ecently, a longtime friend inboxed me on WhatsApp to inquire if there are any readily available real estate investment trusts( REITS) in Uganda he could invest in and my quick answer was NO. This entire week I have been thinking about the subject and why REITs are doomed to fail without a doubt.
At their most basic level, REITs are means one could use to bring in several people to fund a project. A trust is formed, then people are asked to invest in that trust. For instance if you are doing a project of $2 billion, you could either borrow that amount from a bank or you could simply get 10 people to each give you a portion of that money, put it in a trust which you could use as a source of funding for your project. It is almost akin to a stake in a project.
What are REITs?
A real estate investment trust (“REIT”) scheme is an arrangement established for the purpose of collective investment by persons in real estate. The persons investing contribute money or money’s worth as consideration to acquire rights or interest to gain benefits from pooling funds and investment in real estate and earn profits or income from the real estate. The stock market in Uganda can be able to list a new security that makes it possible for institutions and individuals to invest in real estate, and earn high dividend yields that are exempt from taxation.
The Ugandan Collective Investment Schemes (Real Estate Investment Trusts) Regulations, 2017 (the “REIT Regulations”) made by the Capital Markets Authority (the “CMA”) chose not to reinvent the wheel; they copied the Kenyan regulations with just a few modifications. The REIT Regulations provide a regulatory framework for property owners to raise capital using their existing properties and for investors to acquire a part of these properties or for those seeking to acquire real estate and undertake development and construction activities as a collective scheme.
Under Section 21(t) of the Income tax Act, income earned from collective investment schemes is exempted from taxation as long as it is paid out to members. Earnings from the trusts are also exempt from income tax since REITs are classified as collective investment schemes. But given the aggressive tax collection in Uganda, you can’t be sure if this will remain for long.
The REIT regulations approved by the CMA allow two types of trust schemes: the development and construction real estate investment trust scheme (a D-REIT), and an income real estate investment trust scheme (an I-REIT). D-REITs will focus on developing and constructing real estate projects, which will then be sold to generate returns for investors. On the other hand, the focus of I-REITs is long-term investment in income generating real estate projects, distributing rental and lease income to its investors. The regulations require that a D-REIT should, within a year after its authorisation, have invested at least 30% of its total assets in development and construction projects, or income producing real estate it has developed or constructed.
On the other hand, I-REITs should earn at least 70% of their income from rent, licence fees or access and usage rights from investments in real estate at least two years after their authorisation. This is so they focus their investments in real estate, as they are also allowed to invest in cash, deposits, bonds, securities and money market instruments.The regulations require I-REITs to pay a minimum of 80% of their earnings as dividends to their investors.
How to Establish the I-REIT
A promoter may establish an I-REIT by transferring real estate into a trust established under a trust deed. The property would be held in the name and under the control of a trustee, duly licensed by the CMA. A promoter intending to establish and issue an I-REIT must apply to the CMA for authorization to issue the I- REIT. The promoter must present to the CMA:
- draft of the trust deed
- draft prospectus or information memorandum
- draft management services agreement with the REIT manager
- draft agreement with a property manager
- valuation reports of the properties to be transferred to the REIT
- a legal opinion confirming the title to the property
- a contract with and the report of the structural engineer, and;
- audited financials of the REIT manager and the trustee
The reason why these REITs won’t work in Uganda is that the real estate sector is still very opaque. Many people own properties by proxy, yet the spirit of creation of REIT is transparency. Most people don’t want the source of their money questioned. For instance, recently a popular real estate operator in kampala in a video that went viral on social media confessed to not owning certain buildings but was unwilling to mention the people who really own those buildings.
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According to research on African real-estate markets by Jones Lang LaSalle in 2018, South Africa is the only sub-Saharan African country that can be considered transparent. Though moving in the right direction, Nigeria, Ghana and Rwanda are still “low transparency”, while Uganda, Tanzania, Ethiopia, Côte d’Ivoire and Senegal are all “opaque.”
