REIT as Alternative Investment Window



By Eromosele Abiodun, 07.06.2010 


When three Boston money managers pooled their funds in 1924, the first mutual fund was born. In the subsequent nine decades, that simple concept has grown into one of the biggest industries in the world, now controlling trillions of dollars in assets and allowing small investors a means to increase their wealth through systematic investments via a cost-averaging plan. 



The mutual fund industry in Nigeria has spawned several mutual funds. Last week, Real Estate Investment Trust (REIT) was added to the list.It is a known fact that domestic capital formation is the driving force behind any country’s development and effective domestic financial institutions are one of its most important facilitators. They are the key channel between savings and investment and their efficiency is a key determinant of a country’s economic growth. 



It is therefore important that resources are made available for financing long-term development (through debt and equity) by providing additional channel for long-term savings. Though Mutual Funds or Unit Trust Schemes are no longer strange to many investors in Nigeria, the REIT is still relatively a new concept. 



First REIT 


In a move analysts believe would revolutionalise the financial industry, the Nigerian Stock Exchange (NSE) last Friday in Lagos, listed 250 million units of Union Homes Plc’s Real Estate Investment Trust (REIT). Speaking at the occasion, Managing Director of the company, Mr. Samson Olatunbosun, stated that the Union Homes REIT is aimed at accelerating home ownership at all levels, while creating wealth for its stakeholders. 



The REIT, he added, is an investment machinery that packages real estate investment into tradeable securities for investors. He said: “Union Homes REIT can purchase, manage and sell real estate assets and also purchase mortgage assets, thereby creating a professionally managed portfolio of real estate properties. “Union Homes REIT is a closed-ended Unit Trust Fund aimed at taking advantage of the opportunities in the real estate and mortgage sectors of the Nigerian economy. It provides individual, retail as well as institutional investors with an unprecedented first of its kind opportunity to gain access to strong returns from the thriving real estate sector.” 



The fund, he assured, will deliver capital appreciation through investing in a strategic mix of real estate properties that command superior quality rents, excellent mortgage assets and money market instruments. He said: “A potentially high level income and low levels of volatility to the attractive returns on real estate investments makes investing in Union Homes REIT very endearing to any discerning investor.“Union Homes REIT target investors are citizens of Nigeria at home, in Diaspora, foreign investors, such as corporate bodies, pension Fund Administrators (PFAs), insurance companies, assets/fund managers, bankers, government parastatals, investment clubs and cooperatives.” 



He added that the fund’s strategy is to invest in diversified portfolio of real estate assets that have attractive fundamentals in terms of prime location. “The fund manager will identify suitable residential and commercial properties; these properties identified must meet strict criteria of delivering high yield and substantial capital appreciation. Having acquired the properties through due diligence, our own is active management of property portfolio in order to deliver returns,” he said. 

The Union Homes boss disclosed that the global economic meltdown and the crisis in the capital market led to the under subscription of 970.8 million units offered in 2008. 



“About 25.7 per cent of the offer was realised and this performance made forecast in the prospectus unrealistic. This notwithstanding, the fund was able to achieve a modest operation result for nine months ended November 2009 while surpassing the projected earnings per unit and distribution per unit by 168 per cent and 167.3 per cent respectively. “The projection was based on N50 billion offered for subscription while what we were able to achieve is based on the N12.88 billion realised from the offer. The fund intends to distribute 90 per cent of its net income as at November 30, 2009, in line with our prospectus. This translates to N4.01 despite the current hash-operating environment. We plan to maintain the tempo in the current financial year,” he said.



Implementing REIT in Nigeria 


In a paper on the implementation of REITs in Nigeria, Head, Strategy and Business Development Directorate of the NSE, Mr. Farooq Oreagba, said that as a result of the recognised need to develop outlets for Pension Fund assets as well as further deepen the Nigerian Capital Markets, key stakeholders such as the NSE and Securities and Exchange Commission (SEC), have continued to hold meetings to identify suitable products.  He said one of such product that was identified was the REIT. 



According to Oreagba, Real Estate is the largest asset class in the world comprising more than 54 per cent of global financial wealth and in Nigeria; it has consistently shown significant growth over the years.  It also serves as a very important means of asset diversification thereby making it further attractive to both retail and institutional investors.“Unfortunately, in most countries, direct investment in this sector is beyond the reach of most people and as such, as an investment-grade asset class, it is usually traded through indirect instruments such as the REITs.” He described REIT as a company that owns, and operates income producing real estate, whose shares are publicly traded in a way similar to any other stock.  



He said: “A REIT does, however, have two unique features: (i) its primary business is managing groups of income-producing properties and (ii) it must distribute most of its profits as dividends.  It is also often referred to as a tax efficient, closed-ended, listed pass through vehicle (although the South African product is actually a unit trust structured like a REIT). “One of the largest REIT markets in the world is in the USA where it is capitalised in excess of $375 billion.  REITs have changed the way real estate is financed (equity and debt) and acted as a catalyst for the integration of real estate capital markets into general capital markets.  With the proper calibre of assets, real estate investment can provide a regular income stream at low risk and this is evident by the examples in other African countries (South Africa, Botswana) as well as Europe, where these products have been adopted as listed, tax-efficient vehicles for investment.  



He added that REITs mandated high dividend payout is quite attractive to investors seeking regular income.“It is therefore hoped that with the lower rates being paid by banks, REITs along with the plethora of fixed income securities being listed on the NSE, will provide investors with the diversification needed to generate suitable income streams from their portfolios,” he said.



