Real Estate Investment Trusts (REITs) as an Investment Alternative to Limited Liability Companies in Kenya

Victor Ngaruiya, Legal Researcher

Our Discussion encompasses the following:

  1. Overview of REITs
  2. Regulations and legal framework for REITs in Kenya
  3. REIT as an Investment vehicle in Real Estate
  4. Formation and Structure of REITs
  5. Types of REITs
  6. What to look for before investing in REITs
  7. Steps to investing in REITs
  8. Parties involved in REITs
  9. Advantages and Challenges associated with REITs
  10. REITs vis -a -vis Private Real Estate Limited Companies
  11. Conclusion

Overview of REITs in Kenya

A Real Estate Investment Trust (REIT) is a regulated collective investment vehicle that owns, operates and invests in a real estate asset by pooling funds from a group of investors. REITs allows investors in Kenya to invest indirectly in real estate assets such as office buildings, shopping centers, hotels and residential properties.

The REIT leases out the property under its ownership to collect rent, generate income for the investors and drive asset appreciation in the longer term as rent increases. The rental income earned is then distributed as dividends to REIT investors.

Presently in Kenya and as of 2024, there are only four authorized REITs:

  1. ILAM Fahari I-REIT
  2. Acorn Student Accommodation I-REIT
  3. Acorn Student Accommodation D-REIT
  4. LAPTrust Imara I-REIT

However, ILAM Fahari I-REIT, the only one that was actively trading on the Nairobi Stock Exchange, was delisted on 12th February of 2024. On the other hand, Acorn Holdings (both I-REIT and D-REIT) secured USD 180 Million (KES 23.6 Billion) in Funding from the U.S Development Finance Corporation for affordable student housing. The financing will be repaid over a period of 18 years and shall provide a long-term and sustainable financing solution for Acorn.

Regulations and Legal Framework for REITs in Kenya

The Capital Markets Authority (CMA) in Kenya is responsible for governing and regulating REITs. The CMA established a comprehensive framework and regulations for REITs in 2013, as a return ensuring transparency, accountability and investor protection within the sector. REITs are established and governed by the following regulatory framework:-

  1. Capital Markets (Real Estate Investment Trusts)(Collective Investment Schemes) Regulations, 2013
  2. Capital Markets Act Cap. 485A
  3. Capital Markets (Corporate Governance)(Market Intermediaries) Regulations, 2011
  4. Income Tax (Real Estate Investment Trusts) Rules, 2020.

In Kenya, the establishment and operations of REITs are governed by the Capital Markets (Real Estate Investment Trusts) (Collective Investment Schemes) Regulations, 2013 (the regulations).Regulation 8 classifies REITs into two categories, that is, Development Real Estate Investment Trusts (D-REITs) and Income Real Estate Investment Trusts (I- REITs).

In D-REITs, the Trust acquires land, develops it and sells it at a profit whereas in I-REITs, the Trust acquires already developed property or even develop the property for purposes of generating rental income. Further, Part XXVI of the Regulation establishes an Islamic REIT as a unique type of I-REIT that invests primarily in income producing, Shari’ ah- compliant real estate models.

For D-REIT to be licensed in Kenya, it ought to have a minimum of seven investors and the minimum value of the initial assets must be Kenya Shillings One Hundred Million (Ksh. 100,000,000/=). Conversely for I-REITs, the minimum value of the initial assets is Kenya Shillings Three Hundred Million (Ksh. 300,000,000/=). In both, at least 25 percent of the REIT must not be owned by people who are related to the promoter (founder).

Further, there is no regulatory minimum amount of investments for investors investing in unrestricted I-REITs. However, a minimum investment of Ksh. 5 Million is required for an investor to qualify to be categorized as a professional investor for purposes of investment in a D-REIT.

REITs in general must meet specific criteria, such as holding a minimum amount of assets and paying out at least 90% of net income in dividends. This feature allows REIT companies not to be subject to corporate income taxes and thus offering higher returns to the investors. More specific criteria will be discussed in detail under the different types of REITs.

