A Real Estate Investment Trust or REIT is a tax designation for a corporation investing in real estates that reduces or eliminates corporate income taxes. In return, REITs are required to distribute 90% of their income, which may be taxable in the hands of the investors. The REIT structure was designed to provide a similar structure for investment in real estate as mutual funds provide for investment in stocks.
REITs allow participants to invest in a professionally-managed portfolio of real estate properties. REITs qualify as pass-through entities, companies who are able to distribute the majority of income cash flows to investors without taxation at the corporate level (providing that certain conditions are met).
Their business activities are generally restricted to generation of property rental income. They provide ease of liquidation of assets into cash, as compared to traditional private real estate ownership which are not very easy to liquidate because shares are primarily traded on major exchanges, making it easier to buy and sell REIT assets/shares than to buy and sell properties in private markets
The concept was introduced in the United States in 1960 to provide individual investors with the opportunity to participate in different sectors of the real estate market.
Income earned by a REIT flows through to its unit-holders without being taxed at the REIT level, giving regular investors similar flow-through income to that enjoyed by direct owners of commercial property.
Just like a mutual fund, REIT investors benefit from enhanced buying power, diversification, liquidity and professional management. REITs are required to distribute virtually all distributable income to unit-holders with a tax-deferred component.
Assets of a REIT do not deplete in the same way that, say, an oil and gas royalty trust might; so, as long as there are income producing buildings and properties, REITs are a viable investment structure
Typically, the REIT investment works much like bond investments. That is – A group of investors come together to fund the project. – Individual investment amounts will vary greatly and it’s an opportunity for a single person to become as involved as they wish to be.
Like other corporations, REITs can be publicly or privately held. Public REITs may be listed on public stock exchanges like shares of common stock in other firms.
REITs can be classified as equity, mortgage or hybrid. It could be privately or publicly held.
Benefits of REITS
REITs offer diversification and a level of stability, without sacrificing growth potential.
REITs provide exposure to real estate – real assets with tangible value and reliable income streams – in a highly liquid, marketable security.
REITs are distinct in their combination of relatively steady income, capital gains potential, tax benefits and professional, active management.
Typically, REITs provide more attractive yields than other income investments it provides a hedge against inflation.
As a Trust, REITs are subject to more stringent regulations in areas such as leverage and financial reporting, providing investors with an added layer of security.
REITs also offer capital gains potential as the portfolio grows and individual properties benefit from synergies and professional management
With the critical mass to diversify over a number of real estate properties, a REIT can expose its investors to the entire real estate market, reducing the risks that come with owning just one property in one location and/or sector. The metric used REITs is referred to as the Funds From Operations (FFO). This measures the value of the properties owned by the REIT based on income generated.
The major concern about investing in REITs as a means of gaining exposure to the commercial property market is their correlation to equities. Because REITs are stock market listed companies, the performance of their shares is inevitably affected by the performance of the market.
In the short-term, i.e. over periods of less than 18 months, the performance of REITs shares is likely to be more closely correlated to that of other shares than it is to that of commercial property.
As the industry matures, and the economy develops and prices start to follow rational patterns it become very tricky to analyse. It will then depend of actual share market type analysis considering cash flow to investor and using complex valuation models with less risk. This implies lower returns.
REITs with international investments are subject to the behaviour of real estate market in other markets. Structures financed by REITs funds are mostly massive and represents national and international monuments. They may be objects of targets, attacks, threats, etc
Like any investment, the value of a REIT can go down as well as up and past performance isn’t necessarily an indicator of future performance.
Prerequisite for REITs success in an Emerging Market like Nigeria
- Organizational: Structure, ownership, holding, management, asset insurance, accounting, audit, etc
- Operational: The REIT must satisfy annual income tests and a number of quarterly asset tests that are designed to ensure that the majority of the REIT’s income and assets are derived from real estate sources.
- Distribution: In order to qualify as a REIT, generally, the REIT must distribute at least 90% of the sum of its taxable income. To the extent that the REIT retains income, it must pay tax on such income just like any other corporation Compliance
- Compliance: Policy, legal, regulatory, filing and reporting, corporate governance, etc
For a successful Take-off of a Real Estate Investment Trust, the following must be in place.
Review and amendment of statutes and laws governing property rights, foreclosures, sales, assignment and conveyance of properties.
Reduction of transaction costs,Stamp duties, transfer/mortgage registration fees, taxes and fees to regulatory authorities should be minimal to reduce overall cost of flotation and subsequent dealings.
Introduction of adequate mortgage underwriting system. A formalized mechanism for distinguishing poor credit risks from good credit risks through borrower screening.
Strengthening of regulations through capacity building, i.e. Federal Mortgage Bank of Nigeria (FMBN), SEC, the NSE, and the Central Bank of Nigeria (CBN). The Amendment Bill on the Investments and Securities Act (ISA) to reflect international best practices to encourage secondary market dealings.
Deepen the Nigerian financial market to be able to accommodate more liquid instruments and create various entry and exit windows for investors.
SOURCE:Affa Dickson Acho with Agency reports