Understanding Developmental REIT
Developmental REIT is a modern concept for the ages old property investment or limited partnerships. It offers the same benefits of buying, managing and developing a real estate asset except that it is more organized, regulated and much more safe specially when we consider investment models in Pakistan.
Today we will compare a normal project partnership vs a developmental REIT and see how they differ while technically they both serve the same purpose and act as a vehicle for investment in real estate. Whether you invest in a REIT or a limited partnership, keep in mind that real estate investment performance, regardless of the structure, is largely a function of the property being invested in — its type, location, leasing status, condition, management, and market. How an individual partnership or a REIT performs will ultimately depend on these factors more than on its structure. So remember to look closely at the property portfolio, and talk to your investment adviser before investing.
For understanding purpose we will be using certain layman terms to offer comparison during this article which may differ from actual titles.
There are two ways to make a new project, the usual way all developers work here in Pakistan ” Partnership model” and through a ” Developmental REIT”. Now let us briefly analyze how it works in both concepts.
Development Project Limited Partnership: Usually a developer invests certain sum of money to buy land where he wants to develop a piece of land for a housing society, luxury apartments or malls etc. The land can be purchased by him alone or along with a small group of investors usually 2 to 5 under a partnership. The project is than marketed and sold to 2nd tier investors who believe that the prices will appreciate over time as the development continues and value is added to the project.
The 2nd tier investors who now purchase off plan plots, shops or apartments can liquidate there assets any time and take profits over the period of development of the project which may last from 3 to 5 years at an average. The profit margins are not fixed and market decides the appreciation of the property depending on various factors.
Developmental REIT : The initial concept of Developmental REIT is the same as normal project development that is ” A group of investors want to get together to invest in a developmental project to gain profits” However this time the regulations are different to make sure that no conflicts between the investors arise and therefore a RMC (Reit managment company) is put in charge of managing and further planning or the other way around that a RMC comes out with a REIT plan and invites investors to join them.
No matter which path it follows the goal is same, to profit out of developing real estate.
A REIT company formulated thus will be governed by the regulations set by the Govt of Pakistan through SECP and not its own. All the funds collected will be put under an escrow account under the scrutiny & guarantee of central depository committee of Pakistan.
Unlike normal developmental projects, in REIT the number of initial investors can be much larger as the same set of rules are applicable for everyone, hence no dichotomies. So while with a mere amount of 50 M PKR you can not develop a project on your own, in REIT 50 people consortium who can raise 2.5 Billion together if every one invests 50 M each can start and own a huge project and benefit from the profits which only wealthy developers used to make.
The amount usually required to be deposited by the investors for the REIT to start functioning is 50% of the total cost on the project. This does not include profits, it only includes the cost which will be incurred on the development and construction of the said project.
It is important to understand that unlike normal developmental projects the investors in REIT do not hold any fixed property, plot or apartment against there investment, rather they are partners in the entire project and owner of entire building as per there unit holding.
For the sake of ease we will consider a project which requires an investment of 5 Billion PKR for completion while the developers initially have only 2.5 Billion which is valued at 10 Billion for sales purpose.
Limited Partnership Projects : In general projects the investors/developer will start liquidating properties in the project as soon as they launch it. This is done to raise the extra 2.5 Billion they need immediately for development of the complete project plus to gather the 5 Billion in profits as the total sale value of the project is estimated at 10 Billion. In addition to this they do need to get the 2.5 Billion out of it as well which was initially invested in the project.
This is where exactly most projects go wrong, you either start with much less money than you initially required to take the project in the right direction or a developer starts to secure his initial investment and profits first rather than investing and building on the project.
Anyways let us consider that everything goes on smoothly and the developer is able to finish the project by successfully selling it to the market at 10 Billion thus gaining 5 Billion in profits.
REIT Projects: When a real estate investment trust enters a developmental REIT, it gathers the initial 2.5 Billion required from a few small to strategic investors now known as “unit holders”. This gives an opportunity to a lot of people to become part of it as developers/unit holders to enjoy profits used to be only for mega developers.
Now when it is time to raise the remaining 2.5 Billion PKR to finish the project the RMC handling the REIT has three options:
- It can start selling the product which can be plots, apartments or commercial property as we do in the general project.
- It can opt for borrowing from the bank directly.
- It can opt for IPO (Stock market launch), colloquially known as floating, or going public. Initial public offerings can be used: to raise new equity capital for the REIT or to monetize the investments of private shareholders such as company founders or private equity investors; and to enable easy trading of existing holdings or future capital raising by becoming publicly traded enterprises.
Mostly a developmental REIT opts for option 1 and 3 and in some cases even utilizes option no 2 as this strategy allows to tap into a wide pool of potential investors to provide itself with capital for future growth or working capital. In addition it gives the chance to first tier investors/unit holders to liquidate some of there shares to 2nd tier investors in the same way as it was done in the general project however this time not as a property unit (plot, apartment etc) but as a share of the project in question.
The initial share held by unit holders is at 10 PKR and when the IPO is launched the share price will be approx 30 to 50% higher and later on will be decided by the market. This gives a chance to the unit holder to make an exit at a profit which is the difference of price between the units sold to him and later floated in the open market.
This process is very similar to profit taking on pre launch prices and post launch prices during a general developmental project we see happening in Pakistan.
Now for ease of understanding lets assume that unit holders do not liquidate any of there units and in 3 years the entire project is sold out at 10 Billion PKR, in this case the REIT will distribute at least 90% of its taxable profit to the unit holders which amounts to 4 Billion PKR in addition to the 2.5 Billion initially invested by the unit holders.
Tax Benefits : Developmental REIT greatly benefits from tax reliefs as profits from REIT are tax free and only unit holders will be liable for a CGT of 7% on there gains.
Investment Consultant and CEO at Imlaak
Mob : +92 333 1717170 ( Whatsapp)