One year later: What’s cooking in the Real Estate Investment Trusts pot?

When Real Estate Investment Trusts (Reits) regulations were finally gazetted last year, there was excitement across the country. The Capital Markets Authority (CMA) which crafted the rules described Reits as the “exploring of additional channels of raising long-term capital necessary to fund the scale of the projects envisaged under Vision 2030”.

Mombasa developer and host of Mombasa Homes Expo Mwenda Thuranira described it as “cheaper source of funds for real estate development by having investors who will be shareholders and not debtors”.

Under Reits, big real estate projects can be listed on the stock exchange where investors buy and sell shares of listed properties. This means even ordinary Kenyans wishing to invest in property have the opportunity to own a piece of real estate by buying shares.

Kenya became the second country in Africa after South Africa to adopt Reits. South Africa was the top performer in the world in terms of total return at 34 per cent over a three-year period as of last year.

It was the hope of every stakeholder that Kenya would achieve such success as its sister country on the continent once the Reits regulations were gazetted.

Reits Managers

So far, CMA has licensed five Reits managers. In the first quarter of this year, CIC Asset Management, Fusion Investment Management and Stanlib Kenya were issued with licences by the CMA to be identified as Reits managers. CMA had in December 2013 licensed Centum Asset Managers and UAP Investments.

Reits managers are to provide real estate management services to Reits schemes, but not a single one has applied for a licence to operate a scheme.
A licence for a scheme would allow the actual investing and putting up of money for buying of units by the common citizen – retail investors.

It is becoming apparent that unless financial regulations, institutional policies and individual perception are urgently addressed, Reits will be just another pipe dream in the financial and real estate sectors.

Last year, in a presentation to stakeholders, CMA said discussions were underway with the Kenya Revenue Authority (KRA) to make changes to Section 20 of the Income Tax Act to align Kenya’s Reits operations with international practices.

One of the key changes recommended by CMA was that Reits schemes be non-tax payers except for withholding obligations on interest, dividends and other taxable incomes distributed to shareholders. This is yet to be effected.

As of now, Section 20 of the Income Tax Act allows for non-double taxation of collective investment trusts. The collective investment trusts does not include Reits, exposing Reits schemes to be subjected to double-taxation by the KRA.

“The major purpose of Reits is being missed because of the significant changes that are yet to be made to the Income Tax Act,” says Raphael Mwito, Development Manager at Mentor Management and immediate former Investment Manager in Property Portfolio at Stanlib, one of the first fund managers to be licensed as Reits managers.

Clash

He says they have been trying to lobby KRA to make the changes to allow Reits schemes to be non-tax payers. “That is yet to happen,” he says.

According to a research done by Visa Capital Limited for the CMA - A Study on the Viability of Real Estate Investment Trusts in Kenya – in order for Reits to be effective in the country, CMA must ensure that KRA recognises any fiscal incentives given by the Government. Without this level of co-operation, Reits will not succeed.

The clash between Reits managers and KRA does not stop there. The revenue authority’s VAT practices are also considered unfavourable for business activities in capital-intensive, liquidity sensitive sectors such as real estate.

In the construction process, developers incur expenses, which include professional fees, building materials and other miscellaneous costs.

VAT

All these costs carry a Value Added Tax (VAT) component, which are considered business expenses and are hence deductible and refundable to the developer once the project is complete. After producing the receipts and books of accounts showing the claim, developers are supposed to be awarded the VAT refund.

VAT is supposed to be paid only once on sale proceeds or rental income of a property and all other VAT paid before are considered as deductible expense.

Instead of KRA paying VAT refund upfront as done by revenue authorities around the world, the claim is instead carried forward to offset future VAT liabilities. That means Kenyan developers won’t have to pay VAT during the lifetime of their operations until they have fully been paid the refund owed to them by KRA. This is all fine, but there is the time factor to be considered.

“For a Sh1 billion office block with a 10 per cent reclaim, I have to wait seven to eight years to fully recover my Sh100 million,” says Mwito. “This is outrageous. The developer is not getting interest during this period. Basically, we are funding the Government...yet we are already paying KRA.“

The emphasis to have these practices aligned to other revenue systems in international markets is important as it is closely monitored by foreign investors who are accustomed to these practices back home.

Foreign investment in Kenya’s Reits system will greatly determine its success, given their larger pool of funds. According to Mwito, aside from the financial policies in the country, foreign investors make informed decisions before investing after doing adequate analysis of the market and the trends spectrum.

“They (foreign investors) have an appetite for undervalued stock, they invest in them more. They want to get in, make their money through the returns and get out as quickly as they can. Unfortunately, in Kenyan real estate scenario, we have an overpricing problem caused by speculation,” says Mwito. “If you have an eighth of an acre located several kilometres away from Isinya town, which is already 100km away from Nairobi going for Sh300,000, you have a speculation problem, which is not logical. The 10km radius from Nairobi Central Business District (CBD) is enough to house most Nairobi residents. So why would a piece of land so far away have to cost so much?” wonders Mwito.

He says the sad thing is that these prices will continue rising because of speculation. “They say as long as you are not the last fool on the chain, you are safe.”

This carries a risk factor to foreign investors and with fears of a bubble hanging over their heads from firsthand experience in their own countries, they tend to be wary of such statistics.

Fears

Away from the foreign investors, there are fears that the local retail investors have been forgotten. After pyramid schemes that rocked the Kenyan market in the early years of the Kibaki administration, Kenyans became wary of investing in financial securities.

The uninformed decision to invest heavily in Safaricom shares only for it to trade way below the IPO price weeks later made many Kenyans fear the stock market.

“Real estate is a favourite form of investment among Kenyans. The problem is creating awareness of the Reits opportunities and making them interested in it. This would help push Reits to achieve its intended purpose,” says Aly Khan Satchu, CEO of Rich Management.

During the stakeholder presentation last year, the CMA admitted that creation of public awareness for investors, potential issuers, and promoter of Reits is a challenge.

They said this challenge would be addressed through capacity building and public awareness programmes for various stakeholders, including investors, issuers, and professionals. The authority also promised to participate in forums organised by potential issuers, professional bodies and investment groups.

Given its strict rules, Reits managers are also picking a bone with the CMA on the immense amount of power given to trustees.

Under the Kenyan Reits system, the Reits manager shall, at request of trustee, supply trustee with such information as trustee reasonably requires, comply with lawful directions given by trustee and make available additional information required by them. Reit managers are also to give unlimited access to trustee and auditor access to their books of accounts and records in a timely manner.

The trustee has also the power to appoint professionals working under the Reit such as a valuer and others in consultation with Reit manager, thereby denying them (Reits managers) autonomy.

Despite causing bureaucracy problem, trustees limit the operations of Reits managers and the level of risk they can undertake to acquire more profits.

But all is not lost. As Aly Khan Satchu reiterates, Reits is still an infant that is yet to mature. As the regulations take effect and more fund managers register as Reits managers, more changes to make this vital financial system more refined and effective are expected.

— koguoko@standardmedia.co.ke