Legal Framework Governing Real Estate Investment Trusts (REITs) in Kenya
Authored by: Paul M. Syagga, PhD, Department of Real Estate and Construction Management
November 2019
Introduction
The real estate sector in Kenya is increasingly becoming one of the most attractive investment avenues in Kenya. This is courtesy of a bulging population coupled with increased urbanization and growing disposable income for many households. As a result, experts estimate that the industry will keep growing uninhibited in the foreseeable future.
The Kenya National Bureau of Statistics’ (KNBS) annual Leading Economic Indicators released in August 2018 indicated that the real estate and the construction sectors’ contribution to GDP rose from 12.6% in 2010 to 13.8% in 2016. Real estate has consistently outperformed other asset classes in the last five years, generating returns of more than 25% per annum compared to an average of 10% in the traditional assets classes.
While investments in residential units targeting middle level and high-end markets have remained lucrative, with the government currently initiating various projects (Presidential Four Agenda Programme 2018) to realize affordable housing for Kenyans, the lower middle income segment of the residential market presents attractive opportunities for investors.
Equally, student housing in Kenya for university and post-secondary college students is now a powerful alternative asset which if appropriately promoted will definitely guarantee tenanting. Therefore, the development of student’s accommodation may prove to be the next big thing in real estate.
REIT as an Investment Vehicle in Real Estate
A Real Estate Investment Trust (REIT) is a regulated investment vehicle that facilitates collective investment in which third-party financing can be made available for the real estate sector.
REITs may operate in different ways. There are those that may acquire land, develop it and sell it at a profit (D-REITs), and those that may acquire already developed property or even develop the property for purposes of generating rental income (I-REITs). In the latter case, they will hold and manage the properties over a period of time. An Islamic REIT is a unique type of I-REIT that invests primarily in income-producing, Shari’ah - compliant real estate. A fund manager is required to conduct a compliance test before investing in real estate to ensure it is Shari’ah compliant and that non-permissible activities are not conducted in the estate and if so, then on a minimal basis.
In Kenya, REITs may be listed or unlisted. A listed REIT’s units are traded on the Nairobi Securities Exchange like any other company share, offering investors a liquid stake in real estate. In practice, I-REITs are available for purchase to the general public, while the D-REITs are restricted to professional investors only.
In Kenya, REITs operate under the Capital Markets (Real Estate Investment Trusts) (Collective Investment Schemes) Regulations, 2013. They are structured as trusts rather than companies.
The Trustee acquires the property and holds it on behalf of the beneficiaries (individual and corporate investors). The Trustee is responsible for the appointment and supervision of the REIT Manager. It is also the Trustee’s responsibility to ensure that the assets of the scheme are invested in accordance with the Trust Deed and the Offering Memorandum ensuring that distributions from the assets of the REIT are made in accordance to the Offering Memorandum as approved by the Capital Markets Authority (CMA). Therefore, the investment properties are held in the name of a corporate trustee who is the custodian of the REIT assets but managed by a corporate REIT manager. To act as REIT manager, you have to be licensed by the CMA.
Listed REITs units are traded on the Nairobi Securities Exchange (NSE) like any other company share, offering investors a liquid stake in real estate. Individuals and corporate investors may subscribe to a public offer in the NSE as was the case with of the first ever listing under the Regulations (2013) by STANLIB Fahari I-REIT in November 2015. The offer then required a minimum subscription of Kshs. 20,000 at 1,000 units and a nominal value of Kshs. 20.00 each.
The Regulations require REITs to distribute most of their net income to the unitholders. In Kenya, REITs are required to distribute at least 80% of distributable earnings to unitholders.
NSE listed REITs are held to the same standards and requirements of disclosure to investors on financial information and reports on material business developments and risks as other publicly traded companies. As such transparency in REITs operations provides a basis for investors to analyze and appraise REITs assets independently.
Advantages of REITs
The launch of REITs in Kenya was to enhance financial inclusion in Kenyan capital markets, so that investors with less capital could invest in large-scale commercial, residential and industrial properties without requiring large sums of money. This should be a boon particularly for residential development that now has full Government support under the 2018 Four Agenda Programme. Unlike other sectors in real estate, demand for housing particularly for low and middle income wage earners remains insatiable.
Given the lower investment entry threshold, more investors entering the market would provide the much needed funds for real estate investment through REITs and as a result create a vibrant liquid market in otherwise immovable property. It accords the unit holder a hedge against inflation, as a result of ever increasing real estate rental incomes and capital appreciation even during inflationary trends. It also provides the investors with portfolio diversification since they have the advantage of investing in a variety of real estate from shopping malls to office buildings, residential projects and industrial projects among others.
Registered REITs do not attract income tax, but must remit to the tax authorities the withholding tax on the dividends paid by the REIT. Instruments used in transfer of property to listed REITs are also exempt from stamp duty.
The current Section 20 of the Act only exempts REITs from income tax without extending the exemption to subsidiaries and investee companies which are wholly-owned by REITs. Consequently, if a REIT invests in a company, the income of that company would be first subjected to corporation tax at the rate of 30 percent on the net profit before distribution to the REIT. Since the investee company is wholly owned by the REIT, as the law requires, the effect is to subject income due to a REIT to 30 percent corporation tax, hence negating the essence of the tax exemption to income of the REIT.
The Finance Bill 2019, however, provides that REIT wholly owned subsidiaries will also be exempt from income tax. REITs will therefore get income tax exemption extended to companies they use to hold their properties. The proposed amendments to Section 20 of Income Tax Act will ensure that the objectives of REITs are fully achieved as it exempts the income of investee companies fully controlled or owned by the REITs.
Challenges in Use of REITs
REITs have opened the investment market in real estate to a larger population segment that would not have been the case previously, and is equally a tax efficient structure. If appropriately promoted, REITs have the potential to support the achievement of the provision of more housing under the Presidential Four Agenda Programme.
However, participants in REITs investment should appreciate that REITs may grow at lower rates than normal companies due to the restriction to re-invest a maximum of 20% as the rest is distributed as dividends. Debt financing could result in high interest rates.
Investment in REITs is subject to real estate market cycle that may experience market volatility from time to time as a result of changes in the economy, government regulations or political activity.