In addition, Section 20 of the Income Tax Act provides that a Real Estate Investment Trust (REIT) alongside unit trusts and collective investment schemes, is exempt from income tax. The Finance Act, 2019 further exempted investment companies wholly owned by a REIT from Income Tax. In this Regard, the CMA Authority developed draft regulations (Income Tax (Real Estate Investment Trusts) Rules, 2020) to operationalize Section 20 (c) and (d) of the Income Tax Act on Exemption of REITs.

REIT as an Investment Vehicle in Real Estate

REITs are similar to bonds, except that funds are geared towards real estate development. It is a good investment since it allows investors to reap real estate benefits without a huge initial capital outlay or direct ownership of the physical properties.

In Kenya, REITs may be listed or unlisted. A listed REIT’s units are traded on the Nairobi Securities Exchange like any other company share, offering investors a liquid stake in real estate. In practice, I-REITs are available for purchase to the general public, while D-REITs are restricted to professional investors only where a minimum investment of Ksh. 5 Million will be required for an investor to qualify to be categorized as a professional investor for purposes of investment in a D-REIT.

NSE listed REITs are held to the same standards and requirements of disclosure to investors on financial information and reports on material business developments and risks as other publicly traded companies. As such transparency in REITs operations provides a basis for investors to analyze and appraise REITs assets independently.

Mode of Operation

In Kenya, REITs are structured as trust rather than companies. The Trustee acquires the property and holds it on behalf of the beneficiaries (individual and corporate investors). The Trustee is responsible for the appointment and supervision of a REIT manager. It is also the Trustee’s responsibility to ensure that the assets of the scheme are invested in accordance with the Trust Deed and the Offering Memorandum ensuring that distributions from the assets of the REIT are made in accordance to the Offering Memorandum as approved by the Capital Markets Authority (CMA). In this way, the investment properties are held in the name of a corporate trustee who is the custodian of the REIT assets but managed by a corporate REIT manager. For one to act as a REIT manager, he/she must be licensed by the CMA authority.

Formation and Structure of REIT’s

For a company to operate as a REIT, it must apply to the Capital Markets Authority which after considering the application and determining that the scheme does not have a name that is undesirable or misleading, make an order declaring a proposed REIT scheme to be an authorized scheme. A REIT can be a close-ended or open-ended REIT.

A close-ended REIT issue a specific number of shares through an initial public offering and do not issue new shares as investor demand grows. In close-ended REITs, once an offering has been concluded, units can only be traded via the stock exchange for a listed offer. Alternatively, they can be traded over the counter if the offer allows this. In summary, the prices are not determined by the net asset value of the fund, but are driven by investor demand.

An open-ended REIT on the other hand has no limit to the number of shares the fund can issue; as more investors buy into the fund, more shares are issued, hence purchases and sales of fund shares take place directly between investors and the fund company. This requires a daily valuation process, called marking to market, which subsequently adjusts the fund’s per-share price to reflect changes in portfolio (asset) value. The value of the individual’s shares is not affected by the number of shares outstanding.

A REIT can be terminated on the following grounds:

  • Where the authority revokes the authorization of a REIT and applies to the court for the appointment of a person to wind up the REIT
  • The Trustee can initiate the process of revocation of an authorization, and apply to the CMA Authority for the termination of the REIT.
  • The Trustee, REIT manager or any REIT securities holder may make an application to court for an order to wind up the REIT. Prior to making this application to court, a notice should be given to the Authority (CMA) and REIT securities holder by the Trustee or REIT manager and the grounds for making the application.

Types of REITs

In Kenya there are three main types of REITs and they include:-

    1. Development Real Estate Investment Trusts (D-REITs)

A D-REIT is a type of REIT in which investors pool their capital together for purposes of acquiring real estate with a view to undertaking development and construction projects and associated activities. This may include housing or commercial projects.

