Real Estate Investment Trusts (REITs): An Easy Investment and Finance Vehicle

There is no doubt, financing is a critical issue when it comes to housing. The challenge is not only faced by potential home buyers, looking for a mortgage product but also by the builders and developers. To adequately finance the purchase and construction of a new commercial complex or a housing project, while ensuring timely delivery of the property to end-users, is a challenging task for the developers and builders.

While financial markets are strengthening, albeit at a snail pace—and arguably have a dominant role to play in improving housing finance—one option that has been introduced in key emerging markets are Developmental Real Estate Investment Trusts, known as REITs.

REITs were first introduced in the US in the early 1960s, but have since been adopted across the world, benefitting both investors and real estate developers. A developmental REIT is typically a scheme that has been specifically designed for developing an industrial, commercial, or residential real estate, at any stage of construction or refurbishment. In fact, it can be used even for last-mile or emergency funding for projects going into delays.

It is an investment vehicle with a fixed number of shares, lasting as long as the time it takes to develop, build, and sell the property. The REIT functions like any scrip on the stock exchange. Investors buy and sell off shares and indirectly invest in the development of real estate projects.

The benefits of REITs are numerous. First, REITs share the financial institutions’ burden of providing adequate financing to developers. Second, it is a great alternative from the builders’ point of view as well. Currently, builders and developers in Pakistan finance their projects through informal investors, which goes toward the purchase of land while construction is financed through customer installments and down payments.

In many instances, initial customers are, in essence, investors looking for capital gains. Though investors charge a higher return, they are far less cumbersome than the process of loan applications at banks—which mostly require an immovable property that is separate from the land on which construction is taking place as collateral. A REIT vehicle can take away these hassles and provide upfront liquidity. As opposed to direct investment in real estate projects, REITs are less risky, more diversified, and highly liquid.

REITs can also be specifically beneficial for small developers. From a business perspective, evidence suggests that REITs can allow developers to transform their businesses from asset-heavy to asset-light models while they focus on their core competencies. Meanwhile, it is a great avenue for low-risk investors to participate in the market. For small investors particularly, it is an affordable income-generating asset class.

For strategic investors, REITs can broaden existing portfolios and provide a much-needed diversification in investment holdings, thereby reducing underlying risks. Since REITs can last for 3 to 5 years, long-term institutional investors can also be attracted. Another major advantage is documentation; due to its structure, REITs can play a role in formalizing the real estate market.

In Pakistan, there are no developmental REITs, though a strong case can be made to introduce them. The country is grappling with a massive housing gap, and the supply of houses is substantially limited due to the unavailability and inaccessibility of housing finance. However, there exists a rental REIT called Dolmen REIT in Pakistan. It was issued after the project was completed and was welcomed by the market. There were also taxation incentives at the time of its issuance which were reversed thereafter, and no new REIT has been issued since then. There are several regulatory challenges that pose a strong threat to any real progress taking place on this front.

In Part II, we will discuss the challenges in developing REITs and how policymakers can address them.