Pakistan's first real estate investment trust’s initial public offering by the Arif Habib Group in partnership with the Dolmen Group is expected to bring the so far capital-intensive real estate investments within the reach of retail investors.

These investments would be highly liquid, as the shares of the REIT would be traded on the Karachi Stock Exchange The investors would expect to get not only decent dividends, based on rental incomes from Real Estate Investment Trus’st (REIT’s ) underlying assets, but would also hope to benefit from the capital gains.

However, it is still to be seen how the market would receive the REIT shares post-IPO and whether other real estate and financial groups would follow suit, by floating similar projects in the market. While the real estate investments are definitely considered more lucrative in Pakistan as compared to other investment alternatives, it would be interesting to note if the real estate enthusiasts would be equally interested in REITs.

A REIT is a company that mainly owns and/or operates income-producing real estate such as apartments, shopping centres, malls, office buildings, etc. with shares of the company being traded on stock exchanges. In contrast to the typical real estate investments in land, REITs are expected to offer a more stable, less speculative investment, where the investment trust is backed up by proper rent-giving real estate establishments, producing dividends as well as capital gains.

An essential prerequisite for a REIT is to have some real assets and income tied to real estate investment with some threshold for distribution of profits as dividends (90pc in case of Pakistan). Such a structure essentially creates a win-win value proposition for both the real estate developers as well as the investors.

An essential prerequisite for a REIT is to have some real assets and income tied to real estate investment with a threshold for distribution of profits as dividends

While the developers can use REITs to monetize their real estate, ensure liquidity, gain certain tax benefits and easily access the equity capital, the investors can claim a stake in the attractive real estate market, with minimal investment, while having a liquid asset, with a stream of stable income, less prone to risk in case of a downturn.

Since the structure is fully regulated by the government, the investors can have a higher degree of confidence. However, the investors should also rationalize their expectations while investing in REITs, as the rental yields in Pakistan have typically been in the range of 4-7pc and after taking care of the expenses of these funds, this yield is expected to dip further.

In the absence of a totally transparent and retail investor-friendly capital market, real estate investments have traditionally been quite popular in Pakistan. Owing to lack of knowledge and unpredictable market movement on the back of speculative trading, retail investors in Pakistan generally shy away from investing in equities.

Bonds and other interest-bearing instruments, although pay substantial interest rates as compared to regional and global benchmarks, often fall short of investors’ expectations. On the other hand, historically real estate investments have given handsome returns to investors, not considering temporary spikes and downturns. Moreover, land ownership is considered to bring a sense of security in countries like Pakistan and offers a promise to have a roof over one’s head, even if it is in distant future. It is therefore no surprise that the real estate segment has been booming over the last few years, on the back of remittances from overseas Pakistani as well savings from the affluent upper-middle class.

However, when looked at closely, the real estate market in Pakistan is also marred with inefficiencies and information asymmetry, with significant gaps in rental values versus capital gains and markets driven by speculation and impulse buying.

The last few years have witnessed a mushroom growth of housing societies not only in major cosmopolitan cities like Islamabad, Lahore and Karachi but also in and around relatively smaller urban centers like Sialkot, Bahawalpur and Hyderabad.

Land ownership has also taken another interesting form over the last two decades, where trading in ‘files’ has become quite common. These ‘files’ are the promissory notes of sorts for allocation of land within a locality or a development scheme, without any confirmed location. These files are actually traded multiple times, before the land actually gets developed, maps announced, possession is given to the buyer and the actual construction starts.

In some of the localities, these files have been traded for as long as over ten years, without any development work whatsoever on ground. Unlike developed countries, these individual investors shy away from investing in rental properties, as they are expected to make much healthier returns on plots, without any construction or development, through merely capital gains on developed or even undeveloped land.

Pakistan has a proper regulatory regime in place, with SECP governing REITs under Real Estate Investment Trust Regulations, 2008. Recently, SECP has been mulling over some changes in these regulations in response to proposals made by the real estate industry players.

However, in order for REITs to become successful in Pakistan, few factors would be critical. On investors’ end, they would need to develop a longer term perspective about making sound real estate investments backed by income-generating assets or in other ways choosing moderate yet stable returns rather then higher, riskier and speculative returns in land. The real estate developers would need to focus on more sound projects with clear income generation potential and tight timelines, rather than developing housing schemes, which linger on for years and years.

Most importantly, the regulators would need to ensure absolute transparency in management of REITs to provide a sense of security to investors about their investment.

Moreover, the government should make the regulations more favorable for medium size real estate investment projects by reducing barriers to entry to expand the investment base and not let the REITs hegemonised by only a few large real estate and financial groups. Given an assurance of transparency by regulators and a continuous pipeline of healthy real estate projects, with passage of time, more and more investors would be inclined to invest in REITs and the market will witness unprecedented growth in this segment.

This in turn can help in addressing the housing deficit and can also help in unlocking value in existing public and private owned real estate establishments, contributing towards urban renewal projects.

The writer tweets at @hasaankhawar

Published in Dawn, Economic & Business, April 20th , 2015

On a mobile phone? Get the Dawn Mobile App: Apple Store | Google Play