Real-Estate Financing Market To be Democratized

Sri Lanka’s small investors will soon be able to invest in large scale real-estate such as office space, shopping malls and apartment complexes through the stock exchange, as the capital market regulator, is currently working with the Colombo Stock Exchange (CSE) to introduce a realestate-based securities product next year.

To this end, the Securities and Exchange Commission (SEC) will introduce Real Estate Investment Trust (REIT), which will function similar to Unit Trusts (UTs), where small investors could pool their funds and invest in large scale real-estate projects.“The product is still at the designing stage, so we are currently studying the exchanges in Singapore and India to learn how they operate,” SEC Chairman Dr. Nalaka Godahewa said.

Dr.Godahewa however noted that the final proposal in relation to REIT would most likely be submitted at the SEC commission meeting to be held before the end of this year.REITs will democratize the high-end, large scale real-estate financing market which is hitherto dominated by a wealthy few and larger corporates in the country.

SEC, as custom, will initiate a public consultation prior to introducing the product, seeking submissions from interested parties and the general public. This process is most likely to occur early next year.The regulatory framework is currently being drafted with the assistance of the proponents of this investment vehicle, in order to protect potential investors and to avoid double taxation at corporate and individual levels.REIT is a well-timed initiative at a time when the Sri Lanka’s property market is poised for a boom after the end of a 26-year internal conflict.Further, REIT is also likely to shift the current state-led, external debt-driven, physical development model to a more sustainable, private investment-driven construction model.

While the returns could be higher than the alternative stock investments by the booming real-estate sector in Sri Lanka, REIT also have the down side risk of drop in property prices as seen during the 2007/8 global financial crisis triggered by the US sub prime mortgage crisis.In the US, money was invested in mortgage-backed securities and collateralized debt obligations where illiquid financial assets were transformed into liquid and tradable capital market instruments.

Introduction of new financial products is also part of SEC’s 3-year,10-point road map announced in 2012 to increase the market liquidity and to create a vibrant capital market which is hitherto dominated by stocks and corporate bonds.Since end of 2012, the SEC has progressed through a majority of the projects outlined in the road map with only a few, including introduction of the Central Counterparty Clearing House (CCP), yet to be implemented.

However, the CSE has reached a stage where they would forge an agreement with a foreign consultancy firm this week to kick start the project which will take between 12 to 18 months to fully implement.CCP is a joint project between CSE, SEC and the Central Bank. Currently the share transactions in the Colombo bourse are taken place with a significant counter party risk with no intermediary to guarantee the settlement.

Hence CCP will safeguard the counter parties to a transaction – both buyer and seller of a security – from the risk of default.Apart from t he REIT, SEC is also working on to introduce Exchange Traded Funds (ETFs) to the Sri Lankan capital market.ETF is a security that tracks an index, a commodity or a basket of assets like an index fund, but trades like a stock on an exchange. ETFs experience price changes throughout the day as they are bought and sold.