REAL ESTATE INVESTMENT TRUSTS

Presented by:SARWAT AFTAB

Director (REITs & New Initiatives)Securities & Exchange Commission of

Pakistan

STRUCTURE OF THE PRESENTATION

• History/Background of REITs• What is a REIT• Global Overview of REITs• Number of REITs by Region• Inherent Risks• Impact of REITs on the Real Estate Market• Impact of REITs on the Capital Market• Legal and Fiscal support received from the

Federal Government

STRUCTURE OF THE PRESENTATION

• Status of Implementation of SECP’s Recommendations

• Essential Deliverables• Consultative Process followed by SECP• REIT players • Highlights of REIT Regulations• Concerns and Issues• International Affiliation - APREA

HISTORY/ BACKGROUND OF REITS

• Real Estate Investment Trust ("REIT") is a term that originated in the United States in 1960s to describe vehicles used for collective investments in real estate.

• REITs were initially created as a vehicle through which small investors could gain access to large-scale, income-producing real estate properties.

• The concept quickly grew throughout the world, and many countries introduced REITs in their respective jurisdictions.

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 OVERVIEW OF REITS

•Investors still find REIT stocks attractive primarily due to low beta, though dividend yields have plunged in countries like the US.

•Globally, REITs is a rapidly growing asset class - market capitalization increased by 26% during the year 2007.

•Total Real Estate owned by REITs globally is USD 1.273 trillion.

Note: All figures relate to publically listed REITS.*Source: Global REIT Report 2007, Ernst & Young**National Association of Real Estate Investment Trusts

GLOBAL OVERVIEW OF REITS

•As of 31 July 2008, the US Equity REIT market capitalization = $283 billion 

•As of 31 July 2008, US REITs own approximately $600 billion of commercial real estate assets, or 10 to 15 percent of total institutionally owned commercial real estate

•125 REITs are traded on the New York Stock Exchange

Note: All figures relate to publically listed REITS.*Source: National Association of Real Estate Investment Trusts

GLOBAL OVERVIEW OF REITS

•Asia is widely regarded as the new REIT tiger.

•High dividend yields and stock premiums are main characteristics of Asian REIT.

•Singapore is currently the best REIT market in ASIA and has an annualized yield of 12%.

•Japan REIT market boosted by increased activity in Stock market and interest from foreign investors.

•South Korean REITs, though small in size, have exhibited good stock prices and dividend yields due to increasing office rentals and rising debt levels.

*National Association of Real Estate Investment Trusts

GLOBAL OVERVIEW OF REITS

•Australia - the second largest REIT market in the world grew by 45% in 2007.

•Cross border investment flows is a key characteristics of Asian REITs.

•Malaysia has taken lead in introducing Islamic REITs.

•Italy, Philippines and India amongst those who are in the process of adopting REITs.

Note: All figures relate to publically listed REITS.*National Association of Real Estate Investment Trusts

TOTAL REITS BY REGION

2006 2007

North America

253 195

EMEA(Europe, Middle East and Africa)

59 102

Asia 75 83

Pacific 64 68

Note: Decline in US partly recessionary and partly owing to M&A activity & conversion to PE.Source: Global REIT Report 2007, Ernst & Young

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.

•General tendency is “build and abdicate”– i.e., no RE development is planned for rental purposes.

•Multiple licensing jurisdictions in each town with no overall urban planning or fiscal framework.

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 REAL ESTATE 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 standards, professional fund management and trustee.

•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).

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 SECP’s Recommendations

SECP’s Recommendations Status

Provincial

Abrogation/drastic amendments to Rent Control Laws X

New Law development – Condominium Law X

Reduction in transaction costs (stamp duties, registra-tion and commercialization fees and other levies) X

Federal

Tax pass through status (Parallel to mutual funds) on 90 distribution of income √

Reduction in tax (on rental income to 5%) X

Reduction in CVT on all RE transactions X

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).

REITs Public Consultation

6%

3%

33%

6%9%7%

7%

8%

6%

2%

13%

International stakeholders

Valuers and Trustees

Federal and Provincial Govt.

Housing Advisory Group,SBPChartered Accountants

Lawyers

Asset Managers

Bankers

Business Groups

Credit Rating agencies

National Institutions

CONSULTATIVE PROCESS FOLLOWED

CONSULTATIVE PROCESS FOLLOWED

Several meetings held with the leading local valuers of real estate to discuss the issues and their solutions.

In addition two day long consultative sessions were also held with other stakeholders including representatives of Federal and Provincial governments, developers and financial market participants.

The regulations were notified on January 31, 2008.

Two launching ceremonies were also conducted in this regard on February 4, 2008 and February 6, 2008 in Lahore and Karachi respectively.

HIGHLIGHTS OF REIT REGULATIONS, 2008

REITREIT

Management Company

Trustee

Unit holders

REIT Assets (properties)

Management Fee

Management Services

Ownership of assets

Net property Income (from rental or sale)

Acts on behalf of unit holders

Trustee fees

Holding of units Distributions

Management Services Company

(maintenance of properties)

REITs REGULATIONS, 2008The REITs are subject to compliance with the provisions of:

REIT Regulations 2008 http://www.secp.gov.pk/divisions/Portal_RNI/pdf/REIT_Regulation_2008.pdf NBFC Rules http://www.secp.gov.pk/divisions/portal_nbfc/nbfc_laws.asp#list Relevant provisions of the Companies Ordinance 1984http://www.secp.gov.pk/corporatelaws/pdf/CompaniesOrdinance1984_Apr08.pdf Listing Regulations of the relevant stock exchange http://www.kse.com.pkCode of corporate governance would also be applicable http://www.secp.gov.pk/corporatelaws/pdf/CodeofCorporateGovernance.pdf

REITs REGULATIONS, 2008Two types of REIT schemes are envisaged in the

REIT Regulations namely Developmental REIT and Rental REIT.

- Developmental REIT scheme will focus on development of property and then selling it on profit. The sale proceeds will be distributed amongst the unit holders as dividends.

- Rental REIT scheme will invest in income generating properties. The rentals so received will be distributed as dividend to the unit holders.

REITs REGULATIONS, 2008The 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.

Initially REITs would be allowed in Islamabad/Rawalpindi, Karachi, Lahore, Peshawar and Quetta.

REITs REGULATIONS, 2008

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.

International Affiliation - Asian Public International Affiliation - Asian Public Real Estate Association (APREA)Real Estate Association (APREA)

SECP is presently an associate member of APREA and Mr. Salman Ali Shaikh, Commissioner Specialized Companies Division is a member of the Governing Board of APREA.

APREA is a non-profit association that represents the listed real estate sector in Asia-Pacific.

Its objective is to create a market based on international best practices that will facilitate local, regional and international investment in the sector. This includes the development of a robust reporting and corporate governance structure to promote investor confidence.

SECP joined the members’ club to improve cross-border links and benefit from networking opportunities.