Real Estate Investment Trusts (REITs)

Pakistan’s real estate market is growing increasingly attractive to local and foreign investors. It is experiencing phenomenal growth, however, the concept of real estate investment trusts remains relatively new for the majority of its citizens. Growing housing demand is fueling a boom in the real estate and construction sector. With the share of foreign direct investment (FDI) also increasing with the introduction of services like Roshan Digital Accounts, REITs are becoming a more lucrative option for investors. 

Investing in real estate through REITs is similar to investing in stocks through mutual funds. Several benefits come with REITs, such as liquidity, diversification, transparency, and stable cash flows. However, challenges also exist like low growth, high dividend taxes, market risk, and high management fee. Therefore, there is a need to formulate a proper policy for REIT regulation and growth in Pakistan. This can allow Pakistan to develop its real estate sector efficiently while involving small investors and multiple stakeholders in the industry to achieve more sustainable growth. 

Investment companies that manage, own, or finance income-generating real estate are known as real estate investment trusts (REITs). Individual investors receive dividends without having to invest in, manage, or finance any property themselves. Capital is pooled from multiple investors and investors enjoy a steady income from REITs. However, a high capital appreciation is not expected. In comparison to investments in regular or conventional real estate, REITs are highly liquid. Several types of real estate properties can be owned by REITs including, apartment buildings, cell towers, data centers, hotels, medical facilities, offices, and retail centers. Previously, only wealthy individuals could invest in commercial real estate with the help of large financing intermediaries. However, REITs have allowed small and middle-scale investors to invest in real estate as it minimises risk and does not come with a huge barrier to entry in terms of capital. 

A REIT leases space and develops rental for properties then distributes the income to shareholders as dividends. Tax exemption is provided if 90 per cent of the income is distributed. There are three types of REITs, which own and manage income-producing properties, namely, rental REITs, developmental REITs, and hybrid REITs. Real estate management companies are required to meet certain legal requirements prior to registration. One of those requirements is that they must control 20 per cent of the scheme. A REIT does not develop real estate properties to sell on the open market. Instead, a REIT buys and develops properties primarily for the purpose of operating them as part of its own investment portfolio. (US-Securities and Exchange Commission, 2021) 

Businesses and landowners can benefit from REITs in multiple ways. Regulatory business models make it easier to raise funds for large real estate projects that require a lot of capital. Through improved transparency and access to financing for development and renovation of properties, more real estate can be developed at a faster pace as well as attract foreign investment. REITs provide small investors with the opportunity to invest in real estate through an entity that’s professionally managed. They are able to earn higher dividends and benefit from a safer investment as the Trust holds customer advances and property titles. As well as enabling a broader investment portfolio, REITs allow for risk diversification. In contrast to the traditional purchase of real estate, REITs are relatively easy to buy and sell, and most of them are traded on public exchanges, which reduces their risk. In terms of performance, REITs tend to provide attractive risk-adjusted returns and steady cash flows. 

In spite of this, there are some risks associated with investing in REITs. As REITs are linked to the underlying property, a decline in the value of the asset or its rental capacity will directly affect the REIT’s net asset value. As a result, dividend rates may be subject to change depending on local rental dynamics. Returns to investors are affected by the quality of management officers. The capital appreciation potential of REITs is limited. Their corporate structure dictates that they must return 90% of their income to the shareholders, and only 10% may be reinvested in new holdings. Moreover, REIT dividends are subject to regular income tax and come with high management and transaction costs. Lastly, there is no method of price discovery in the real estate sector, and only a handful of properties in Pakistan have transparent leases, which compounded with the history of real estate fraud in Pakistan makes investing in real estate risky. (SECP, 2015) (KASB, 2005)

Pakistan is experiencing a real estate boom as a result of the growing demand for housing. As foreign direct investment and local investment are increasing in real estate, the Securities and Exchange Commission of Pakistan (SECP) began working on Real Estate Investment Trust (REIT) regulations in 2004. Due to some regulatory issues with the draft prepared by SECP, the process was delayed, and a new draft was prepared in 2010. Companies were only allowed to invest in real estate, real estate related assets, and non-real estate assets. Although this new asset class created much hype in the investor market, business remained low as it takes time for people to trust a new investment model. Initial SECP guidelines required REIT management companies to have a minimum size of Rs 5 billion, but no one was willing to commit such large amounts. However, the regulator later cut back the initial investment to Rs 500 million to kickstart investment in the sector. As Pakistanis invest more in open plots, it should promote the growth of its rental market, which gives no real benefit to the economy. By leveraging modern valuation standards, REIT companies should strengthen their capacity to better equip managers to handle portfolio management. Furthermore, Pakistani authorities should promote high-quality construction as it will generate longer-term revenues rather than the current practice of building and abandoning. As a result, more commercial and residential real estate will be available. (Dawn, 2012) (Dawn, 2006) 

Real estate investment trusts provide a similar structure for investment in real estate as mutual funds provide for investments in stocks. Unlike other real estate companies, a REIT does not develop real estate properties to resell them. Instead, a REIT buys and develops properties primarily to operate them as part of its own investment portfolio. Enhanced transparency and availability of finance also means that real estate can be developed at a faster pace and attract more foreign business in Pakistan. Therefore, the development of this new asset class is necessary for boosting the growth of the real estate sector. 

Dawn. (2006). Tax holiday on REIT incomes? Retrieved from Dawn: https://www.dawn.com/news/218652/tax-holiday-on-reit-incomes

Dawn. (2012). Real estate funds emerging as new asset class. Retrieved from Dawn: https://www.dawn.com/news/770155/real-estate-funds-emerging-as-new-asset-class

KASB. (2005). Research Paper on Real Estate Investment Trust. KASB Securities Ltd.

SECP. (2015). What is REIT. SECP.

US-Securities and Exchange Commission. (2021). Real Estate Investment Trusts (REITs). Retrieved from Investor.gov: https://www.investor.gov/introduction-investing/investing-basics/investment-products/real-estate-investment-trusts-reits