Riding the REIT wave in Dubai

Riding the REIT wave in DubaiImage Credit: Supplied

Real Estate Investment Trusts (REITs) are financial instruments known for more than half a century. Created in the US, they are meant as an investment vehicle with income-producing property as the underlying asset class, like a mutual fund that would invest in certain asset classes. REITs were launched to give as many investors as possible the opportunity to invest in big real estate portfolios, be it residential, commercial or industrial.

A number of REITs are also listed on stock exchanges. This, however, exposes them more to market volatilities than a privately held and managed REIT. Some REITs are also designed as real estate finance vehicles and used for land development and construction deals.

The concept has been adopted by more than 20 countries, which have set up their own tax legislations and regulations for REITs. However, it took some time for the Middle East to jump on the bandwagon.

It was shortly after 2000 when a Kuwait-based REIT, Markaz Real Estate Fund, was launched. Others followed in Bahrain and Saudi Arabia, including the first Sharia compliant REIT's. One of the earliest REITs in Dubai was the $200-million (Dh734.52 million) Arabian Real Estate Investment Trust, or Areit, launched by HSBC and Daman in 2006, and it was followed by a few others.

The latest REIT in the UAE was Emirates REIT, jointly developed by Dubai Islamic Bank and Eiffel Management, a French REIT specialist. Emirates REITs initial public offering (IPO) in April on Nasdaq Dubai raised $175 million after boosting the issue size from an original $150 million on investor demand.

Any person or institution who wants to venture into commercial real estate investment, but does not have the professional expertise on commercial assets, can consider REITs as a good, hassle-free option.

Arvinder Singh, Residential Consultant at Better Homes, explains, ''A REIT is a company or trust which can be publicly listed or privately held. This trust usually either owns or operates commercially viable income-generating real estate. This is a good option for investment as usually by law, 90 per cent of the income is paid as dividend to the investors or shareholders.''

However, be points out that in Dubai, REITs may or may not operate on the same principle of paying dividend as it is in other countries or are governed by the same rules. Additionally, there are not enough professional investment brokers to guide investors on which trust to invest in and this can be due to the lack of options available locally, he says.

What attracts investors generally to REITs is that they enjoy preferable tax treatment. This was initially not so much a draw for investors in the tax-free environment of the GCC and this is why the concept probably developed slowly.

''No GCC jurisdiction offers special taxation treatment for funds investing in real estate, so there is no real regional REIT structure as the term is understood internationally,'' says Jane Clayton, Partner at the Middle East branch of international law firm Norton Rose Fulbright. '''The term REIT, when used in relation to Middle East funds, is used as an indication of the commercial terms of an investment fund, as opposed to an indication of a special tax status.''

Diversification vehicle

Robin Teh, Country Manager - UAE at Chesterton Middle East and North Africa, says, ''REITs offer transparency and confidence to the international market, making them attractive to international institutional investors as they can diversify their investment and risk. They are used as a diversification tool [money pool is invested in a range of properties] and provide high levels of continuous current income to investors.

''Listed REITs are highly liquid investments as compared with traditional real estate investment and can be converted into cash instantaneously by selling units or shares on the stock market.''

However, a REIT remains attractive for investors because it is a medium-risk and asset-backed investment with average returns of 5-10 per cent annually, with the advantage of providing greater diversification as well as capital appreciation. In times when the market is volatile, many investors resort to REITs as an alternative to stocks or bonds. Other advantages are that many REITs offer an attractive dividend reinvestment policy based on the fact that most REITs that want to retain their tax advantages are obliged to pay out 90 per cent of their taxable profits in the form of dividends.

While special tax treatment is not an incentive for Gulf investors to buy into a REIT, they can still benefit from the high dividends. Emirates REIT, for example, says it is benefiting from the recovery of the real estate sector in the UAE, with rents expected to jump significantly this year.

Thus, Emirates REIT plans to purchase a ''very significant number of properties this year after having bought three last year'', says Sylvain Vieujot, Executive Deputy Chairman of Emirates REIT Management.

As of last month, Emirates REIT has 11 properties in its portfolio, valued at Dh13 billion. Returns stood at around 11 per cent in 2012, 25 per cent last year and 8.81 per cent so far this year. Emirates REIT made a profit of $34.8 million last year on a net revenue of $46 million.

With the successful IPO, experts expect other funds to show interest and some investors to shift to REITs as an income vehicle.

Bigger market

Vieujot says Emirates REIT has shown that there is significant appetite among institutional and retail investors for exposure to income producing real estate in the Middle East.