Eligibility requirements to offer a real estate trust for D-REITs in Kenya

  1. Property must be held in trust and professionally managed by a REIT manager
  2. The Trustee must be independent of the promoter
  3. May only be listed on an approved market segment of approved licensed securities exchange which limits trades to minimum of Ksh. 5 Million and the investors to professional investors
  4. Should only be offered to professional investors and does not need to be listed on a securities exchange
  5. Direct Investments in real estate with at least one investment within 180 days of close of the offer or else 25% of the unit holders may request the return of cash.
  6. A minimum 30% to be invested in development and construction projects or income producing real estate within a year of authorization which the D-REIT has constructed or developed.
  7. May borrow up to 60% of the asset value or up to 75% of total asset value with approval of unit holders, by way of an ordinary resolution, for temporary period of up to 6 months.

A D-REIT can be converted to an I-REIT once the development is complete. With this flexibility the investors can choose to sell, reinvest or lease their shares or convert their shares into an I-REIT. This transition allows them to shift their focus from capital gains generated through development to the income-generating potential of the completed properties.

    • Income Real Estate Investment Trust (I-REITs)

An I-REIT is a type of REIT in which the investors pool their capital for purposes of acquiring long term income generating real estate including housing, commercial and other real estate. The investors gain through capital appreciation and rental income. The appreciation is usually distributed to unit-holders at the agreed duration.

Eligibility requirements to offer a real estate trust for I-REITs in Kenya

  1. They must be registered as Public Limited Liability Companies under the Companies Act of 2015 and have a minimum authorized share capital of Ksh. 100 Million.
  2. Property must be held in trust and professionally managed by a REIT manager
  3. The Trustee must be independent of the promoter
  4. Only persons qualifying as professional investors in D-REITs qualify to invest in restricted I-REITs
  5. If unrestricted, offer must be listed on an approved exchange (for instance the Nairobi Securities Exchange (NSE).
  6. If restricted, an offer may be listed but only on restricted exchange as per D-REIT made to professional investors.
  7. An I-REIT should invest, within two years of the date of its authorization as a real estate investment trust scheme, at least 75% of the total net asset value in income producing real estate.
  8. The investment must be an income generating real estate property
  9. At least one investment within 180 days of close of the offer or cash will be returned in full to the investors. During this period, funds to be held in trust account controlled by the trustee until registration
  10. Must be wholly owned and controlled company/corporation conducting real estate business
  11. May borrow upto 35% of the total assets value and up to 40% of the total asset value with approval of the unit holders by way of an ordinary resolution for a temporary period of up to 6 months. No extension is permitted.
  12. After the second year of authorization, at least 70% of the income must come from eligible investments in income producing real estate.

An I-REIT can develop properties

This is possible pursuant to Regulation 70 of the Capital Markets (REIT)(Collective Investment scheme) Regulations, 2013.

However, the Trustee of an I-REIT on the recommendation of an I-REIT manager and subject to the limiting conditions of the scheme documents, can acquire a real estate under construction, vacant land for development or carry out construction on vacant land for purposes of development provided that :-

  1. Total value of the land and cost of construction or cost of acquisition of real estate under construction does not exceed 15% of total asset value.
  2. Total value at acquisition, cost of vacant land held for development/construction by an I-REIT and the value of real estate that is not producing a commercial income at any time does not exceed 10% of the total asset value.
  3. Vacant land acquired by the I-REIT for development/ construction shall only be held for a maximum period of 3 years, after which it shall be developed and generate commercial income or sold.
  4. Incomes from other assets are sufficient to ensure that earnings of the fund per unit are not substantially diluted during the construction/ development period.
  5. The contract for any acquisition of property under construction is subject to the completion of the building and for an agreed fixed price.
  6. The REIT manager reasonably believes that the prospects for obtaining tenants for any property being developed at a commercial rent are good.
  7. Development contracts are carried out on the best available terms and at arm’s length transactions.
    • Islamic Real Estate Investment Trusts

This is a unique type of REIT which only undertakes Shari’ah compliant activities. A fund manager is required to do a compliance test before making an investment in this type of REIT to ensure it is Shari’ah compliant.

