Real Estate Investment Trusts (REITs) in Kenya

With the tremendous growth of Real estate business in Kenya KASNEB introduced REAL ESTATE FINACE study in their syllabus which will be done as a topic in Advanced Financial Management subject for those taking CPA SECTION 5. The following is covered in that Unit

REAL ESTATE FINANCE

  • Overview of real estate business – nature of real estate business, legal and economic framework and participants in real estate business in Kenya
  • Valuation approaches (income, cost and sales comparison approaches)REITS: types; advantages and disadvantages; valuation: net asset value per share (NAVPS); use of funds from operations (FFO), adjusted funds from operations (AFFO) in REIT valuation
  • Instruments of real estate financing – mortgages, lien, title, mortgage requirements and mortgage clauses
  • Rights in case of debt – default and its consequence, equity of redemption, foreclosure, statutory redemptions
  • Mortgage and financial markets: demand for funds in mortgage market, disintermediation effects, primary and secondary mortgage market, mortgage market and cost of money, role of central bank and the role of government in mortgage markets
  • Savings and loan association – classification, state accounts, insurers. Mortgage backed bonds and services

In regard to that let’s see what REITS are, Who can register them, how they operate, requirements needed and their benefits and challenges they face

What is a REIT?

A REIT is a regulated investment vehicle that enables the issuer to pool investors’ funds for the purpose of investing in real estate. In exchange, the investors receive units in the trust, and as beneficiaries of the trust, share in the profits or income from the real estate assets owned by the trust.

Type of REITS

Income Real Estate Investment Trusts (I-REITs)

An Income-REIT (I-REIT) is a real estate investment scheme which owns and manages            income generating real estate for the benefit of its investors therefore providing both liquidity and a stable income stream.    Distributions to investors are underpinned by commercial leases.  This means that income returns are generally predictable.

Development Real Estate Investment Trusts (D-REITs)

A  Development  Real  Estate  Investment Trust  (D-REIT)  is  a  development  and construction real estate trust involved in the development or construction projects for  housing,  commercial  and  other  real estate assets.

Islamic 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.




Who can issue a REIT?

A REIT can be issued by a property manager, owner, developer or their representative. A REIT issuer could also be the person who is nominated to be the promoter of the REIT, in the application to the CMA, for the authorization of the REIT.

Types of properties that can be owned and managed by a REIT

REITs own and manage a variety of property types including: offices, apartments, serviced accommodation, factories, warehouses, cold storage facilities, shopping malls, hospitals, clinics, age care units, primary and tertiary learning facilities, student accommodation, car parks, ports, airports, hotels, specialist property (clean rooms, science labs, food processing facilities, theme parks, stadiums, convention centres, restaurant facilities (pubs, fast food stores), ships, mines, communication towers, toll roads, water treatment plants, power stations, and plantations. There are even REITS of REITS, which are REITS that invest in other REITS.

Who can invest in a REIT?

REITS are for investors who want exposure to the property market without the large initial capital outlay.

What is the process of setting up a REIT?

 

The REIT formation process requires technical expertise and advice. Promoters are advised to consult their advisors as early as possible before proceeding with a REIT transaction. The milestones involved in setting up a REIT are listed below:

  1. Evaluate what type of property you hold in order to make a decision on the type of REIT. Land for development – D-REIT; income producing property, I-REIT;
  2. Appoint a REIT manager, trustee, and advisors; Consider accounting, tax and legal implications (you can use advisors);
  3. Consider accounting, tax and legal implications (you can use advisors);
  4. Preparation of legal documents by the transaction advisor in accordance to the REIT Regulations;
  5. Submit REIT application to CMA and NSE;
  6. NSE gives the feedback to CMA;
  7. CMA approval of the REIT;
  8. Selling of the REITs units to investors (IPO);
  9. Application for listing of the REITS Units at the NSE;
  10. Approval of listing by NSE;
  11. Listing of the REITs units.

 

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.

Types of offers that can be issued in a REIT

REIT offers can be restricted or unrestricted. D-REIT offers are restricted, while I-REIT offers/issue can either be restricted or unrestricted

Restricted Offer

Restricted offers refer to issues or offers made to professional investors. These are investors who, whether as individuals or as registered groups of persons, subscribe for REIT securities worth at least Kshs. 5.0 million; or any person licensed under the Capital Markets Act as a professional investor, an authorized scheme or collective investment scheme or a bank or subsidiary of a bank, insurance company, cooperative society, statutory fund, pension or retirement fund.

Types of Restricted I-REITs

Restricted I-REITs can either be structured as open ended funds or a Close Ended Funds and may be converted from one form to another. Open ended funds are characterized by the following qualities;

  1. Open Ended Funds

Investors invest in the fund by acquiring REIT securities which they may dispose by having the REIT trustees redeem the shares.

  1. The value of the investment and redemption price per unit is determined by the net asset per unit as calculated from time to time as per the scheme documents.
  2. The size of the fund may increase or decrease as investors acquire or dispose REIT securities.
  1. Closed Ended Funds

Closed ended funds on the other hand have the following characteristics.

  1. Investors invest by subscribing for an issue of REIT securities or by acquiring REIT securities in a secondary market;
  2. The value of the investment fluctuates over time as determined by market price for the REIT securities;
  3. The number of the REIT securities issued remains constant over time except where a new issue of REIT securities is made or there is a reduction in the capital of the fund initiated by the trustee or as a consequence of termination or winding up of the trust.
  4. The REIT securities holder, except where there is a reduction in the capital of the fund initiated by the trustee or as a consequence of termination or winding up of the trust –
  5. Is not entitled to require the trustee to redeem the REIT securities; and
  6. May only exit the investment in the REIT securities by selling the units in a secondary market

Ultimately this means that restricted I-REITs may or may not be listed in the in the securities exchange market depending on the memorandum of offering. If they are structured as open ended funds then they cannot be listed. Only restricted I-REITs that have the structure of closed ended funds qualify for listing. Even when they are listed, the segment in which they are listed will only be a reserve of the Professional Investors

 

Unrestricted Offer

Unlike restricted REITs, unrestricted I-REITs must be listed. They are structured as close ended funds. An unrestricted offer is open to investors who need not be professional investors.