In Kenya where CMA, borrowed its REITs regulations from, the only point of departure the Kenyan REITs regulations have with Uganda’s is that Kenyan registered REITs can only invest in Kenyan real estate in other words, the Kenyan registered REIT cannot invest outside Kenya while in Uganda, the Ugandan registered REIT can invest anywhere in east Africa.
The biggest problem with REITs in Uganda is that the different regulators don’t appear to be speaking to each other. You find that whereas the Capital Markets Authority (CMA) could spell out one direction from a tax perspective, that tax position may not be harmonized with the tax person (URA). Another possible reason why REITs will fail in Uganda relates to the much publicized disorder in the management of registration of land, casting some doubts on authenticity of records on land ownership and the lack of industry standards with respect to property valuations. This will certainly keep away investors.
Any lawyer who has done due diligence on a land transaction deal knows how hard it is these days. I never saw Capital Markets Authority officials appear before the Bamugemereire land commission of inquiry to tender in their views. They tend to think that whatever is happening in the land administration process doesn’t concern them.
The dismal performance of REITs in Kenya and Nigeria, which are far larger economies with far larger real estate sectors, is discouraging. On the other hand, Uganda is in a unique position to draw lessons from Kenya and Nigeria’s experiences.
Since 2013 when Capital Markets Authority Kenya made the REITs legislation, Kenya has had only one listed REIT i.e. the Stanlib Fahari i-REIT, which started trading in November 2015. However, since 2017, when Capital Markets Authority made its regulations, there hasn’t been even one REIT listed in Uganda. The CMA must continue to lobby for policy changes and sensitise the public about the REIT Regulations, otherwise this law will be added to the growing list of capital markets laws that have been passed over the years but never applied.
The advantage of REITs is that they are exempted from double taxation; REIT schemes are exempt from corporation tax and are also exempted from income tax except for the payment of withholding tax on interest income and dividends. Other benefits include;
- Capital Access and Access to investments; REITs enable mobilizations of savings from individuals and groups- this means groups and cooperatives will be able to invest in the market. This offers investors especially the middle-income class, easier access and ownership in the growing real estate sector in a manner which is not as capital intensive as a direct purchase of property.
- Higher yields and returns; REITs offer predictable income streams because of long-term lease agreements with tenants thus rental income and management expenses are predictable in both long and short time frames. Notably, the real estate sector generates positive returns, attaining yields of 10.0%, 8.9% and 5.6% for commercial, retail and residential respectively in 2017.
- Liquidity; Unlike direct investments in property which are generally illiquid, investments in I-REITs may easily be converted into liquid cash by selling the units in the market or offering them for redemption in the case of open-ended funds.
- Portfolio Diversification; Investors in REITs have the advantage of investing in a variety of real estate e.g. shopping malls, residential projects, industrial projects, among others.
- Professional Management; REITs provide investors with access to professionals such as property managers and fund managers who understand the industry and the business and can take advantage of opportunities.
- Transparency; REITs are listed and traded in the public domain making them sufficiently transparent. Additionally, REITs must disclose financial information to the respective investors on material risks and business developments on a timely basis
- Simple Tax treatment; Unlike other partnerships, tax matters for REIT investors are straightforward. REITs are exempt from VAT and stamp duty and for tax purposes its dividends are allocated to capital gains, ordinary income and returns on capital. REITs do not pay taxes at the corporate level and hence investors pay taxes at individual tax rates for the ordinary income portion of the dividend. The portion taxed as capital gains emerges only when the REIT sells assets.
However, REITs, like any other venture, have shortcomings. They include;
- The decrease in rental income as a result of the termination of lease agreements or non-renewal of lease agreements and failure to secure to secure replacement tenants in good time.
- For close-ended REITs, the investor is not able to access their investment before the end of the investment period. The investor cannot seek to redeem his investment before expiry of the investment period unless there is an arrangement with the Trustee’s consent for the sale of the Investor’s units.
- Economic and political situations that could lead to depreciation in the value of the property.
- Change in taxes – While REITs are currently exempt from VAT and stamp duty taxes, these benefits may change depending on the regime in place.
- Competition from other assets classes e.g treasury bills and stocks.
- Limited pool of investors especially institutional investors like pension schemes that are only allowed investment to a tune 30% of asset of trustees♦