Topical Feature: Real Estate Investment Trusts – A piece of the action.

A Real Estate Investment Trust (REIT) is a company that owns and at times operates income producing real estate. A REIT has the capacity of providing the investor with not only regular income streams but also diversification and long term capital appreciation.

1. Unit Holders – they invest in the REIT and the REIT in turn distributes dividends to them.

2. Trustees – they act on behalf of the unit holders and in turn receive a fee for their services.

3. Properties – a REIT owns or manages property and in turn receives rental income.

4. Property Managers – they manage these properties on behalf of the REIT and receive a fee for their services.

5. REIT Managers – they manage the REIT and receive a fee for their services.

Types of REITS

Equity REITS:

These Real Estate companies acquire commercial properties and lease the space in the properties to tenants who in turn pay rent. After paying their expenses associated with operating the properties, they would payout a significant proportion of the income on an annual basis as dividends to the unit holders. Capital appreciation occurs from the sale of properties and is also included in the dividends paid out to unit holders when realized.

Mortgage REITS (mREITS):

These Real Estate companies invest in real estate mortgages or mortgage backed securities which they earn income from the interest on the investment and sales of the mortgages. Profit is realized from the income they receive and their costs. They lend money directly to landlords and their operators to purchase a property. They can also lend for an acquisition of loans and mortgage backed securities. Factor that affect mortgage REITS include changes in mortgage rates, prepayments of a loan before the due date and credit related issues.

Benefits of REITS to Investors:

Diversification – REITS, especially equity REITS, have shown little correlation to the returns of the broader stock market.
Dividends – REITS provide a stable income stream to investors especially publicly listed REITS.
Liquidity – REITS can easily be bought and sold.
Performance – REIT returns especially those for publicly listed REITS have outperformed the S&P 500, Dow Jones industrials and NASDA composite.
Transparency – since they are like publicly listed companies they face the same regulation and financial reporting standard.

Global Trends

Global risk to REITS:

There are several risks to the REIT industry that could potentially see a slow down in the market:

Overbuilding

As discussed in previous reports, the global apartment market is experiencing oversupply. For REIT markets that are dealing in this market that is experiencing slower return growth in a market with oversupply that has been hit by slower job growth that won’t support demand – this is not good news. In the US, multifamily apartment supply growth has stood at an average of 26% per annum which is more than the 30 year average (Everore ISI) which drives home the fact that oversupply is an issue and an issue that will continue to hit that market.

Vacancy rates

The rise in vacancy rates is eminent in a global economy that is facing an easing in property prices on the back drop of a tough economy. A weaker global economy could mean that there is lower consumer confidence and less spending in shopping malls which have been an attractive investment for commercial REITS. Increased vacancies in the office market, for example, means lower rental yields which form a basis of valuation which in turn underpin REIT share prices.

Higher interest rates

This would raise REITS debt-financing costs which would cripple profit margins. It would also make other income generating investment that carry less risk more attractive. For mREITS, higher interest rates may at first seem like a good thing as it means higher returns, but it could also mean that mortgages becomes more expensive for the borrower to repay back and thus the increased possibility of mortgage defaults thus lower returns.

Brexit on the REITS markets

Following the announcement of Brexit last month, UK REITS have started to under perform their counterparts in the US and the EU. This is partly due to the uncertainty that the announcement has had on the real estate markets as tenants shy away from making any real estate move until further notice. This has slowed down up take of office space and also halted real estate projects. The US economy has continued to be a much stronger economy with a more robust job market in terms of job creation thus continued growth in demand for real estate property. The EU comes in second in the REITS market with its loose monetary policy which the ECB intends to boost prices of yielding assets.

Kenya Trends

Introduction of the Real Estate Investment Trust concept:

The Capital Markets Authority adopted REITS regulation in 2014 with the first REIT being issued by Stanlib in November 2015 which is an income REIT (I-REIT)while Fusion Capital was given the go ahead to issue a development REIT (D-REIT) this year.

REITS are mandated by law to distribute at least 80% of the profits to investors in form of dividends irrespective of the value of the profits made. REITS profits are not taxed when paid out (unlike other publicly listed companies) but the investors would have to account REIT dividends as income which will be identified collectively as taxable income for the year.

Stanlib, a regional financial services provider, became the first company to provide a REIT in Kenya with the aim of allowing investors to invest in large scale income producing real estate either through rental income and/or capital appreciation. Investors had the opportunity of investing a nominal value of Ksh 20 for each unit with a minimum subscription of 1,000 units which translates to a minimum investment amount of Ksh 20,000.

Fusion Capital, has issued a development REIT which seeks to raise funds worth Ksh 3.7 billion with Ksh 2.3 billion coming from equity while 1.4 billion coming from debt. An investor would need a minimum investment amount of Ksh 5 million which is significantly higher than the Ksh 20,000 minimum required in the I-REIT. The monies will be used to develop Greenwood city in Meru County which will boast a 160,000 sqft mall, a 6 floor office block and 53 executive apartments.

A D-REIT proceeds go into real estate development and construction and it realizes its returns from capital gains from the sale of real estate developments. I-REIT proceeds go into purchasing and managing income generating real estate. It realizes its returns from rental or lease proceeds making their returns much more predictable and less volatile than with D-REITS.

Statistics on the Kenyan Real Estate Market

According to popular real estate site Lamudi, these are the current trends in Nairobi over the past week:

Interest Rate Watch

T-bills rates have had an upward trend over the past 5 weeks following the announcement of Brexit late June 2016.

An increase in T-bill rates is normally followed with an increase in mortgage rates which could limit the demand for real estate in the market as most investors purchase property with a mortgage.

Market Data (Weekly Average)