 




Requirements for Income Real Estate Investment Trusts (I-REITs)

Permitted InvestmentsIncome generating real estate and other investments such as bonds, cash, securities and shares
Types Of OffersRestricted or unrestricted.
Listing1. Unrestricted offers must be listed;

2. Restricted offers may or may not be listed. If listed, can only be listed on a market segment of the NSE approved by the CMA which limits trading to (i) professional investors and (ii) minimum lot sizes worth Kshs. 5.0 Million.

Minimum Investors7
Minimum Value Of Initial Assets (Kshs.)300 Million
Minimum Subscription (Kshs.)5.0 Million (only if restricted)
Minimum Free Float Requirement25%

1. Doesn’t’ apply where securities are issued to the promoter, REIT manager or parties connected with them to fund   unscheduled cost overruns on a development;

2. Securities issued must not have voting rights but can have the right to participate in distributions.

Minimum Retention And Lock In Periods For The PromoterMandatory (not subject to trust document)

1.   20% of NAV – Year 1;

2.   10% of NAV – Year 2;

3.   0% – Year 3 and beyond

Borrowing Limits1.   Not to exceed, in total, at the time the liability is incurred, 35% of the total asset value;

2.   Limit on borrowing can be increased to 40% with consent of the securities holders if the borrowing is for a temporary purpose and for a maximum term of 6 months.

Investment Of Capital Raised1. At least 1 investment within 180 days of close of the offer or cash will be returned in full to the investors. During this period, funds to be held in trust account controlled by the trustee until registration;

2. Within two years of the date of its authorization as a real estate investment trust scheme, at least 75% of the total net asset value in income producing real estate;

3. The investment must be an income generating real estate property.

Distribution RequirementsSubject to REIT manager’s recommendation, scheme documents and the REIT regulations

1. 80% of net after tax income within 4 months after the end of each financial year;

2. Realized capital gains.

 




Requirements for Development Real Estate Investment Trusts (D-REIT)

Permitted InvestmentsDevelopment and construction projects
Types Of OffersCan only be restricted.
Listing1. May or may not be listed;

2. If listed, can only be listed on a market segment of the NSE approved by the CMA which limits trading to (i) professional investors and (ii) minimum parcel sizes of Kshs. 5.0 Million.

Minimum Investors7
Minimum Value Of Initial Assets (Kshs.)100 Million
Minimum Subscription (Kshs.)5.0 Million
Minimum Free Float Requirement25%

1. Doesn’t’ apply where securities are issued to the promoter, REIT manager or parties connected with them to fund unscheduled cost overruns on a development;

2. Securities issued must not have voting rights but can have the right to participate in distributions.

Minimum Retention And Lock In Periods For The PromoterSubject to the trust documents

1. 10% of net asset value (NAV) – Year 1 and 2;

2. 0% – Year 3 and beyond.

Borrowing Limits1. Not to exceed, in total, at the time the liability is incurred, 60% of the total asset value;

2. Limit on borrowing can be increased to 75% with consent of the securities holder if the borrowing is for a temporary purpose and for a maximum term of 6 months.

Investment Of Capital Raised1.         Direct investments in real estate with at least 1 investment within 180 days of close of the offer or else 25% of unit holders may request the return of cash;

2.         A Minimum 30% to be invested in development and construction projects or income producing real estate within a year of authorization which the D-REIT has constructed or developed.

Distribution RequirementsSubject to the scheme documents and the REIT manager’s recommendation

1.         Income- no limit;

2.         Realized capital gains.

Benefits of REITS to the Issuer

  1. A tax efficient structure. REITS approved in Kenya are exempt from a number of taxes including:
  2. REITS registered by the Commissioner of Income Tax are exempt from Income Tax except for the payment of withholding tax on interest income and dividends;
  3. Income of exempt investors remains exempt;
  • There is no capital gains tax upon the sale of property in a REIT;
  1. A transaction where a transfer of assets into a REIT owned by the same person or when the person transferring the asset, acquires units in the REIT, is exempt from stamp duty.
  2. Access to new investors/capital makes financing developments easier and hence reduces the interest rates for properties;
  3. Sharing of risks by bringing other investors on board.

Benefits to the Investors

  1. Exposure to a wide variety of expertly managed properties;
  2. Regular income stream with lease agreements which increase/grow on an annual basis;
  3. Well-regulated and subject to the REIT legislation particular to the country in which the company is incorporated;
  4. Investors may gain exposure to immovable property with lower initial outlays;
  5. Exemption from Capital Gains Tax (CGT) in respect of the disposal of the its immovable property, shares in another REIT or shares in a controlled property company;
  6. Shareholders who sell their units in REITS listed on the NSE do not pay CGT or stamp duty;
  7. The unit price of a listed REIT is determined by market forces (demand and supply) and is visible to the public.

Frequently used terms

Closed end Fund (CEF)

A closed-end fund is essentially an investment vehicle that issues a fixed number of units in an initial public offering, and invests the proceeds in assets dictated by its mandate. After its IPO, the CEF’s units trade on an exchange; just like a stock, the price of the fund’s units is determined by supply and demand.

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