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Monday, February 13, 2017

What are REITs and how they work.

They knew it or not but when group of merchants raised money for the Boston pier in 1772, they were early pioneers of vehicle called REIT. The financing structure for the pier – merchants owned the land together and shared the rent-after 250 years has become an important way for investors to earn hefty returns.

The idea behind REIT is simple raise money from investors, buy property and share more than 90% of its earnings back to investors. REITs have become an active tool to avoid taxes. Many businesses started taking advantage of this structure and arranged themselves as REITS.
Empire state building owned by Empire State Realty Trust is one such building. The massive revenues generated by visitors and rental income are distributed to the investors.

REITs take money from retail investors, pool it and then invest it in real estate and related projects. Real estate is capital intensive business and pooled funds enable individual investors to own piece of lucrative real assets, much bigger than they could manage or afford on their own. Apart from pooling of funds REITs also offers investors the benefit of economies of scale.  

Furthermore, owning real assets through REITs keep you away from hassle of managing your property. The collection of rent and maintenance is outsourced to REIT.

The dearth of available options and illiquidity in realty sector makes REITs an attractive option for small investors.

Investing in REITs is like investing in real economy, unlike stock and bonds. REITs are considered good alternative to bond markets and is considered to move in opposite direction to stock market.

REITs are also tax-efficient structure as they are treated as pipes, structure whose returns are only taxed in the hands of investors. Its tax efficient character is major attraction for many businesses to register themselves as REITs.

These are more liquid than other forms of investments and attract new classes of investors. Moreover they allow industrial companies and insurers to realize the value of properties lying idle on their books.

Till date there are 05 REITs management companies operating in Pakistan.  The number of REITs and asset under management is abysmally low. The number can be compared with more than 40 mutual funds for the stock market, worth capitalization of 75 billion $. Real estate market is worth a lot more than that and even then there are only two REITs available to investors.
Although Real estate took a nosedive after imposition of transaction tax on the sector in the last budget, but it rebounded quickly owing to host of reasons.

Real estate can offer tremendous growth to investors because of CPEC impetus, Trump effect and rising unemployment of workers in Saudi Arabia, home to some 2 million Pakistani workers.

Realty is a save venue for parking untaxed wealth, and therefore expected to grow upward. Moreover, the development in Gwadar would help Pakistan become a transport hub for international trade, which would increase property prices beyond the present level.

Commercial as well as residential property market is facing shortage of supply. It is expected that in 2025 Pakistan will be facing shortage of 20 million housing units. The pooling of funds from savers and using it for development of residential and commercial spaces will be a lucrative option for entrepreneurs and investors at the same time offering living and working spaces to growing population. The growing cement and construction sector will have excess capacity after the completion of CPEC and it would be viable option to use that capacity for construction. 

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