Can the real estate investment trusts (REITs) prosper in the existing real estate regime marred by under valuation of property and absence of proper accounting system?

Has any homework been done on how the transition from the current mode for property registration will be made to a more fairly documented tax regime prior to launching REITs?

Will the present non-corporate real estate market adopt transparency, proper evaluation and accounting in official documentation in case of the REITs or will the later stand alone in the system as a threat to the status quo?

The Securities and Exchange Commission of Pakistan (SECP) is now ready to receive applications for REIT’s licences. When REITs go into operation, their mode of business will come to surface..

Real estate experts fear that REITs landscape is likely to be dominated by the same old faces allegedly involved in “scams” and building luxurious housing schemes besides a good number of retired army officers already well-entrenched in this sector.

Will these veteran property agents and builders be ready for transparency and for proper evaluation of real estate once they form REITs, list them on the stock market and sell their shares to the public?

Historically, a fair valuation of property has been missing link. In most cases, property under transaction is grossly undervalued to avoid taxes. This problem can prove as an impediment in the way of REITs’ success. There is a need for the government to ensure fair property valuation and documentation across the country’s real estate market.

For this, the government has to introduce proper accounting system across the board. While, under valuation of property is the hallmark of the real estate market, the incidences of over valuations can’t be ruled out once REITs are operational. The REITs will hold portfolios of commercial or residential property. They will receive income from tenants and then distribute it to investors, less whatever the trust needs to service its debt, maintain buildings and pay expenses etc.

Last month, a major Australian REIT, Centro Properties hit by a credit crisis defaulted on $450million in debt. Centro offered lenders collateral for its $1.3 billion debt refinancing, which is now worth as little as $750-800 million. It was due to huge over-valuations on its assets.

In a market in which people can easily get away with under-valuation, it will also be a disadvantage for REITs to report the actual cost of land they buy. For example, REITs, like non-REIT real estate businesses, will have to pay 17 per cent tax to the government for buying and developing property in Lahore. This includes three per cent stamp duty to be paid to the provincial government, one per cent registration and corporation fee each payable to the local government and city administration respectively, two per cent capital value tax to be paid to the federal government and 10 per cent commercialisation charges payable to the Lahore Development Authority (LDA).

The REITs Task Force and the Housing Advisory Group of the State Bank of Pakistan (SBP) have suggested that the government must develop an electronic registry system which must keep the records of attachment orders and decrees issued by various courts in property cases. This will help discourage the buying of property with fake or vague ownership.

The REITs have been provided with tax exemption, if 90 per cent of the income is distributed among the unit holders. Under the SECP’s regulations, REITs income is exempted from tax, but the dividends to be paid to the shareholders are taxable. This is now being considered a disincentive for the shareholders.

Legal experts also believe that the federal government has no right to tax gains on the sale of immovable property. It is considered to be the right of the provinces.

Sarwat Aftab, Joint Director (REITs) SECP, told Dawn that the market response has been positive to REITs , keeping in view the stable returns which such trusts provide compared to stocks. She said for the time being REITs were being launched in the country’s two largest cities – Lahore and Karachi.

She said the SECP will award licences to those interested parties which fulfil the criteria no matter to which section of the society they belong.

“We will be more than happy to award licenses to anyone who is fulfilling the application requirements no matter whether they are mutual funds, real estate agents or who- so- ever,” Ms Aftab observed.

With a population growth of two per cent, rapid urbanisation (3.5 per cent) and a housing backlog crossing seven million units, Pakistan is considered to be a good market for REITs.

But, REITs will have to be different from the recent bank ventures to finance cars and housing mortgage. In these two cases, there are more loan defaults than predicted earlier.

According to a recent report of Ernst & Young, the REIT landscape has experienced some major shifts in 2007. It noted that the global REIT market, as a whole, has grown, as evident from all key indices, including market capitalisation, volume of trading over the year and total rate of return, and a total market capitalisation of $764 billion---a $156 billion increase from 2006.

Much of this growth can be attributed to Asia’s REIT market, which has experienced strong performance in stock prices, total return and dividend yields. The number of REITs in Asia has grown faster than in any other region. Singapore’s attractive regulatory environment, Japan’s increased stock market activity and foreign investment and South Korea’s impressive stock prices and dividend yields contributed to Asia’s success..

But, Pakistan needs to bring changes in its existing real estate market to make REITs a success.