Investment Perspectives A Deeper Understanding of Real Estate Investment Trusts (REITs) Presentation by: Nozipho Makhoba Ag. CEO: STANLIB Fahari I-REIT Wednesday, 17 th October 2018
What is a REIT A REIT is an entity that invests primarily in real estate and qualifies for special tax treatment, providing a conduit for earnings to be taxed at the investor level and not at the entity level. Subject to limitations specific to each jurisdiction, REITs may own, operate, acquire, develop and manage real estate assets and/or provide related services.
REITs investable properties REITs invest in different types of properties Retail Convenience, neighbourhood, life-style, regional, super-regional malls Office High-rise, low-rise, office parks Industrial Warehouses, distribution centres, industrial parks Residential Flats, apartments, townhouses Hospitality Hotels, hotel apartments, casinos Student housing Student apartments or houses Schools Private schools, colleges, etc Hospitals Private hospitals
Benefits of investing in REITs Benefits Diversification Lower correlation with traditional assets Liquidity Through listing on the securities exchange Transparency and monitoring Requirement to disclose annual reports Heavily regulated; scrutinised by analysts Annuity income REITs have to distribute earnings for tax purposes Preferential tax treatment Flow through structure Inflation hedging Through lease escalations and capital appreciation
Risks of investing in REITs Every good investment has its risks
Risks of investing in REITs Risk Tax risk Loss of tax exemption status Market risk Market price fluctuation Vacancy risk Failure to let/re-let property Credit risk Tenant delinquency Liquidity risk Might not exit at desired timeline Development risk If D-REIT the REIT takes on development risk including cost overruns, project delays, vacancy risk, exit risk, etc
Countries that adopted REITs
SA REITs SA has 36 REITs in total Market cap R365 billion (USD 24bn) Largest REIT has a market cap of over KES 0.5 trillion Source: Java Capital & JSE
SA REITs (continued) Source: Java Capital & JSE
REITs in Kenya Income REIT (I-REIT) Development REIT (D-REIT) Focuses on income producing properties Specific regulations for I-REITs Focuses on property development Specific regulations for D-REITs
Typical REIT structure in Kenya
Regulatory aspects I-REITs Constitution Company/Trust REIT Trust CMA REITs Regulations Unit offer Can be restricted (i.e. offered only to professional investors) or unrestricted Open/closed ended fund If restricted, can be either open or closed ended Listed/unlisted If unrestricted, must be closed ended and if closed ended, must be listed If restricted can either be listed or unlisted Free float At least 25%
Regulatory aspects I-REITs Constitution Minimum unitholders 7 CMA REITs Regulations Minimum size (assets) KES 300 million
Regulatory aspects D-REITs Constitution Company/Trust REIT Trust CMA REITs Regulations Unit offer Must be restricted Minimum subscription/offer parcels KES 500 million Listed/unlisted If listed, must be in market segment that limits trading to parcel sizes of KES 5 million; and limits investors to those to whom the offer has been made Free float At least 25%
Regulatory aspects D-REITs Constitution Minimum unitholders 7 CMA REITs Regulations Minimum size (assets) KES 100 million
Ongoing requirements I-REITs Aspect Regulations Distribution At lease 80% of earnings Asset allocations At least 75% in real estate and up to 25% in cash* Income requirement At least 70% of income must be from real estate assets* Gearing Up to 35% of TAV Co-ownership of assets Prohibited except in case of units in another REIT An I-REIT that fails to comply with distribution and gearing requirements may cease to be classified as a REIT for tax purposes and may have its authorisation revoked by the CMA TAV Total Asset Value *after 2 years of authorisation of REIT scheme
Ongoing requirements D-REITs Aspect Regulations Distribution Per distribution policy Capital gains not reinvested must be distributed within 2 years Asset allocations At least 30% in construction/developments or income producing real estate, within 1 year of authorisation Gearing Up to 60% of TAV Co-ownership of assets Permitted in case of part sale of developed property A D-REIT that fails to comply with distribution (of capital gains) and gearing requirements may cease to be classified as a REIT for tax purposes and may have its authorisation revoked by the CMA TAV Total Asset Value *after 2 years of authorisation of REIT scheme
IFRS Typical income statement
IFRS Typical balance sheet
IFRS Case Studies IAS 40 Investment property Initial recognition Subsequent measurement Subsequent expenditure Treatment of appurtenances Construction work in progress at cost including transaction costs Fair value model Cost model (still required to disclose fair value) Capitalised if probable future economic benefits If replacement of previously capitalised item, derecognise previous item eg. aircons, lifts, escalators, lighting, etc Capitalised to investment property; not treated as property, plant and equipment Follows the elected measurement model fair value or cost Disclosure Valuation hierachy (level 3 classification) Non-observable inputs (eg. discount rates, cap rates)
IFRS Case Studies IAS 40 Investment Property Scenario 1 REIT acquires 100% shares in property owning subsidiary ( SPV 1 ) in 2015. The REIT s accounting policy is to recognise its property (and appurtenances) held to earn rental income as investment property under IAS 40 and to carry it at fair value. SPV 1 treats its investment property as property plant and equipment (IAS 16) and carries it at amortised cost (i.e. depreciates it).
IFRS Case Studies IAS 40 Investment Property Solution to Scenario 1: Fundamental error disclosure Previously, investment property comprising land, buildings and certain items considered an integral part of investment property (i.e. lifts, escalators and lighting) in terms of IAS 40 Investment Property, were erroneously included in property and equipment and carried at amortised cost. In 2015, the above items have been correctly classified as investment property and carried at fair value. The 2014 figures have been restated to reflect the reclassification of the relevant property and equipment to investment property, though the reclassified amounts are reflected at amortised cost and not at fair value. The change in accounting policy to fair value the investment property has been applied prospectively as it is impractical to use hindsight to determine the fair value of property in the comparative and previous financial periods of 2014 and 2013. Therefore the change in accounting policy has been applied prospectively and had the following impact on the financial statements:
IFRS Case Studies IAS 17 Leases Scenario 2 Over and above the erroneous classification and treatment of investment property in Scenario 1, SPV 1 also does not straight-line its lease income over the term of lease in line with IAS 17 Leases.
IFRS Case Studies IAS 17 Leases Solution to Scenario 2: Fundamental error disclosure Previously, the Company did not apply the straight-lining of lease income over the lease term in line with IFRS for SMEs 20 and full IFRS, IAS 17: Leases. From 2015, lease income is recognised on a straight-line basis over the lease term resulting in straight-line lease adjustment recognised in profit and loss and a straight-line lease accrual recognised in the Statement of Financial Position. The impact of straight-lining of leases goes hand in hand with the revaluation of investment property so as not to create any doublecounting, resulting in the straight-line leasing adjustment recognised under revenue being deducted from the fair value adjustment of investment property. As the Company only began fair valuing its investment property in 2015, the change in accounting policy to straight-line lease income has also been applied prospectively from 2015. The change in accounting policy had the following impact on the Company s financial statements:
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