Almost everyone knows that real estate is one of the most lucrative investment vehicles. Most investors rely on the traditional buy and sell or rent to build their wealth but over the years the real estate market has seen a number of innovative investment methods. One of these is the Real Estate Investment Trust (REIT).
REIT basically stands for Real Estate Investment Trust. These are corporations that own real estate on behalf of their investors. A REIT is a vehicle through which investors earn a share of the income produced through commercial real estate ownership without actually having to go out and acquire commercial real estate.
REITs also allow the investor the opportunity to have their properties managed by a professional real estate team that knows the industry and understands the business. REITs have been touted as an innovative way to invest in Real estate that allows investors to venture into the real estate market without incurring the large capital requirements which act as a barrier to entry. With REITs, investors can own a portion of the income-generating property and earn a return on their investment.
There are various types of REITs classified by how they are traded (private vs. public), type of assets (equity vs. mortgage), and what sectors they operate in. More to that, REITs can also generally exist in three forms;
- Development REIT (D-REIT) – Where the REIT focuses on the development of real estate projects and investors earn returns upon sale of the project.
- Income REIT (I-REIT) – where the REIT derives income from the rental income of its commercial property. This rental income is distributed among investors.
- Islamic REIT. This type of REIT focuses mainly on shariah-compliant real estate projects.
So how does a REIT work?
In a nutshell, REITs promoters source funds from investors to build or acquire real estate assets, which they sell or rent to generate income. The income generated is then distributed to the investors as returns in investing in REITs.
The parties in a REIT are generally the promoter, the REIT manager, the project/ property manager, and the trustees. A REIT promoter has the prospective project in mind but may lack the finances. They can then issue a REIT where potential investors contribute capital by buying units in the REIT. The investors then own a stake in the project but they do not participate in the active operations. A trustee is entrusted with the role of overseeing the project and they may, in turn, engage a property or project manager to run the day-to-day of the project. The income obtained from the property is then proportionally distributed to the investors.
A REIT enables property developers to access alternative sources of funding other than banks and at the same time enable investors to passively get into real estate investment without having to physically own the property.
Some of the benefits of investing in REITs include liquidity where units in a REIT can easily be traded especially if they are listed in the stock market. As opposed to traditional property ownership where illiquidity is one of the biggest drawbacks, a REIT allows an investor to easily trade the units they own in an asset to create liquidity. Additionally, REITs generally have a number of tax benefits which include;
i) REITs registered by the Commissioner of Income Tax are exempted from income tax except for the payment of withholding tax on interest income and dividends,
ii) Transfer of properties to a REIT also attracts a stamp duty exemption, as per Section 96A (1) (b) of the Stamp Duty Act.
iii) REITs’ companies are exempted from income tax as stated in the Finance Bill 2019, section 20 of the Income Tax Act,
Some of the drawbacks of REITs include high minimum investments especially in Kenya where the minimum amount required is Ksh. 5 million. This effectively eliminates prospective investors who cannot come up with this amount.
REITs in Kenya have also suffered from low uptake by investors due to inadequate knowledge of the scheme.
In conclusion, REITs present themselves as a lucrative investment vehicle that provides passive income to investors. While REITs are yet to pick up the pace in the country, it would be wise to increase their publicity to help improve their performance.