January 23, 2006	Monday	Zilhaj 22, 1426

PROPERTY is the next frontier for the capital market and investors, as demand for housing, commercial and industrial property escalates rapidly, while the supply essentially stays bottled up. The demand for land required by business for starting up or expanding industrial units, can not be quantified. But the country faces an accumulated shortage of six million houses and requires 570,000 to 600,000 new houses annually. Only half of that additional annual demand is being met.

The government’s record to provide housing, especially for the low-income groups, is leaves much to be desired. The private sector, excepting some good examples and successes, is marked by scams and huge frauds that has robbed thousands of people who stay homeless.

One of the highest real estate speculative boom in the country’s history, over the last four years, has made it nearly impossible to own or rent a house, by even the middle classes. The number of occupants for each house is growing. Reasonably priced credit for housing and mortgages has been extremely limited. Does the country require a new and transparent mode of financing these needs?

Security & Exchange Commission of Pakistan (SECP) is leading a pack of capital market ‘gurus’ and has come up a new product: Real Estate Investment Trust (REIT).

It is a product drawing upon experience of Turkey and Malaysia and sites the property crunch in such “city-states” as Singapore, Hong Kong, Mumbai and Kolkotta where people and businesses live and work, packed like sardines in a tin can.

Looking at some of the Pakistani cities—-Karachi and Lahore in particular—-where the people are moving on this “sardine track,” there are desperate efforts to find new solutions. The ingredients are land-property, financing, management and the “consumers,” trying to own a home or rent it, and property to establish businesses and industries.

SECP has just finalized the draft of the proposed real estate investment trust’s rules. The draft rules have been published, as required under section 506 of the Companies Law for information of the public. The draft, dated December 30, 2005 is likely to be taken into consideration by early February, after receiving public comments. It will then go to Ministry of Finance (MoF) for finalization and vetting by the Law and Justice Division before promulgation

Reits will be incorporated under the Companies Ordinance, 1984, and subject to the Real Estate Investment Trust Rules, 2005.

What is a Reit? It is a security which sells like a stock, and invests in real estate (RE), directly or indirectly. It has various types—‘equity’ and ‘mortgage’. Equity Reits invest in, and own, properties. Their revenue is linked to the rent on property. Mortgage Reits deal in investment and ownership of property mortgages. Their revenue, primarily, is linked to the interest they earn on the mortgage loans.

These modes are not in use in Pakistan where property is bought and sold, bilaterally, that needs larger capital size, or by investing in schemes sponsored by developers, but not much regulated. The property market is highly speculative, unregulated and unmonitored.

KASB Securities research paper that preceded formulation of the rules, claims that a typical Reit offers several advantages to investors, and it “serves to open up real estate investment to the small investor who otherwise could not have had this investment opportunity.”

It also says, Reit helps participants to broaden their investment portfolio and diversify risk. It is tax—transparent, as there is only one level of taxation. It does not pay tax on its profits which maximizes dividends to shareholders who then pay their tax on their dividends as on profits made when they sell their shares.

A typical US Reit pays back at least 90 per cent of its profit to its shareholders and in some cases even more.

Encashment of investment is easy because it is traded on the stock exchange. Reits tend to be stable, because of historically low volatility, and offer an attractive return on investment.

KASB also recommends several modifications to regulations to provide “ a framework that allows investment in real estate.” “Markets will not function smoothly unless the rental yields improve, tenancy laws strengthened, official and unofficial pricing issue settled, ‘pagri’ system abolished, and the time consumed in legal proceedings reduced.”

SECP is upbeat over Reits, hoping these will enable raising money from the public, invest it in real estate, and expand opportunities offered by the stock market, which, for years is facing shortage of new floatations, rising demand for shares and a perpetual short supply. It is the key reason for high prices of the existing shares.

The actual start up of Reits, however, may take two to three years to get going.

A Reit Scheme or Real Estate Investment Trust Scheme, incorporated under the law, and licensed by SECP, will consist of a closed-end collective investment scheme, constituted as a unit trust fund to be known as “Reit Fund.” It will be vested in a Trustee in terms of a deed of trust and managed by a Reit Management Company for investment, primarily, in real estate for a definite or indefinite period.

