On resiste a linvasions des armees; on ne resiste pas a linvasion des idees (Victor Hugo - 1852)

REITS
Nothing is as powerful as an idea whose time has come

WHAT IS A REIT
Real Estate Investment Trust is a mutual fund that invests in properties and derives income from such investments for its unit holders. Globally, REITs are open-end structures. In Pakistan, initially closed-end structure is being introduced owing to high redemption and systemic risk. REITs are very diverse - investments are in office buildings, residential, shopping malls, hospitals/ schools and industrial uses.

GLOBAL REITS
Globally, REITs is a rapidly growing asset class - market capitalization increased by 26% during the year 2007. US Market is in a state of contraction.

Growth in the Asian market coupled with growing REIT sector in the UK has offset the effect of the US market decline.
Total Real Estate owned by REITs globally is USD 1.273 trillion.
Note: All figures relate to publically listed REITS.

GLOBAL REITS
Asia is widely regarded as the new REIT tiger.

High dividend yields and stock premiums are main characteristics of Asian REIT.
For instance: Singapore has an annualized yield of 12%, and REIT stocks trade at a 71% premium to NAV. Australia is the second largest REIT market in the world. Grew by 45% in 2007. Cross border investment flows is a key characteristics of Asian REITs.

TOTAL REITS BY REGION

2006 North America EMEA
(Europe, Middle East and Africa)

2007 195 102

253 59

Asia
Pacific

75
64

83
68

Note: Decline in US partly recessionary and partly owing to M&A activity and conversion to PE.

INHERENT RISKS
Currently no method of price discovery in the RE Sector. Only a handful of properties in Pakistan with transparent leases. Antiquated rent control laws. History of scandals in the RE Sector (Co-operative Societies, Twin Towers Modaraba, etc.).

Differential between the real price and the recorded price can be as high as 900% e.g. Karachi.

INHERENT RISKS
Tax load on land as high as 28% - e.g. Lahore. Land value can be higher than Southern Europe e.g. Islamabad. Tax regime is leading to the conversion of genuine white money into black money. The taxation structure is also responsible for the build and abdicate culture i.e., no RE development is planned for rental purposes. Multiple licensing jurisdictions in each town with no overall urban planning or fiscal framework.

LAHORE
Rate of Levy Cost of Land 8 kanal Cost in Rs. 1 bn -

KARACHI
Rate of Levy Cost in Rs. 1.2 bn

Registration Fee
Stamp duty

1%
2%

10 m
20m

1%
3%

12 m
36 m

Transfer Fee (Lhr)/ CDGK Tax (Khi)

Commercialization Fee

1%
20%

10m
200m

1%

12 m

Rs. 8000 per 32 m sq, yard = 2.67 % in this case 2% 4% 13.67% 24 m 50 m 166 m

CVT Expediting payments Total Additional Cost

2% Approx. 2% 28%

20 m 20 m 290 m

The two year research process revealed decades of fiscal neglect (at the provincial level). SECP, therefore, had two options: - wait for fiscal and legal reform in the provinces i.e. delay REITs for several years; or - launch REITs with appropriate firewalls.

IMPACT OF REITS ON THE RE MARKET

Improve price discovery for both rental and sale transactions. Promote development of long-term rental market. In RE, money is mainly made by transacting in open plots no real benefit to the economy or to society. Capacity building - modern valuation professional fund management and trustee. standards,

Promote high quality construction as promoters will seek long-term revenues rather than the current practice of build and abdicate i.e. reduce speculative activities.
Increase supply of residential and commercial properties.

IMPACT OF REITS ON THE CAPITAL MARKET

Alternate asset class which will increase the supply of securities with the combined benefits of an equity security and real estate. Provide real estate upsides to non-property owning segments of society.

Will broaden and diversify the mutual fund industry.

Units of the Scheme listed and traded on the Stock Exchange (therefore greater corporate governance and liquidity for investors). FDI flows will be enhanced as this product will provide a structure to a largely unregulated market segment.

FEDERAL GOVERNMENT SUPPORT (LEGAL)

RE is a provincial subject. The pace of progress could not be dictated by the Federal Government/ SECP. Therefore, it was crucial that the Commission be given enhanced regulatory control and fast track remedial capability through improved legal empowerment. The Federal Government (June 2007) greatly enhanced our powers to deal with the NBFC sector through a series of amendments in Section 282 of the Companies Ordinance.

