With the advent of Real Estate Investment Trusts (REIT) into the Sri Lankan capital market in August this year, the Securities Exchange Commission (SEC) says it is making progress with efforts to grow awareness on the new instrument.
As part of this measure, a seminar on Sri Lanka REITs was held in Colombo last week to educate stakeholders on this new investment opportunity through the capital market, and a book published by the SEC for this purpose was handed over by its Chairman Viraj Dayaratne, to State Minister for Finance and Capital Markets Ajith Nivard Cabraal.
REITs have been in existence for a considerable length of time in other markets – from the 1960s in the US, where today over 87 million individuals have invested in REITs. Addressing the forum, Dayaratne said soon after new Commission members took over at the SEC earlier this year, they were keen to introduce a new product and awareness is critical to ensure its success.
“When we had to decide on the product, we had to see what was suitable for Sri Lanka and at this time. There was a lot of discussions about introducing derivatives to Sri Lanka, but we felt it was a little too early. REITs had been spoken of for some time, with several rounds of consultations. Investments in real estate are popular in Sri Lanka. Property prices go up almost daily, and people have paid for this type of investments. Therefore, we believe anything to do with Real Estate would become popular,” Dayaratne said.
To introduce REITs, the SEC had to ensure the necessary legal framework to invest in them. It found the existing law on Unit Trusts provided for REITs, by simply bringing in additional rules by way of a gazette that was published in end July.
With REITs, buildings are brought into the system and the rent income that is generated by letting space is distributed amongst unit holders. Any building including office space, apartments, malls, hotels, hospitals can be brought into a REIT, as long it satisfies specified requirements. For instance, the building must be fully complete and secondly it should have a minimum occupancy of 20%. Importantly, it should be an income generating property.
Explaining why investors and the public should invest in REITs, Dayaratne said the SEC rules mandate that 90% of income generated must be distributed amongst unit holders, and therefore there are guaranteed returns. He also explained that projects such as power generation which have a short period of completion can be brought into REITs as well.
“The Government has shown its commitment towards improving or developing capital markets, and one of best examples for that is our Chief Guest who is a Minister for Capital Markets; that shows the commitment of the government to its development. Honourable Minister we seek your support in trying to address this issue of Stamp Duty, and I’m confident we can overcome that. There can be some mechanism where we either do away with Stamp Duty altogether, or maybe we can reduce the present percentage, or we could have a grace period until this gets off the ground and becomes popular. There has already been a lot of interest shown which is encouraging,” Dayaratne stated.
Also addressing the gathering was Dayanath Jayasuriya, former Chairman of the SEC, who touched on potential concerns for the sector stated there can be governance issues between the property manager and the trustees, which can be mitigated by showing preference to public listed REITs, whilst people must also carefully consider overleveraged balance sheets. He also pointed out that Malaysian authorities recognised there was a need to grant maximum tax benefits to REITs, and when properties were sold they were exempt from stamp duty. This demonstrates the level of Government interest and backing it must receive to make REITs work.
“A problem experienced in many countries is that the trustees’ fees and management fees tend to be on the very high side. Some countries have regulated these fees, but it would depend on how the management and the trustees wish to proceed on their operations. Another problem we encountered with rules is that only those that are free from all encumbrances are entitled to be listed. So, if you look at an apartment complex, most of the property developers mortgage the entirety of the property with banks. There are instances where a client has paid the full amount, but they have not got the title deed. The reason is banks have not released the developer from the obligations in terms of the facility that has been taken. So, there could be questions whether the property in the REIT is with encumbrances or not. The Sri Lankan law says it must be free from all encumbrances to qualify,” Jayasuriya explained.
Lending further perspective, with property developers offering a 7% bank guaranteed return, this indicated the level of return and trust the real estate industry has kept on growth over a period, either as regular returns or capital appreciation, added SEC Director Corporate Affairs Harshana Suriapperuma. Allaying concerns express earlier on management fees, Suriapperuma explained that with SLREIT the managing company’s fees are capped at a maximum of 4%, which presents an advantage to investors. Since it is a new product, leveraging is also capped at 30% until the market becomes more savvy and able to fully understand the dynamics of REITs, he said. REITs are also open to the government sector, particularly with infrastructure projects, he added.
“This is nothing but the right time for the capital market regulator to engage and facilitate a product that goes hand in hand with industry expectations and stakeholders. There are various events during the life of a REIT that require the approval of the SECC. However, to start a REIT you only need one approval from the SEC. Even the gazette has set a timeline for the regulators within which we have to provide an approval or show cause – which is 30 days. We do not allow loss-making REITs to come into the system, as we must safeguard the interests of the investing public.”
“For an investor or developer, once a project is complete instead of waiting 20 years to recover the money, they could quickly transfer the property into a REIT; cash the project and move onto the next one. The country will benefit and this creates opportunities for new investments. REITs are a sub-species of Unit Trusts, so we expect the same tax pass through benefit to be available to REITs as well. Investors will get the distributable dividend income free of any tax,” Suriapperuma said.
Addressing the gathering, State Minister of Finance and Capital Markets Ajith Nivard Cabraal said REITS was first conceived for Sri Lanka in 2013 to be born in 2014 and shifted to 2015. He said it underwent some difficult situations after that but has finally seen the light of day in 2020. He stressed on the need to make the Sri Lankan capital market sector more robust, and the time was right with the prevalence of new instruments coupled with digitalisation.
“The market has reduced from over $ 25 billion to $ 12.5 billion even though five years of profits were made by these shares. But it also shows there is a major gap that can be filled with proper products and confidence in our markets. We also saw that when foreigners sold there were Sri Lankans to buy. For a long period there was concern this was a thin market, and foreigners used this as an excuse to demand low prices. But these last few months as foreigners exit Sri Lankans would buy those shares, which shows that it’s not so thin after all.
That’s a good signal we have given to worldwide investors. I would like to see our market reaching out towards the $ 60 billion mark from the current 15 billion over the next five years. It’s a target that we can reach I am confident it can be done,” Cabraal said.
(FT)