take advantage of opportunities. Most importantly REITs are excellent for the investor who wants to avoid capital risk as much as possible while enjoying a decent dividend or interest yield.

The Legal Framework governing REITs in Kenya

REITs are regulated by the Capital Markets Authority (CMA) under the Capital Markets (Real Estate Investment Trusts) (Collective Investment Schemes) Regulations, 2013.

The high interest rates associated with real estate development and the undersupply of housing especially for the lower segment of the market have proven to be a challenge towards the further advancement of this sector. To remedy this, the Government seeks to encourage investment in real estate through REITs.

How do REITs Operate?

The Trustee acquires the Property and holds it on behalf of the beneficiaries (the Investors). The Trustee is responsible for the appointment and supervision of the Manager. It is also the Trustee’s responsibility to ensure that the assets of the scheme are invested in accordance with the Trust Deed and the Offering Memorandum and ensures that distributions from the assets of the REIT are made in accordance to the Offering Memorandum.

The Scheme is managed by a Professional Manager who is answerable to the Trustee. The Manager’s duty is to oversee the investment of the assets of the scheme and maintain proper accounting records and other records of the scheme. The Manager also collects rent and other income on behalf of the Trustee. The income is distributed to the Investors at the rate agreed upon in the Memorandum or at any other rate as may be agreed between the Trustee, the Manager and the Investors.

Prior to issuance of the Memorandum by the Trustee, the Scheme as well as the Offering Memorandum should be approved by the CMA. On invitation by the Trustee, the Investors pump capital in form of units with a view of having a return on investment within a specified duration.

Types of REITs

There are three types of REITs namely: Income REITs (also referred to as I-REITs), Development REITs (also referred to as D-REITs) and Islamic REITs.

I-REIT 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, with the latter being distributed to unitholders at the agreed duration.

D-REIT is a type of REIT in which resources are pooled together for purposes of acquiring eligible real estate for development and construction projects which may include among others housing or commercial projects. It should be noted that a 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 offer or issue in a D-REIT may only be made as a restricted offer to professional investors.

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.

Benefits to Investors

Investing in REITs offers the following benefits to investors:-

1. a) REITs offer 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. b) More often than not, the value of the property appreciates thus minimizing the risk of capital loss.
3. c) 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. d) Investors in REITs have the advantage of investing in a variety of real estate e.g shopping malls, residential projects industrial projects e.t.c.
5. e) 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. f) 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.
7. g) REITs are considered to be efficient from a tax perspective. This is discussed in detail below.

Taxation of REITs

One of the key advantages of investing in a REIT is the tax regime that governs REITs both from the REIT’s perspective and also from the investors’ perspective. The Kenyan government in an effort to encourage investments in real estate has put in place a tax regime that favours REITs. A REIT is generally exempt from taxation if it complies with REIT Regulations and remains registered with the Capital Markets Authority and the Commissioner of Taxes.

However, REITs are not exempt from withholding tax on interest income and dividends. These are taxed at the rates shown in the table below:

Type of income     Resident(%)  Non-resident(%)   Exempt(%)
Dividends                  5                        10                            0
Interest                     15                        15                            0

When a REIT distributes its income to its unitholders, the same will be deemed to have already been taxed. The unitholders will therefore not be required to account for further taxation. This is also the case with payments for redemption or sale of units received by investors.

In the event that a unitholder transfers its share in a REIT or redeems its units from the REIT, they will be obliged to account for capital gains tax on the gain made. However it will be exempt from Stamp Duty.

Shortcomings of investing in REITs

1. a) Economic and political situations that could lead to depreciation in the value of the property. However, gauging from the trend in the Kenyan property market in the past few years, the values of properties have been escalating.
2. b) Decrease of rental income as a result of termination of lease agreements or non-renewal of lease agreements and failure to secure replacement tenants in good time.
3. c) For close-ended REITs, the Investor is not able to access their investment before the end of the investment period. In a close-ended REITs, 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.

The trend of REITs in Kenya

RElTs in developed capital markets have been in existence in their present format since the 1960s, but they were actually introduced in the 1800s. The US has the most advanced REIT in the world. In Africa, growth in this market has been limited by the absence of enabling legislation. With the opening of the Stanlib Fahari I-REIT public offer, Kenya became the fourth African country to launch REITs. South Africa has traded in REITs for the last 10 years, while Ghana has had access to REITs since 1994 and Nigeria 2007.