Regulation 122 states that where it is proposed that REIT securities be issued in respect of a real estate investment trust scheme which is to be offered or in any way represented as an Islamic REIT or Islamic securities, then in addition to complying with the provisions of the Act and the regulations, the Trustee shall:

    1. Prior to any offer or issue being made, appoint a Shari’ah adviser to assess the compliance status of the REIT scheme and in the event of the resignation, retirement or termination of such advisor, the trustee shall ensure that a substitute adviser is appointed as soon as is practicable;
      • In appointing a Shariah adviser, comply with the requirements on any law in Kenya and the views of any Kenyan regulatory authority and may take accounts of the views of any party whose views are influential or accepted as determining or ruling on Shariah principles applicable in Kenya , and
      • Together with the REIT manager, ensure that the Shariah adviser establishes and updates from time to time Shariah guidelines for the assistance of the trustee and the REIT manager and conducts Shariah compliant assessments:

-of the terms of the scheme documents and of the REIT securities

-on any real estate asset prior to acquisition or disposition

– of the tenants and changes in tenancy arrangements to ensure that only permissible activities and businesses are conducted by the tenants or if some non-permissible activities are conducted, then the level of such activities falls below the acceptable maximum and by how much

-on the method and terms of any borrowing or financing to be entered into in respect of the trust

– of any insurance contracts and the parties with whom such contracts or arrangements are entered into; and

– of the proposed method and terms of investment any eligible assets

4. The Shariah adviser shall, in addition to any other periodical report required to be prepared by the Authority and matters to be included in semi-annual and annual reports, prepare and submit to the trustee a report confirming compliance with Shariah principles.

5. In the case of an Islamic REIT, the trustee shall request a report from the Shariah adviser confirming that any acquisition or disposal shall not affect the compliance of the Islamic REIT with Shariah principles

6. The Trustee and REIT Manager shall consult the Shariah adviser whenever required and put in place a reporting mechanism and procedures to ensure that the continuing disclosure obligations under Regulation 42 are complied with as regards the compliance of an Islamic REIT and Islamic REIT securities with Shariah principles.

What to look for before investing in REITs

  1. Legal due diligence
  2. Yield in form of rates of return
  3. Previous performance
  4. Occupancy rates
  5. Debt accumulation level by the REIT
  6. Quality of Management
  7. Trends in the economy
  8. Liquidity of the REIT

Steps for investing in REITs

    1. Research and choose a REIT

Presently, in Kenya as of 2024, there are only four authorized REITs:

  1. ILAM Fahari I-REIT
  2. Acorn Student Accommodation I-REIT
  3. Acorn Student Accommodation D-REIT
  4. LAPTrust Imara I-REIT
    • Open a Brokerage Account

This account will serve as your gateway to the stock exchange, where REIT units are sold and bought. However, apart from a local broker, there are other ways of buying REIT units in Kenya such as through the Nairobi Stock Exchange or through a mutual fund that specializes in REIT investment as part of their investment portfolio.

    • Fund your Account

Deposit funds into your brokerage account. The amount you invest will determine the number of REIT units you can purchase.

    • Place your order

Once your account is funded, log in to your brokerage account and place an order to buy REIT units. Then keep monitoring your investment

Parties involved in REITs

The key players in REIT are; promoter, REIT manager, Trustee and Property/project manager

    1. Promoter- The promoter is regarded as the initial issuer of REIT securities and is involved in making submissions to the regulatory authorities to seek relevant approvals. This is the party involved in setting up a real estate investment trust scheme.
    • Trustee- A Company or corporation appointed under a trust deed and licensed by the CMA Authority to hold the real estate on behalf of all the investors. The company also ensures that the assets of the scheme are invested in accordance with the trust deed.
    • REIT Manager- This is a company that has been incorporated in Kenya and has been issued a license by the authority (CMA) to provide real estate management and fund management services for a REIT scheme on behalf of the investors.
    • Project/ Property Manager- The role of the Project manager is to oversee the planning and delivery of the construction projects in the REITs, while the property manager is involved in the day to day running of an I-REIT on behalf of the REIT manager.

