FOUR parties from Lahore, including a private school chain, have approached the Securities and Exchange Commission of Pakistan (SECP) for securing licences for setting up the Real Estate Investment Trust (Reit). But, insiders say the commission may take a few months to issue the first-ever licence to a Reit Management Company (RMC).

The general business attitude is that of wait and see. Political uncertainty is one of the reasons behind the reluctance of investors to venture at the moment into the domain of Reits that requires a real estate with a minimum value of Rs5 billion. Other hurdles include property laws and taxes.

The Reits are designed to provide a structure for investment in real estate similar to mutual funds which offer for investment in stocks. A Reit is a security that sells like a stock. Its rules allow indirect investment in real estate that are expected to yield, in most of the cases, 90 per cent of its profit in the shape of dividends to shareholders.

Head of the SECP’s Speacialised Company Division (SCD) Salman Ali Shaikh told Dawn that the Reits process was naturally time-consuming keeping in view the big amount of money involved in this business. In Malaysia, he said, there were only 22 Reits so far, in Europe, the Middle East and Africa (EMEA) the number of Reits was just 102. He said that despite several legal and tax-related issues at the provincial and federal levels, there was still a good Reits market potential.

He said there were several organisations that owned real estate and were best suited for launching RMCs i.e. the Pakistan Railways, hotel and school chains, shopping malls and owners of commercial buildings. Reits are for the time being close-ended and can be set up in Karachi, Lahore, Peshawar, Quetta and Islamabad.

“It took Malaysia more than seven years to register 22 Reits. I think it will be a success if SECP registers five to seven Reits in the first year of its launching,” Mr Salman observed.

With reference to global trend, he said the number of Reits in North America declined from 253 in 2006 to 195 last year. But, Asia was still a booming market for Reits. Globally the size of Reits’ investment was around $1.273 trillion in 2007 -- a 26 per cent increase over the previous year.

He said to promote this product certain legislations were required and some others were needed to be removed and amended at the provincial level.

Now, the SECP is faced with an uphill task of making this new product a success. At present, there is no method of price discovery in the real estate sector. Only a handful of properties are with transparent leases. Real estate is a vehicle for turning their black money into white.

A report of the SECP experts, who have investigated the prospects for Reits , have found up to 900 pc of differential between the real price and recorded price of real estate in Karachi. Another issue is the tax load that is as high as 28 per cent.

According to the SECP, the cost of eight kanal of land in Lahore is around Rs1 billion these days, while a plot of similar size and location is priced at Rs1.2 billion in Karachi. The registration fee for eight kanal is Rs10 million or one per cent of the total value of the land each in Lahore and Karachi. The stamp duty on this much land is Rs20 million (two per cent of the total land value) in Lahore and Rs36million (three per cent of the total land value) in Karachi. Buyers have to pay Rs10 million as transfer fee on eight kanal in Lahore and Rs10 million in Karachi. Commercialisation fee of this land in Lahore is Rs200 million (20 pc of the land value). In Karachi, commercialisation fee is Rs8,000 per square yard that can take the commercialisation fee amount to Rs32 million.

Moreover, the government has imposed two per cent Capital Value Tax (CVT). The overall tax load on registration and commercialisation of eight kanal is 28 per cent i.e. Rs290 million in Lahore and Rs166 million in Karachi. The experts also found that the land value in Islamabad can be higher than land in Southern Europe.

Now, the SECP has recommended the federal government to abolish CVT. It is of the view that CVT should have not been imposed by the federal government in the first place as it was a provincial matter. The commission also seeks abrogation of rent control law in Islamabad. The central government has already provided exemption from tax to sellers of property to Reits till 2010 and reduced the tax on rental income to five per cent, which are positive signs.

But, some vital recommendations of the SECP’s for the provinces are yet to be accepted that is likely to adversely impact Reits in its initial phase. The commission has sought abrogation of the provincial rent control laws and development of a new law (condominium law). It has also proposed reduction in transaction costs –stamp duties, registration and commercialisation fees and other levies.

The Punjab’s new draft Rental Law suffers from the same lacunas. The existing 10pc annual rent increase needs to be abolished as it imposes unnecessary hurdle in supply of rentable properties.

Due to very high property tax rates and commercialisation fee, rental Reits are not feasible in Lahore. The development of rental Reits are more likely to emerge in those areas of Lahore, which do not fall in the jurisdiction of the Lahore Development Authority (LDA). The existing laws in Quetta and Peshawar are not favourable at all. The SECP is now asking the government that the total tax load on real estate transaction should not exceed 4-5 per cent, which is in line with international best practices and may discourage under-valuation of property. It has also proposed changes in the method of calculation of commercialisation fees/property taxes to a covered area formula with zero tax for aesthetics (e.g. parks, fountains) and utilities (car parks, toilets).