A Real Estate Investment Trust (REIT), is a company that owns or finances income-producing real estate.
There are different types of REITs, but only the D-REIT and the I-REIT have been contemplated under the Kenyan law. The main difference between the two is that the D-REITs focuses on construction and development of real estate. They acquire land, develop it and sell at a profit. I-REITs on the other hand focus on income generating property. That is they may acquire already developed property or in some cases decide to develop property. I-REITs keep and manage their properties.
How I-REITs Work
Having established that I-REITs own and actively manage property portfolios, it is important to note that management of these properties include, but not limited to, the following;
- Handling rentals
- Leasing properties
- Controlling expenses
- Directing maintenance and improvements
- In some cases after careful and critical considerations may consider disposing the property
REITs in Kenya
The real estate market segment was launched at the Nairobi Securities Exchange on 22nd Oct 2015. The segment will allow listing of the I-REIT and at a later stage D-REIT. The Stanlib Fahari I-REIT is the first to be issued in Kenya whose public offer to the investor market was on October 22, 2015 at a minimum subscription of Kshs 20,000 at 1,000 units and a nominal value of Kshs 20.00 each.
In Kenya, there are currently 5 companies licensed to act as REIT managers by the Capital Markets Authority (CMA). These are;
- Centum Asset Managers Limited
- UAP Investments Limited
- Stanlib Kenya Limited
- Fusion Investment Management Limited
- CIC Asset Management Limited
The STANLIB Fahari I-REIT was close-ended, meaning that investors had to invest by subscribing for an issue of the I-REIT security (through the IPO) and at the completion of the, units of the STANLIB Fahari I-REIT would only be traded on the secondary market through the NSE. One implication of trading in the secondary market as we are currently seeing is that the value of the investment fluctuates over time as determined by market prices for the I-REIT
REITs are required to distribute, in the form of dividends, most of their taxable income to their unit holders, some up to 90% of their revenue. In Kenya, regulation requires that at least 80% of earnings be distributed to unit-trust holders twice a year.
This means that the main source of income is net rental earnings from eligible real estate investments owned directly by the STANLIB Fahari I-REIT and dividend income from wholly-owned subsidiary companies that own eligible real estate investments. At the very minimum, 80% of the profit after tax excluding unrealized fair value gains will be distributed as dividends. The income of the STANLIB Fahari I-REIT will be tax exempt as long as;
- It continues to comply with the REIT Regulations
- Remains authorized by the CMA, and
- Is registered by the Commissioner of Taxes
Factors that Drive REITs Earnings
As an investor it is crucial that you understand the factors that affect REITs earnings especially given that 80% of these earnings are supposed to be distributed as dividends to the unit holders.
- Economic growth: Economic growth is the major factor that determines REITs’ growth. An uptick in economic fundamentals positively affects the REITs by increasing business growth.
- Job Market: The strength of the job market fuels the demand for housing, office, and hotel industry. Strong job growth can drive higher occupancy rates and lead to a rise in the unit rental revenue. In contrast, high unemployment and slow job growth can result in falling occupancy rates and lower revenue per unit.
- Demographics: The rate of population growth in the company’s operating regions is another key determinant of the company’s success. Rising population results in greater demand for apartments, hotels, and warehouse units.
- Occupancy rates and rents: Higher occupancy rates and rising rents are the most immediate sources of revenue growth for REITs. Higher occupancy rates lead to higher income for REITs and vice versa. As the economy expands, the demand for space increases. This leads to a rise in rents.
- Mortgage rates: If mortgage rates are lower, buying a home becomes more attractive than renting. It’s more affordable to buy a house. In such a scenario, the demand for rental properties diminishes. In contrast, if the mortgage rates are higher, renting an apartment becomes more appealing. This leads to a rise in occupancy rates and higher rental revenue.
- Interest rates: Rising interest rates can hurt REITs in many ways. When interest rates rise, investors demand a higher dividend yield on REITs. This drives down their stock prices. Another effect of rising interest rates on REITs is that they have to incur a higher interest cost to finance building purchases. This puts the margins under pressure.
REITs Financial Benefits
- Income: This is in form of dividends and capital gains.
- Diversification: Decades of portfolio research globally show REITs have a low-to-moderate correlation with other sectors of the stock market, as well as bonds and other assets.
- Inflation protection: REITs provide natural protection against inflation. Real estate rents and values tend to increase when prices do. This supports REIT dividend growth and provides a reliable stream of income even during inflationary periods.
- Transparency: Stock exchange-listed REITs are held to the same standards and requirements as other publicly traded companies.
- REITs must disclose financial information to investors and report on material business developments and risks. This transparency enables investors to analyze and value REIT assets independently.
- Investment performance: Globally, REITs' track record of reliable and growing dividends, combined with long-term capital appreciation through stock price increases.
- Liquidity: Globally, there are more than 200 REITs from 30 countries outside of the U.S., which are transforming how people invest in real estate opportunities around the world.As a result of public market liquidity; REITs make real estate investing efficient and accessible for individuals.
- Tax efficiency: Different countries have different tax policies when it comes to REITs. In Kenya, the Stanlib Fahari I-REIT investors will not have to pay additional taxes on their earnings from trading in REITs as the Kenya Revenue Authority “KRA” approved the tax exempt application made by Stanlib.
- Capital: For the developers, this provides the easier access to capital. It frees up developers’ capital so that that they may focus on new development opportunities.
Risks Associated With REITs
Like any other investment, REITs are also exposed to risks. It is important to be aware and watch out for these so that you are better able to manage your expectations concerning your portfolio;
- Slower Growth: REITs can only reinvest a max of 20% of their annual profits back into their core business lines each year. This may cause some REITs to grow at a slower pace than a normal company.
- May rely on debt: A higher dividend pay-out by many REITs may force management to go for higher leverage to expand real estate holdings. This would result in higher interest going out. This would reduce their earnings. In contrast, expansion in real estate holdings may create additional sources of income for leveraged REITs.
- Real estate is a cyclical business: Although REITs have to pay at least 80% of their income as a dividend, their income stream isn’t guaranteed. Cyclical downturns in the real estate market could make REITs business unstable. REITs may be subject to market volatility from time to time.
- Change of government regulations: in Africa especially, growth in the real estate market has been limited by the absence of enabling legislation.
- Expenses incurred in managing the properties may vary due to unforeseeable circumstances and beyond the control of management. In the event that the REIT company is constructing the building - special challenges may occur e.g. construction delays, cost over runs, failure to receive permits ( occupancy permit), financing challenges ( interest rates, top ups)
- Their activities, which may range from raw land acquisition through to operational property management, are largely restricted to the real estate sector. It is usually the case that around 75% of their income must come from real estate activities and they must also distribute the lion share of their gross income (depending on the jurisdiction this can be as high as 90%) in order to continue to enjoy their tax exemption. Illiquidity of the underlying investments in real estate could impact efficient portfolio rebalancing. Other companies listed in the NSE have the leeway of investing in multiple industries, thereby spreading their risks.
- Political activity : typical of emerging /frontier market risks
In conclusion, REITs are transforming how people are investing especially in the real estate opportunities around the world. Ultimately, the successful performance of the REITs depends to a large extent on the ability of owners/agents to successfully operate the underlying properties.