In April last year, the first Islamic Real Estate Investment Trust (iREIT) was listed in the GCC and it was none other than NASDAQ Dubai, which got a new and innovative investment class on its trading board. Emirates Islamic REIT, which raised $175m in its IPO in 2010, was then oversubscribed by 3.5 times. Although the US signed legislation to create the US REIT industry in 1960, the increased interest in iREITs was triggered by Malaysia in July 2006, with the innovative launch of the world’s first iREIT, Al-Aqar KPJ REIT.
By definition, REITs are an investment vehicle for all types of investors to participate in an asset class that has traditionally required large investment sizes, and iREITs must observe the principles of sharia. In addition, REITs provide the benefit of easy liquidity, meaning investors can buy and sell their units (if publicly traded) – something not possible with physical real estate. It is more like a mutual fund that invests in real estate, yet it differs on aspects of regulation.
It is important to understand that REITs are a wonderful combination of two different types of returns – regular income and capital appreciation. The income is generated mainly through a periodic cash flow – for instance, rental income from a house – while the capital appreciation comes by way of increase in value, such as price appreciation of a stock or in the value of a real estate property you own. REITs invest in income-generating assets and can vary from hospitals to commercial/retail properties, which provide rental income periodically.
It is important to understand that REITs are a wonderful combination of two different types of returns – regular income and capital appreciation
On a more international level, REITs are affiliated to key circles of the economy like apartments, self-storage centres, office buildings, hospitals and so on. In simple terms, REITs assure long-term, committed revenues to their shareholders. As per the Dubai Financial Services Authority (DFSA), a REIT is restricted to leverage at 70 percent of its total assets; not allowed to invest more than 30 percent in property under development; and must distribute 80 percent of audited income to shareholders.
As reported by REIT.com, the REIT industry in the US has flourished extensively in the past few years recroding $191.65bn in recession-hit 2008 to $670.33bn in 2013. This super growth of 249.8 percent shows that investors are looking for the promising aspects in REIT, especially in terms of hedging against inflation and as a regular income generator. The story does not end there however. The past 20 years in the REIT industry have revealed that across the 10 major categories, the Mortgage REIT has given a robust return of 77.35 percent, while the self-storage REIT has witnessed wonderful annual positive returns, with a mere three years of negative returns in its 20-year history. When it comes to average returns, REITs have yielded a very smart return, with a minimum of 10.84 percent to a maximum of 17.53 percent in last two decades (see Fig. 1).
From the Asia Pacific side, Malaysia has got the highest number of REITs listed on the exchange since the first iREIT launched in 2006. The Islamic Republic currently has 14 REITs, three of which are sharia-compliant, with each REIT specialising in a different asset subclass. On average, REITs are returning 6.83 percent to investors. Specifically, YTL Hospitality – a diversified REIT, is earning the best yield of 9.56 percent while the minimum of 5.12 percent was awarded by Pavilion, a mall-oriented REIT.
The concept of REITs is not new in the GCC, but it is indeed very fresh in terms of its implementation and adaptability. In the past, REITs in the GCC have not gone on to fulfil their potential for several reasons.
One such reason was the global financial crisis in 2008. From 2006, most of the GCC members were trying their best to formulate a regulatory framework, but when the crisis struck, it took with it any realistic chance of progression. Kuwait and Bahrain along with the UAE (especially Dubai) were front runners, as major real estate players in these three countries were looking towards real estate-friendly, small investors to invest in a REIT pool. Unfortunately, the eruption of the 2008 crisis, which caused property prices to crash by more than 50 percent, forced them to roll back their plans.
Another hindrance is a lack of clear regulations in the industry. Only Dubai, via Dubai International Financial Centre and Bahrain took a lead and rolled out REITs-type regulations in 2006 and 2009 respectively. Saudi Arabia, the biggest market in the GCC, is yet to disclose any legal structure pertaining to REITs.
In addition, there are no tax benefits. The biggest incentive of REITs is not to pay any tax, but as the region does not book any rule on tax; and investors earn most of their income tax free, it remains highly inapplicable in such a format.
Finally, there are limits in place for foreign ownership. Though Saudi Arabia has planned to open its stock market for foreign institutional investors, many GCC nations have limitations on foreign ownership for real estate, thus making the development and growth opportunities of these trusts less appealing worldwide.
In the past, specifically before the crisis, investors avoided these type of products, mainly because they wanted a quick appreciation in their investments, which REITs do not offer because of their structure. Furthermore, private and closed REITs (not listed) further intensified the liquidity pain for investors due to their illiquid nature. However, after 2008, the sector underwent quite the turnaround and investors began to realise the importance of regular returns, attached with such a product. They began to reassess this unique real estate specialised product with an affirmation and adoption. Investment managers also conceded to add a ‘public trading’ feature, so as to make REITs more viable and adaptable among the investor community.
Moreover, to infuse higher interest for the product, particularly among Islamic investors (high-net-worth individuals), iREITs became priorities for various investment companies and market regulators. These developments did not happen overnight; the intense efforts of the Securities Commission of Malaysia remained a key force behind this change. The legal body took a lead by providing a suitable environment through clarity of regulation and incentives to support the development of iREITs across the globe. Investors, for whom the stock market was the sole investment option apart from fixed deposits or similar traditional investment products, have already started looking affirmatively towards REITs, in a bid to diversify their assets class.
Currently, most of the REITs running in the GCC region are private and closed, either due to lack of regulations or by their nature, with Emirates REIT an exception (see Fig. 2). Though, Kuwait was the first to launch an iREIT in 2007 (in the GCC), the public listing of Emirates REIT has infused a new investment phenomenon among GCC investors who feel that it is the right time to seek income producing assets/vehicles, rather than taking persisting volatile risks of market.
Even though iREITs have witnessed a few issues in the GCC and Middle East during the past eight years, the prospects for the trusts in the region are still promising. Reviving sentiments in the industry are assuring for a better REIT market; as unveiled during the Emirates REIT listing. Property prices and rents are on the recovery path, which are quite favourable to REIT. iREITs are becoming more popular primarily due to their permissible structure as per sharia law and, believing in its potential, one should not be surprised if the industry taps a significant share in the trillion dollar Islamic finance industry.
REITs’ affiliation with low correlation, common stocks (as a potential hedge against inflation), high dividend yields, and the higher certainty of income, are just some of the characteristics which are attracting the attention of high-net-worth individuals. The rising interest in iREITs, as shown in the Asian Pacific region, across Singapore and Malaysia, and the regular floating of REITs IPOs, suggests that the GCC remains a region of opportunity due to the massive wealth it carries, and the limited availability of this product.