Real estate schemes the building blocks to dream mortgage

Real Estate Investment Trust Schemes (REITs) may be considered the new kid on the block in Kenya. This instrument can provide the way out for medium or even low-income earners who may find the initial and subsequent cash injection required in mortgage financing prohibitive.

In most parts of the developed world and emerging economies, REITs are not a new phenomenon.  In the US for example, REITs were created by the Act of Congress in 1960.

The business concept has matured over time. In countries like Kenya, REITS is largely a new phenomenon, the REITs Act having been signed on June 18, 2013.

But what are REITs? They commonly refer to an arrangement made or established for collective investment with a view to earning profits or income from real estate as beneficiaries of a trust which is divided into units.

REITS are managed by trustees or boards. Investors contribute money or money’s worth for rights or interests. This is a cheaper way for individuals who otherwise will not qualify for mortgage facilities outright.

REITs have the advantages over direct real estate ownership through shares of the real estate corporation in that they provide the smaller investor with the opportunity to diversify among the real estate classes and locations.

They can also be the option for some small investment groups (like chamas in Kenya).

Under this scheme, investors do not have the day-to-day control over the management of the assets of the real estate investment trust and also the assets are managed by an entity.

A REITs governance structure is similar to that of a corporation. The trustees represent the unit holders and, in many cases, the trustees must be independent of the management or the sponsor.

A group of investors can construct and sell the property or retain it as rental premises or simply purchase completed units as long-term investment.

What should motivate a potential investor to go the REITS direction instead of stocks, bonds or just acquiring a mortgage facility? It boils down to three issues: return on investment, risk and affordability.

Lower volatility

The best real estate investment trusts employ managers who are up to the task, leading to maximum rental income and profit. With equity stocks, management decides whether to distribute dividends or to reinvest the profit.

REITs shares enjoy lower volatility than equity stocks and at the same time their performance may not be correlated to other asset classes. When the performance of stocks is low, holders of REITs will still gain from the likely profitability derived from constant stream of rental income.

REITs own hard and tangible assets such as buildings and often sign their tenants to long-term lease agreements. Rental incomes are generally very predictable.

However, depending on the range of portfolio that a REIT holds, there are some property that are susceptible to market cycles such as retail and hotel properties.

They, therefore, should provide higher returns as the stability of those returns can be affected by short term changes in the market. REITs, being trusts, are taxed at a lower rate in a number of regimes and may be completely exempt from tax.

In Kenya, the Capital Markets Authority requires evidence of minimum paid-up share capital of Sh10 million in the case of REITS managers and not less than Sh100 million in the case of a trustee.

Therefore, it may make sense for investors to form a group similar to a co-operative groups in order to qualify under the CMA Act.