FEDERAL GOVERNMENT SUPPORT (FISCAL)

The Federal Government, through Finance Act 2007, allowed REITs the tax pass through status (in line with mutual funds). Reduced tax on rental income to 5% (full and final settlement). This is a major incentive to promote transparent leases in Pakistan. To encourage transparent sale transactions, the Federal Government has provided exemption from tax to sellers of property to REITs (up to 2010).

Status of Implementation of SECPs Recommendations

Federal Government No progress on following two issues: Abolition of CVT (should not have been imposed by the Federal Government. in the first place Provincial issue) Abrogation of Rent Control Law in Islamabad

Status of Implementation of SECPs Recommendations

Provincial Government (Legal)

No progress on legal and fiscal issues Punjabs new draft Rent Law has the same basic deficiencies as the existing law Punjab has the highest concentration of historical towns in Pakistan Older parts of these towns are in drastic need of Urban Renewal, can only be done if Renovation is added to the reasons for eviction The figure of 10% as an annual rent increase needs to be abolished as it imposes an unnecessary hurdle in supply of rentable properties

Status of Implementation of SECPs Recommendations

Provincial Government (Fiscal) All the fiscal deliverables for REITs are contained in National Housing Policy 2001 and the Punjab Development Report 2005 Owing to very high Property Tax Rates, Rental REITs are not feasible in Lahore only 1 building with transparent leases in the whole town!!! Developmental REITs are more likely to emerge in the nonLDA parts of Lahore owing to very high Commercialization Fees (LDA)

Status of Implementation of SECPs Recommendations

SECPs Recommendations
Provincial Abrogation/drastic amendments to Rent Control Laws New Law development Condominium Law Reduction in transaction costs (stamp duties, registration and commercialization fees and other levies) Federal Tax pass through status (Parallel to mutual funds) on 90 distribution of income Reduction in tax (on rental income to 5%) Reduction in CVT on all RE transactions X X X

Status

Tax waiver for sale of properties to REITs (till 2010)

ESSENTIAL DELIVERABLES
Transaction Costs Federal -Elimination of 2% CVT on all RE transactions. Provincial - Downward revision of Stamp Duty and Registration Fee. - Drastic downward revision of Commercialization charges. - Change in method of calculation of Commercialization fees/ property taxes to a covered area formula with zero tax for aesthetics (e.g. parks, fountains) and utilities (car parks, toilets). -Elimination of differential in property tax applicable on rented and owner-occupied property. The total tax load on a RE transaction should not exceed 4-5% international best practices. It may be noted that all these fiscal reforms are revenue-neutral. These reforms already in NHP 2001, Punjab Development Report 2005 (World Bank) and the Housing Advisory Group of State Bank (2007).

Clearly the cost of delaying fiscal and legal reform is very high as the current tax regime is leading to the conversion of genuine white money into black money. It is also one of the primary reasons for RE development to remain a cottage industry.

HIGHLIGHTS OF REIT REGULATIONS, 2008

Unit holders
Holding of units Distributions Acts on behalf of unit holders

REIT Management Company

Management Fee

REIT
Management Services Trustee fees Ownership of assets

Trustee

Net property Income (from rental or sale)

Management Services Company

(maintenance of properties)

REIT Assets (properties)

REITs REGULATIONS, 2008

Types of REIT Scheme Projects envisaged in the REIT Regulations: Buy-Build-Sell REITs (Developmental REIT popular form of RE investment in Pakistan). Rental REITs (Rental REIT - transparent leases are very rare in Pakistan). Trust Structure with following key players: REIT Management Company (RMC) Trustee Unit Holders Listed Closed End Fund.

REITs REGULATIONS, 2008

The minimum fund size of a REIT Scheme shall be Rupees Five (5) billion. RMC shall maintain at least 20% of the units of the REIT Scheme and a maximum of 50%. Real Estate along with necessary approvals to be provided by the RMC.

REITs REGULATIONS, 2008

Initially REITs would be allowed in Islamabad/Rawalpindi, Karachi, Lahore, Peshawar and Quetta. No taxation if 90% of the income of the REIT is distributed. A REIT Scheme shall undertake only one Real Estate project. RMC may undertake more than one scheme. Portfolio of buildings allowed for Rental REITs.

CONCERNS AND ISSUES

The good news is that the licensing window for REITs is now formally open. The bad news is that initially the success rate of REIT applications is likely to be low. RE development in Pakistan is a fragmented activity only one public listed company.

Interest in REITs is very high. However, many aspirants lack requisite expertise. To develop this sector, foreign collaboration and joint ventures will be encouraged.

REITs
AN IDEA WHOSE TIME HAS COME