By Alex Delmar-Morgan
Is the Middle East ready to embrace Real Estate Investment Trusts as an investment class?
Last week the Middle East ushered in the first of a new form of property investment vehicle — real estate investment trusts. But as the region reels from a sharp correction in its property market, is it ready to embrace this new-look investment class?
Before the financial crisis hit, property investment took a front seat in the Gulf. Fuelled by loans for speculative off-plan purchases, the real estate boom was the biggest game in town.
Now the property bubble has burst and Gulf markets face sharp corrections, genuine investors may be wondering whether real estate is an asset class that can be trusted again.
Bahrain’s Inovest is banking on their renewed interest. The asset management firm last week won approval from Bahrain’s central bank for its $80m Inovest Real Estate Investment Trust (IREIT).
The fund, the first of its kind in the Gulf, is expected to float on the Bahrain Stock Exchange in September.
Inovest is currently raising cash from investors — the fund may grow by up to 50 percent if interest is high — and intends to snap up residential, commercial and industrial property across the GCC. The trust will be the first listed REIT in the MENA region, as well as being fully Sharia-compliant — and all eyes will be on the concept to see if it succeeds.
Experts are upbeat on REITs’ growth potential in the region, based on the view that a more prudent breed of investors will emerge from the downturn; one looking for more risk-averse returns.
“I certainly think there is likely to be more of an appetite for REITS in the future than there has been in the past,” says David Sanson, a Dubai-based partner in law firm DLA Piper’s real estate department.
“In the glory days of 12 to 18 months ago people were very happy to part with their cash, with deals being done on the back of a fag packet. I don’t see this happening again; people will be much more weary, much more careful and will want to carry out a thorough due diligence on whatever they are looking to do.”
In mature markets, REITs are a common investment class that offer the public a chance to take a stake in a broad portfolio of property. For a minimal outlay, investors can secure a slice of assets such as warehouses, shopping malls and office blocks, without the complications of a direct purchase.
Like any other investment trust, REITs can be traded on the stock market. Income is mainly generated through rental yield.
First established in the US in the 1960s, REITs are exempt from corporate tax if they give back 90% of taxable income to investors each year. Historically, they have become a popular financial vehicle in the West, providing solid dividend yields and a liquid and safe option to would-be real estate investors.
But in the last 18 months the world recession has put the brakes on REITs. Trusts with stakes in shopping malls, traditionally one of the highest performing REIT classes, have been particularly badly hit, as mall occupancy and rental revenues dip.
British Land and Land Securities, two of the UK’s biggest REITs, have seen their share price plummet 73 percent and 78 percent respectively, since their peak in December 2006.
In the US, real estate upheaval has meant returns from REITs dived 37 percent last year and have fallen a further 6.2 percent in 2009, according to NAREIT (National Association of Real Estate Investment Trusts).
REITs in the Gulf may be new but they are still vulnerable to the same market forces seen elsewhere in the world. As Sana Kapadia, a real estate analyst at Egyptian investment bank EFG-Hermes points out, the key will be where the investment exposure lies.
“It’s a function of where in the GCC [the exposure is],” she says. “A market like Saudi Arabia offers strong growth potential as it is quite underpenetrated, given the strong underlying demand [for housing] from the population.
“In the UAE and Dubai, in particular, where there are falling rents and lower occupancy rates, it may be less attractive.”
In Bahrain, Khalid Abdulla, chief executive of Inovest, which first announced plans for its REIT in April, says the move was aimed at exploiting the slump in Bahrain’s property market where, as in most parts of the Gulf, prices and transactions volumes have plunged.
“We are trying to capitalise on the significant correction that has taken place in the real estate market over the last few months,” says Abdulla, estimating that values have fallen 30 percent in Manama, Bahrain’s capital, over the last few months.
“Nobody can predict the bottom but by the time we start acquiring properties immediately after the summer, it will be near the bottom.”According to EFG’s Kapadia, the Gulf has been slow to embrace this form of property investment largely because of the immaturity of its markets.
“It’s the understanding that they are alternative investment vehicles. There is appetite for alternative and direct property investment, but it’s also a function of maturity for companies looking to get into REITs. They want to develop their portfolios and then use these assets to set them up,” she adds.
Abdullah claims returns from IREIT will be around 8.5 percent and, while fundraising is targeted at a mixture of pension funds, financial institutions and high-net worth individuals, he aims to float the trust in Kuwait and perhaps Saudi Arabia at a later stage.
Inovest’s REIT is Sharia-compliant, meaning that income derived from interest is forbidden, together with revenue produced by prohibited activities or businesses.
These include gambling; the manufacture or sale of non-halal meat or related products; arms manufacturing; the adult entertainment business; nightclubs; hotels and resorts; tobacco and alcohol.
As Sanson points out, an Islamic REIT is only permissible if the income-producing property portfolio does not include a shopping mall, for example, which might house a supermarket selling pork, a tobacconist or an alcohol store.
Potential investors may ask themselves what the advantages are to be in investing in an Islamic REIT rather than one in the West. Kapadia at EFG puts it down to the rosier macroeconomic picture in the Gulf.
“Economic conditions in the West look likely to remain depressed for longer [than in the Gulf],”she notes.
However, the Gulf’s patchy regulatory framework could prove a deterrent. In 2006, the Dubai International Financial Centre (DIFC) took the lead on REIT laws by passing the Investment Trust Law and the Investment Trust and REITs Rules Instrument.
At the start of 2007, DIFC, Abu Dhabi Commercial Bank (ADCB), and the real estate division of Australia’s Macquarie Bank announced plans to create a REIT and acquire assets of $2bn. However, the framework remains untested as the REIT was never listed.
Experts believe that the regulations in place do not go far enough. Further financial legislation is needed to give greater security to companies launching REITs and those investing in them.
“They [laws] are not of a level of sophistication to provide sufficient levels of comfort to proposed investors,” says Sanson at DLA Piper. “Given how young and immature the real estate market is in this region in comparison to the UK and the US, if this is going to be a vehicle that is attractive to investors, there will need to be a review of existing REIT-specific legislation.”
At Inovest, Abdullah agrees. “The rest of the GCC can develop the right environment for REITS. It may take a bit of time, but they need to pass the right kind of laws.
“It’s just about creating the right regulatory environment and legal framework for such products.”
Despite Dubai’s early enthusiasm, Saud Masud, a real estate analyst at Swiss investment bank UBS, says the emirate is some time away from providing a platform from which REITS can operate.
“They will happen, but I don’t see them being a meaningful player in this market in the next five years,” he says. “REITs are a function of a steady market and the one thing you look for is recurring income and recurring revenues that can be passed to the end user.
“Dubai is not ready for it yet.”
State-owned developer Nakheel floated the idea of launching REITs with assets up to $2.72bn in February last year but the plan failed to materialise.
Emaar, the largest developer in the Middle East, and Abu Dhabi’s Aldar, both of which have large rental portfolios, would be the companies most likely to consider REITs, Masud notes.
For now, though, the litmus test remains Inovest’s $80m REIT fund and whether it proves a trigger for the investment class to take off in the Gulf.
“In the market there will be an awful lot of people who have had their fingers burned,” says DLA Piper’s Sanson, “and I think that, with the shake-up that is happening here now, once things stabilise, a vehicle such as a REIT could be an attractive proposition.”