Tax Treatment 


Oreagba said that the tax treatment of profits (corporate income tax) and withholding tax regime applicable to distributions to shareholders varies in many jurisdictions.“In Europe, the Dutch “REIT” does not benefit from tax exemption.  Technically, the taxable profit of the Dutch Fund is subject to a rate of corporate tax income of 0 per cent – a defacto exemption.  In other European jurisdictions, income from RE is fully exempted from corporate tax and capital gains tax. 



“In South East Asia, generally, REITs are tax exempt on the portion distributed and are not subject to capital gains tax.  Hong Kong is an exception – if a REIT holds the real estate directly, it will be subject to property tax (chargeable on the net assessable value of property based on rental income less statutory deductions).  However, if the REIT holds the properties indirectly via SPVs, any income received by the REIT is exempt from tax. 



“In most of Europe, Corporate investors are subject to corporate income tax as standard rate and are generally not eligible to exemption except under specific conditions in which the withholding tax on the dividend is credited against corporate income tax, and can even be reimbursed.  However, capital distribution is generally tax free in Europe,” he said.He explained that dividend payments in South East Asia are subject to withholding tax and capital gains tax discount (usually 50 per cent – 100 per cent).  



“In Japan, there is no withholding tax payment, although capital gains are subject to the full applicable tax. For individual investors; also subject to withholding tax on dividend.  In most jurisdictions (apart from the Netherlands and Japan), there is discounted tax regime, or zero tax on capital gains. “In the US, shareholders are subject to income tax on ordinary dividend distributed by a REIT.  The REIT can however, qualify for a significant discount on tax rates. Generally, foreign shareholders (corporate and individual) are subject to different tax rates,” he added.He said that for all REITs to enjoy the tax-free status, they must necessarily be approved as such by the Federal Inland Revenue Service FIRS and SEC. 



“FIRS needs to ensure that non-REIT related gains are not shielded from tax, simply because they are generated by a REIT. REIT focus should not obviate withholding tax responsibilities. Activities must be carefully monitored to ensure that they conform to the REIT charter,” he stressed 
He said the Honourable Minister of Finance on advice from the relevant stakeholders such as SEC, NSE and the FIRS, should implement the necessary tax regime and land title transfer rules that will allow the development of the REIT in Nigeria.



SEC Rules, Regulations  


Rule 194 of the Investment and Securities Act 2007 states: A real estate investment company or trust may be registered by the commission if it: (a) is a body incorporated under the Companies and Allied Matters Act. (b) Has a capital and reserve as prescribed by the commission from time to time.(c) Carries on business as a collective investment scheme solely in properties. (d) Complies with the requirement prescribed by the Commission through its rules and regulations made from time to time.



Rating, Valuation Reports 


In order to ensure transparency in the management of REITs in the country, the SEC included in its rules that a rating report by a registered rating company shall be filed with the Commission every two years. The SEC in its rule also stated that for close-ended real estate investment fund, the following requirements shall apply: “At least 75 per cent of the fund’s total assets shall be in real estate; the remaining 25 per cent may be in real estate related assets.  Provided that not more than 10 per cent shall be in liquid assets; the level of development activity by the fund Manager shall not exceed 20 per cent of the Fund’s gross asset value; the manager shall hold on to any development for a minimum of 2 years before disposing off.” 



It added: “For open-ended real estate investment Fund, the following shall apply: At least 70 per cent of the fund’s assets shall be in real estate or real estate related assets, a maximum of 10 per cent of the funds’ assets shall be in liquid assets at all times and 20 per cent may be in other assets. The assets of real estate investment fund, whether close-ended or open-ended shall not be invested outside Nigeria.”



Regulatory Authorities’ Efforts 


Oreagba said that efforts of the regulatory authorities have resulted in the recent pronouncement by the Central Bank of Nigeria (CBN) and the Debt Management Office (DMO) granting tax-exempt status for next 10 years to Asset Backed Securities (ABS), Mortgage Backed Securities (MBS) and all classes of bonds.He said: “By definition, an Asset Backed Security (ABS) is a security whose value and income payments are derived from and backed by a specific pool of underlying assets (Wikipedia).  In the case of the N-Reit, this pool of assets being real estate and the rental income derived thereof. By interpretation therefore, the N-Reit as defined by the rules and regulations of the SEC qualifies as an Asset Backed Security (ABS) and thereby qualifies for the tax-exempt status stated above. 



“This exemption should mean that the N-Reit is exempt from : (i) Companies income tax on the income/profits of the N-Reit (ii) Capital gains tax arising from profits during disposal of assets/properties (iii) Stamp duties on purchases and sales of properties. “In my opinion, the issues of Withholding Taxes (WHT) and Value Added Tax (VHT) still need clarification but should be covered by the exemption. With regards to the listing of such instruments on the Nigerian Stock Exchange, the normal listing rules will apply,” said Oreagba. The regulatory authorities, he added, have laid an adequate platform for the introduction and take-off of REITs in Nigeria.  



He, however, contended that the issues surrounding the matter of Transfer of Title can still be a hindrance until resolved adding that it is paramount that the necessary stakeholders continue to raise this matter until it is satisfactorily addressed.  He declared that in the meantime, a solid foundation for the development of REITs in Nigeria.





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