Real estate stakeholders in Kenya have a reason to smile after the 2011/2012 budget due to the introduction of real estate investment trusts. The CMA (REIT) Regulations of 2009 are drafted and will have a great impact on the real estate sector. In this column I have zeroed in on the financial impact of the REIT introduction on real estate developers.
Construction finance has been a long term challenge for many would be developers. Infact large construction projects are only undertaken by developers with financial muscle. An average construction project runs into the hundreds of millions a figure out of reach for many. The real estate development sector is limited to developers with ability. Yet many developers have developed innovative concepts for the real estate sector.
The options for construction finance are limited. Traditionally the most common form of construction finance has been debt finance from financial institutions. The developer may take out a loan and issue alternative security or in most cases, secure the land on which the development is undertaken. The income from the development is then used to service the loan. Repayment of the loan is pegged on the sales. The risk from debt financing is very high due to the fact the income may be uncertain. A developer may find himself in a dilemma if the units constructed do not sell or if the construction does not occur fast enough. This kind of scenario leaves the developer exposed to penalty interest and other undesirable costs.
Equity finance has also been used to finance construction projects though it is rarely used and is for the risk takers. Many landowners are very sceptical of equity finance due to the fact that there is an element of dilution of ownership. Most people want to hold on to ownership of their land and prefer debt finance to equity. There are several ways to finance a construction project using equity but the most common model is through the formation of joint ventures. The most simple is for the land owner to contribute his land into the venture while the developer or financier provides the capital required for construction. The sales are then split pro rata the contribution of each partner. Another common way of financing construction projects in Kenya has been through formation of a new entity with developers. Many foreign investors are keen on investing in developing countries and are therefore willing to pump in equity capital into a real estate venture. Once they recover their investment and get the required return then they exit the project.
The two have worked for construction finance. However real estate developers have been presented with a new alternative to construction finance through the REITs. The developer approaches a registered Trustee under the REIT regulations and forms a REIT. The developer would be the sponsor of the REIT while the Trustee, a financial institution registered under the Regulations acts as the trustee to the scheme. Once the concept of the REIT is agreed upon then the same can be registered with the CMA. Section 5 of the Regulations set out the requirements of registration of a REIT. Amongst the other persons the sponsors must approach is a registered REIT manager who shall manage the scheme on behalf of all the unit holders, be they the sponsors or the new unit holders. To form a REIT the developer must have a trust deed drawn up and a management agreement between the trustees and the REIT manager.
Once all the regulatory approvals for the REIT are passed, then the REIT can access funds from the public. The schemes may be listed whereby the public is invited to invest in them. However it is not compulsory for them to be listed and if they are not then they have to be registered with the CMA and must provide for ease of transferability of shares.
A loose and simple form of REITs has always been in existence in Kenya. The infamous land buying companies of the 1990s were a loose form of REITs in that investment into real estate was done through a pooled fund. The promoters would form a land buying company and invite persons to subscribe in its shares with the promise that the company would acquire a large tract of land and thereafter subdivide portions for the benefit of the shareholders. More often than not the subscribers ended up losing their money to the promoters. However the REITs are heavily regulated by the CMA and it is difficult for an investor to lose his investment due to fraud or such other misrepresentations.
The introduction of REITs is therefore very welcome for the public as well as the developers and promoters.