JLL calls for re-evaluation of regulatory and legal mechanisms for introduction of REITs

Global real-estate consulting powerhouse Jones Lang LaSalle (JLL) called for a re-evaluation of the regulatory and legal mechanisms around Real Estate Investment Trusts (REITs) as a vital first step towards their introduction into the domestic market.

In a global context, Real Estate Investment Trusts (REITs) have become an integral part of the investment landscape, accepted by individual and institutional investors, alike, as providing greater access to commercial real estate projects.

In Sri Lanka too, the potential benefits to the domestic economy from the introduction of REITs are significant. Their introduction will likely signal stronger economic growth and job creation, but moreover, REITs provide a platform for much needed foreign direct investment in Sri Lanka without transferring the ownership of the real estate asset to the foreign investor. Given the current regulations around foreign ownership, we believe that REITs are one of the most viable mechanisms for attracting investment into Sri Lanka’s commercial real estate sector,” JLL observed.

Defined as a company that acquires, owns and operates income producing real estate assets, which typically include apartment blocks, commercial office buildings, shopping malls, hotels, warehouses and industrial buildings, their requirements for external funding means that REITs are typically listed on a country’s stock exchange and unit holders are able to purchase shares via an initial public offering (IPO) or on an exchange platform.

The funds collected through this mechanism are invested in a diverse portfolio of professionally managed real estate assets and, the income thus derived, by renting, leasing, or selling those assets, after costs, is distributed directly to unit holders, by way of a dividend.

However, JLL noted that prior to the introduction of REITs to the domestic market, significant reforms would be necessary in relation to Sri Lanka’s legal and regulatory frameworks in order to ensure sufficiently robust safeguards and procedural mechanisms to enable a secure foundation for REITs to flourish.

“Establishing REITs in a new market depends heavily upon support from local regulatory bodies and authorities including the implementation of a Unit Trust Code, but there also needs to be an efficient and stable tax regime in place to instill confidence in investors. In addition to transparent taxation policies, that are required to be applied in an equitable fashion, there is a need for certain limited tax concessions to stimulate yields and make REITs more attractive,” statedJLL, citing the example of stamp duty as one area where concessions could be applied.

“Several studies have shown that the socio-economic benefits provided by REITs outweigh any losses in tax revenue, and supportive policies, along with international standards of corporate governance are essential to entice foreign investors who are, in turn, the lifeblood to the longer term prosperity of REITs in the country,” it noted.

Current restrictions on foreigners owning land in Sri Lanka have been a significant hurdle to foreign capital inflows in Sri Lanka, however JLL noted that if regulations were enacted to help mitigate these challenges while still ensuring that the title of a given property is not directly transferred to a foreign investor, then a significant obstacle to the establishment of REITs in Sri Lanka would have been cleared.

First established in the USA in 1960, REITs are widely regarded as investment vehicles that democratize real estate ownership, enabling retail investors to take a diversified stake in real estate, something that they, in all probability, could not achieve as individual investors. The benefits to individual investors are well documented, including greater access to commercial real estate projects, but also a secure and stable income stream, derived from multi-year lease contracts from the real estate assets held, swift entry and exit options, via exchange listings, which effectively turn an illiquid asset class, real estate, liquid, and the prospect of steady long term appreciation. Unlike stocks and shares, the value of the underlying assets is more insulated from business cycle pressures.

While REITs are yet to be introduced in Sri Lanka, the Asian REIT market is now valued at approximately US$180 billion with Singapore, Hong Kong and Japan being the clear market leaders. The REIT market in Singapore alone was worth US$38 billion, in 2012, and these figures encouraged Pakistan to launch the first South Asian REIT ahead, even, of India in 2015.

“The raft of benefits to the Sri Lankan economy presented by the introduction of REITs is surely too tempting to resist for much longer, but, this is only one side of the coin. Authorities and regulators in Sri Lanka must clearly understand that for REITs to flourish in the longer run, they must focus on establishing a conducive environment to encourage corporate and investor participation.

“This needs to be supported by strong corporate governance, a commitment to transparency and a stable taxation regime, before the investor community embraces Sri Lanka’s hesitant first steps into the REIT arena,” JLL concluded.