Benefits of a REIT Investment

  1. Tax Benefits
    REITs enjoy various tax advantages in Kenya. They are exempt from Corporation tax, income tax, value added tax and stamp duty making them an attractive investment option. However, the gain accrued by an investor on the transfer of property into the REIT is subject to Capital Gains Tax (CGT) at a rate of 15 percent. In addition, REITs are subject to withholding tax on interest income and dividends.
  2. Stable and Consistent income
    Investors in I-REITs enjoy regular rental income, with regulations mandating the distribution of at least 80% of earnings as dividends to unit holders.
  3. Diversification
    Investing in REITs alongside fixed income securities and equities helps spread the risk across diverse asset classes, industries and sectors when combined into a single portfolio.
  4. Competitive Long-Term Returns
    REITs deliver robust, long-term yields, enhancing portfolio efficiency.
  5. Liquidity
    Unlike physical property, REIT investments offer greater liquidity, with units or shares easily tradable, particularly in publicly listed REITs.
  6. Access to Capital
    REITs enable pooling of funds for long-term Real Estate projects, supplementing existing capital sources like debt and equity markets
  7. No Shareholder Liability
    As is the case with equity investments in other publicly traded companies, shareholders have no personal liability for the debts of the REITs in which they invest.

Challenges facing REITs Investments

  1. Inconsistent rental income
    As a result of the termination of lease agreements or non- renewal of lease agreements and failure to secure replacement tenants in good time
  2. Barrier in accessing investments before the end of the stipulated period
    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.
  3. Lengthy Licensing and Approval Processes
    The licensing and approval procedures for REITs are arduous and time consuming, demanding extensive documentation and adherence to diverse legal and regulatory stipulations.
  4. Changes in taxes
    While REITs are currently exempt from Corporation tax, income tax, value added tax and stamp duty, these benefits may change depending on the regime in place.
  5. Market Volatility
    REITs are subject to real estate market cycles, which can result in market volatility due to economic changes, government regulations or political activity.
  6. Debt Financing
    In some cases, debt financing may be used by REITs, leading to higher interest rates, which could affect returns.

REITs vis -a -vis Private Real Estate Limited Companies in Kenya

A private Limited Company is a legal business entity formed by a group of individuals or shareholders. It offers limited liability protection to its owners and restricts the transferability of shares to a pre-determined group. This structure poses great drawbacks in Real Estate projects. The following is a highlight of the challenges likely to be encountered:-

Double Taxation

This occurs because the company pays corporation tax on its profits, and when these profits are distributed as dividends, shareholders must pay income tax on them. On the other hand, REITs are exempt from Corporation tax, income tax, Value added tax and stamp duty and only subject to income tax on the dividends.

Restricted Access to Capital Markets

Private limited companies have the maximum number of shareholders, which limits their ability to offer shares to the public or trade them on stock exchanges, limiting their ability to attract a wide range of investors and raise substantial capital. This restricted access to stock exchange markets can make it challenging for private limited companies to raise capital compared to REITs models that can easily trade in the stock exchange.

Limited Liquidity for Shareholders

Shareholders in a Private Limited Company often face limited liquidity options. Selling or transferring shares can be more challenging compared to publicly traded REITs. There may be restrictions on the transferability of shares, requiring the approval of other shareholders or compliance with specific procedures.

Limited Valuation and Marketability

Private Limited Company shares lack the regular valuation and marketability associated with publicly traded REIT stocks. The absence of a public market for the company’s shares can make it challenging to determine their fair value and negotiate transactions. This can impact the company’s ability to use its shares as currency for acquisitions or attracting key talent through stock-based compensation.

Reduced Visibility and Brand Recognition

REITs often enjoy higher visibility and brand recognition due to their listing on stock exchanges. Private Limited Companies, on the other hand, may have limited exposure to potential customers, partners, and stakeholders. This can impact the company’s ability to build a strong brand presence and compete effectively in the market.

Conclusion

REITs therefore present themselves as the most efficient vehicles to invest in income-earning-property courtesy of their tax efficiency. From the flexibility feature observed from REIT models, they can make an invaluable contribution in addressing the persistent affordable housing deficit in the country and this potential is yet to be fully tapped.

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