''So I would expect the REIT market to develop steadily in the coming years,'' he says. ''Investors are drawn to REITs because they offer the type of yield and capital appreciation given by direct property investment, but crucially they also offer liquidity - in other words, units are easily tradable - and professional asset management.

''This effectively opens up commercial property investment, which was previously the sole domain of pension funds, insurance companies and wealthy individuals, to a very wide range of investors.''

He adds, ''We think REITs will grow because they offer investors high liquidity levels, diversification, stable returns and small capital exposure by offering the opportunity to invest in a portfolio of income-generating real estate assets where contracts and tenants are managed professionally.''

Campus property

One of the largest recent deals of Emirates REIT, for example, was the October acquisition of a long leasehold interest in a school campus of Gems Education in Dubai.

''Emirates REIT has invested in one of the best schools in Dubai, representing a very stable income-generating asset,'' says Abdulla Ali Al Hamli, Chairman of Emirates REIT Management.

In a nutshell, REITs in the Middle East should distribute the majority of their returns to shareholders, be built on a diversified property portfolio rather than on singular investments and have a diversified investor base, which can be achieved through a listing on a regional exchange.

How does a REIT work?

A Real Estate Investment Trust (REIT) is a company or security that owns or is invested in a portfolio of real estate assets. Although REIT shares trade like stocks, REITs are actually more comparable to mutual funds that invest in actual real estate properties or in real estate mortgages. A REIT basically offers individual investors a way to own real estate without the trouble of being a landlord.

REITs are structured in such a way that they must pay out a certain percentage of profits to investors - depending on the regional legislation and regulation- so they normally offer a good dividend stream when the market is in their favour. This makes them particularly attractive for retirement investors and those looking for passive income.

There are three types of REITs: Equity REITs, Mortgage REITs and Hybrid REITs. Equity REITs are the most common type, representing about 90 per cent of the global REIT market. These REITs own and operate the real estate they invest in. But these are not real estate investments that will be sold REITs must invest in properties that produce income, which means they make their money off rents.

Mortgage REITs borrow money at short-term interest rates and lend it to real estate owners and operators, or simply invest in mortgage-backed securities. These REITs make money on the interest or profit generated from loans or investments, which are sensitive to interest rate swings.

The third variant are Hybrid REITs, which invest in a combination of actual assets and mortgages. There are special variants of REITs, such as Retail REITs, Healthcare REITs, Residential REITs and REITs investing in other property classes.

The main advantage of REITs is that they offer tax benefits for investors, something that is not relevant in the GCC. But for those seeking an above-average steady income flow with low to medium risk exposure, REITs in the GCC are worth looking at. As always, some aspects have to be considered.

When buying into REIT stocks, they should have an appropriate liquidity and a diversified investor base. It is, however, not the case that REITs are more stable than stocks or bonds because they invest in property as market corrections happen. As such, shares of REITs can be just as volatile as stocks and lose value. To minimise risk, investors can enter the REIT world through mutual funds or exchange traded funds that invest in REITs. Another issue is that REITs more often than not use leverage to buy real estate and thus dividends can swing with real estate markets.

On the positive side, REITs normally trade easily and allow smaller investors to partake in the property market with smaller sums rather than buying actual real estate, probably on a mortgage, and experience all the hassles a landlord might face. There is also a much higher opportunity for diversification, especially in large international REITs that provide investors access to markets that would normally be out of reach.

Things to consider when investing in REITs by Sunil Saraf

• Know the fees associated with the product.

• Understand how the distribution is being funded and whether a portion of that distribution comprises a return of investor capital.

• Understand the Funds From Operations (FFO) and Adjusted Funds from Operations (Mfo) of the REIT you are investing in.

• If the REIT offers a share redemption programme, make sure you understand how the repurchase price for your shares will be determined. Look at the limitations of the plan.

• Review with your financial advisor the risks associated with real estate investment and evaluate other products that could meet your investment objectives (investment income, for instance).

• Understand the various liquidity events specific to the REIT you are considering.

• Invest only if you are confident the product can help you meet your investment objectives and you are comfortable with the associated risks. Understand and analyse how asset valuations are done. If the assets are overvalued, then the yields will never be encouraging. High valuation leads to lower yields and can lower the stock prices.

• Once interest rates rise, REITs could be affected because they rely on borrowed money to make acquisitions. When interest rates go up, so do the borrowing costs of REITs.

• Read the prospectus well and understand it. If required, take advice from your financial advisor. Invest only once you understand it.

Source: Arno Maierbrugger and Hina Navin, Special to Property Weekly


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