A detailed criteria and qualification for trustees, directors, officials, valuers, and others is provided in the rules, in order to ensure a proper and prudential management of the company and protecting investors interests. Its objective will be to maximize the return for the unit holders, through a prudent strategy of investment in and development of real estate.

The Reit Management company’s minimum paid up, capital or equity will be Rs50 million, under the two-tier system. Its second tier will be Reit Trust Fund. SECP is empowered to cancel the company’s license and wind it up, in case of violation of rules, remove its management, issue cease and desist orders, order compensation to be paid to the unit holders, impose fine, or take any combination of these actions.

A Reit Scheme can be established, and its units offered to any person, only after obtaining SECP’s permission. Its Reit Fund with a minimum capital of Rs250 million can be invested only in real estate, real estate-related assets and non-real estate assets within Pakistan. The funds will not be invested in more than five real estate projects.

Not less than 90 per cent of the annual audited accounting income, arising out of the Reit Scheme will be distributed to unit holders as dividends in each financial year.

“No speculative trading of real estate shall be conducted,” and any RE acquired, shall be held at least for a period of two years. This provision aims at curbing speculation that has marred several of previous property-related private schemes. The units of Reit Fund will be listed in accordance with the listing regulations of the stock exchanges and will be freely tradable. The units will not be de-listed without the prior permission of the SECP. The units will be underwritten by an underwriter appointed by Reit Management Company with the prior approval of SECP.

The company will be entitled to be paid annually a remuneration not exceeding three per cent of the average asset value over the preceding year.

In case a company does not wish to continue in business, it will give a three month notice to SECP and get its permission before closing down.

Every scheme will be structured as a trust which will have a scheduled bank, holding an investment grade rating, as trustee. The trustee’s appointment will be approved by SECP. The trustee will exercise all due diligence, ensure that Reit assets are properly identified and held for the benefit of the unit holders, under the rules.

Each company will appoint a property valuer with SECP’s approval. He will value all the real estate comprised in the Riet assets on the basis of full valuation with physical onsite inspection of buildings and facilities erected thereon, once a year, and in any event for the purposes of issuance of new units. He will also prepare a valuation report on the scheme to be acquired or sold.

The investment policy of a Reit Scheme will clearly state all facts with regard to scheme, indicate how investments out of Reit Fund are likely to be allocated among real estate-yielding rental income, real estate to be acquired, held and resold, and the RE to be acquired, developed and resold, and to specify wither the Reit scheme is to exist for a definite or an indefinite period.

If it is to exist for a definite period, it will have to state the circumstances in which it will cease to exist and the manner in which holders will receive their respective proportionate shares of the net asset value (NAV).

The RE acquired by investing Reit fund must be reasonably diversified in the form of residential, commercial and industrial, and geographical location, taking into account the type and size of the Reit scheme, its investment objectives and the prevailing market conditions.

The Trustee may borrow for financing investment or operating purposes, but the aggregate borrowings will not, at any time, exceed 35 per cent of the total net asset value of the Reit Assets, at the time borrowings are incurred. The dividends will only be paid in cash, unless otherwise allowed by SECP.

No Reit Scheme will be terminated unless, the unit holders approve the plan and scheme of termination through a special resolution at a general meeting, and SECP has granted its written approval to such a plan.

Several property-related problems will have to be addressed before the new financing mode or Reits become effective. These range from rationalization of high stamp duty on property-related transactions, to reduction of charges on change of use for property classified as “commercial” under zoning regulations.

Steps are also needed to rationalize development charges imposed by local water and sanitation agencies for change of use from “residential” to “commercial”, imposition of a land non-utilization fee or an idle land tax, abolition of ‘benaami’ holding of property, revamping the Rent Restriction Legislation which tilts towards tenants, and narrowing down of differential in property tax on renter and owner-occupied property.

The corporatization of the property market, most stakeholders believe is likely to raise rents and property values, whether you are looking to buy or rent a house, or an apartment in a condominium, or space for an office or businesses, or to establish an industry. It will be costly and inflationary in nature.

Whether the common citizen will move closer to realize his dream to own a shelter of his own will be the test of this new move.