Have you ever wondered who owns the apartment where you live in? What about the shopping mall where you frequent over the weekends? Who owns the hotel where you spend your Christmas vacation? What about the office building where you spend most of your life working in? Who owns all these and more? Certainly, these are owned by very wealthy individuals or chamas or state corporations.

What if you were told that from now on you can own a slice of ownership of one of such establishments by investing through a real estate investment trust (REIT)?

What is a REIT?

A real estate investment trust (REIT) refers to an investment vehicle in the form of a legal entity – such as unit trusts, corporations, partnerships or funds – that invests in property in the long-term. A REIT holds and manages the portfolio of commercial real estate property with the sole aim of generating income from it.  A REIT can then distribute most of this income to the investors on an annual basis. Therefore, investing in a REIT is an indirect way of investing in real estate.

Regulations require that a REIT has to be listed in a stock market such as the Nairobi Securities Exchange (NSE) with the approval of the Capital Markets Authority (CMA). This makes REITs considered as publicly-traded entities. It is at this point where real estate property development and stock markets meet. Therefore, in order to make a sound investment decision, you need to have a good understanding of both markets: real estate market and the stock market. It is through this listing that a REIT is able to raise funds from investors. And that by giving a REIT your money, you will get a share or stock in exchange.

But before an investment vehicle is listed as a REIT, it must fulfill the various requirements that govern REITs in Kenya. The main regulations governing REITs in Kenya are contained in the Regulations 125 of Capital Markets, covering Real Estate Investment Trusts and Collective Investment Schemes. A REIT also has to adhere to the various laws that govern banking and investments. An investor also is expected to familiarize themselves with the tax rules that govern various aspects of investment through a REIT.

REITs: Are we really ready?

The recent STANLIB approved REIT, the Fahari I-REIT, has been met by the general public and investors alike with a lot of excitement, to say the least. The REIT system has been touted as one way for ordinary investors with liquidity challenges to invest in the real estate market without taking on the relevant and inherent high capital expenditure that is typical with real estate development. Essentially, you’re buying into a company that is by law supposed to derive most of its income from real estate related activities.

A lot has been written about REITs following and leading up to the announcement, but not a lot about how they actually function in terms of the actual ‘’brick and mortar’’ practicality and what it would take for a REIT to be profitable. This is perhaps what has brought other would be REITs to their knees. A lack of understanding around the functionality of a REIT.

Regulation Systems and Asset Classes

REITs around the world are very well regulated machines. Regulated in what and how they invest in real estate and what and how their main income streams look like. For example, UK REITs by law are mandated to have 90% of their income derived from real estate. Most of the REITs in that developed country are based on specific asset classes of commercial real estate: retail, office, residential and industrial asset classes.

First, the question of portfolio diversification arises. The choice between which asset class to build the REIT’s income upon is usually based on portfolio diversification principles to ensure that there isn’t too much over reliance on income from a particular asset class (or sub-sector) given that they all have different characteristics and correlation, volatility and risk characteristics. Too much exposure in the residential market in the US, for example, saw the collapse of some real estate companies/developers/REITs during the 2007 global financial crisis)

The question is, does Kenya offer such diversification options at the moment?

REIT Strategies and Transparency

Every major REIT in the world has a particular strategy that it employs. One is to ensure that the general public is typically made very aware of, and kept abreast of, the life of the REIT as a way of ensuring transparency and accountability. After all, REIT’s depend on shareholder capital to achieve their investment goals. Essentially, they invest in real estate using YOUR money, keep that in mind. Either, it is to hold a specific type of asset class for a number of  reasons, or to hold a specific asset class for a given number of years before seeking an exit. The other alternative is  to hold a specific asset class in a specific location due to specific reasons.

All in all, REITs are very deliberate in their acquisitions, sales, and investments brought about by thorough analysis of the commercial real estate market, in terms of yields, cap-rates etc. It is such data that is currently unheard of or if available is unfortunately, unverifiable in Kenya.

Core Investments

REITs, especially the Investment REITs (I-REITs), typically do not engage in development, and rather, seek to purchase what are usually termed ‘’core’’ investments and/or ‘’value add’’ investments rather than the more ‘’opportunistic’’ investment criteria of development. The difference among the three lies in the manifestation of the risk and consequently, the rewards offered by the assets. 

However, the development REITs (D-REITs), are involved in the development of commercial property.

Let me first point out that in Kenya, in my opinion, very few buildings can assume the tag ‘’core investment’’  Instead, most fall within the ‘’value-add and opportunistic’’ categories for various reasons. First, you can argue that our construction industry is usually unable to construct a building that maximizes the value of the site for little longer than 5-10 years. Consequently, rents depreciate because the building looks dated and dilapidated in MOST cases or because operating costs are so high.  Such running costs include air conditioning, or maintenance works or management fees.

You could also argue that Kenya has very few top-tier companies with good credit ratings that have the financial capacity and number of employees to occupy significant amounts of floor space within one building without posing significant tenant risk to the landlord who, in this case, would be the REIT. Not to mention the planning issues we have as a country that is rendering swathes of locations within Nairobi un-investable due to congestion, lack of infrastructure etc. The risks are high, basically. Also, bear in mind, that the owner-occupier market in Kenya is more developed than the investor market, which is now picking up.

Qualified Asset Management Companies

Let’s assume that Stanlib, with the Kshs 12.5 billion that they intend to raise, invest in, say, one of the new gleaming towers in Nairobi’s Upper Hill and secure a top tier bank – or other service/financial sector related company – as a tenant on a 10 year lease.  Fantastic, right? Say they are then able to achieve good rents giving a good initial yield when compared with the capital value of the building. The struggle doesn’t end here, unfortunately, because for the next 10 years or however long the holding strategy is, they have to guard or ‘’protect’’ that initial yield.

Easy enough, property values are skyrocketing in most places in Nairobi you would say, but then, how many qualified asset management companies are there in Kenya that are knowledgeable when it comes to securing the rental income? Besides that, the Landlord and Tenant Act 2007 is precariously tenant-favoring, leaving the landlord more exposed. Those asset managers that do exist are almost exclusively tailored for other specific asset classes. Okay maybe there are one or two, but the question is, how ready are they to meet what will definitely be a demanding environment with demanding investors? After all, it is you and me, the general public, who will put money into the REIT at NSE. It is your money. Typically REITs would look to hire asset managers to protect the yield for them, with an in-house team to keep the “consultants” in check. This is key.

Experience Counts

You can also argue, you know, we will cross these bridges when we get there. I will, for example, wait until people have crossed that bridge once or twice, and the real estate market has adapted to this new frontier, where asset management, construction and design are being challenged to see how well we adapt before sinking in a single cent. Good thing too, hopefully by then I’ll have accumulated a lot more.

Just food for thought, most major REITs were property developers before they were REITs and just converted upon securing income generating properties that enabled them to be a lot more attractive to their potential investors. A route that I support simply because in real estate, the only trial is by fire, especially in this ‘’inefficient’’ market characterized by a lack of information.