REITS IN KENYA – Your Thoughts?

Came across this article by Christopher Grune, Jua Miradi Kampuni Ltd from Apr 22nd 2014….your thoughts?

The Nairobi Securities Exchange is the most active equity market in East Africa, so it was natural that it would be at the forefront of listing new types of investment products. REITS–Real Estate Investment Trusts–are new to Kenya but other countries have a lengthy history with these hybrid equity products. The legislation for REITS has been in the works for some time, but only finalized and the CMA Act modified to incorporate them, last year.

Let’s look at a few points that make REITS particularly attractive in Kenya but also consider how investors can weigh these securities against other investments.

Investor Preferences

It would be fairly uncontroversial to state that there is a local affinity for owning land. The transparency of listing on an exchange and a relatively low required initial investment means REITs will make land accessible to retail investors. These features alone should make REITs a hit in the local market. But there are other attractive aspects.

Risk Mitigation

Investors in REITs will be in effect hiring professional investors to do due diligence for them on a large scale, with the cost of such services lowered by spreading it across all shareholders. If real estate is about “location, location, location,” then REITs will provide a valuable type of diversity for property investments. Rather than investing a sizable amount in a single plot in one region as an individual might do, they will spread valuation and development risks across projects in at least several locations. Compared to equity investments in a single listed company, REITs may also provide more diversification across the broader economy with residential projects reflecting personal income and the job market and commercial property spanning many industries at once.

Yield Attractiveness

Kenya is a high interest rate country and there are numerous choices in the fixed income market to achieve double digit rates. For example, some banks offer in excess of 10% on large-sized time deposits, the on-the-run 10-year treasury bond was recently auctioned at 12% and there are several corporate bonds which have been issued at par carrying an even higher coupon. So REITs may not stand out as one of the only ways to generate a high level of consistent investment income. This compares to countries like Japan and the US, where rates are low or effectively zero but where REITs historically could provide up to high single-digit yields. On the other hand, trading in the secondary government and corporate bond markets in Kenya is relatively thin and REITs can be expected to have better liquidity.  That being said, they may likely provide higher yields than dividends from other stocks listed on the NSE. For example, a number of blue-chip companies pay out around 3% whereas yields from large commercial and residential properties can provide around 6-10% and REITs in general (see below) are required to pay out the bulk of their income as dividends. At the same time, REITs in other markets typically have lower daily price volatility compared to blue chip equities so the same can reasonably be expected in Kenya. REITs will also be affected by mortgage rates and the availability of credit. If inflation moderates, allowing interest rates to fall further, this could be a positive driver for the REIT market.

Flexibility

K-REITs will come in two “flavours” so to speak, income-focused REITs (“I-REITs”) and development-focused REITs (“D-REITs”). I-REITs can be expected to trade more like fixed income securities—relatively low volatility with higher yields, since they are required to invest most of their assets in income-generating projects and also to distribute a high percentage of their income. D-REITs on the other hand can be expected to trade more like equities, perhaps even like growth stocks—investors will buy these in the hopes of price appreciation upon the completion and exiting of projects. They will generally be more volatile and payout will be lower since the distribution requirement is relaxed for D-REITs.

Other Points to Consider

As with any investment, it will be important to evaluate each REIT on its own merits. The quality of the projects owned or in the pipeline, the capabilities of the manager and the valuations at the point of entry will all help determine if an investment in a REIT will end up being profitable or not. Not least, general equity market conditions will also be important. Whereas property in many parts of Kenya has enjoyed a steady upward march, even during downward cycles in stocks, once REITs start trading they will most likely be influenced to a greater extent by movements in the broader market.

While two firms have already received licenses to be REIT managers (Centum and insurer UAP) and real estate developer Home Afrika was listed last year on the new Growth Enterprise Market Segment (GEMS) of the NSE, we are still waiting for the first official REIT listing. As they are new to the market, REITs are an untested investment product, built from an entirely new regulatory structure. At this point, it is still difficult to know how they will behave with regard to trading liquidity, but also it also remains to be seen how easily managers will be able to comply with such requirements as minimum income pass-through and proportion of income-generating vs. development properties. Recent suggested changes to taxation on property, based on unrealized gains, may cause some complications which had been unforeseen early in the roll-out process.

Conclusion

I expect that REITs will be popular with local investors and possibly with foreign investors as well. Property has been a sector not previously represented on the NSE, while foreign institutions frequently represent more than 50% of daily trading, so REITs may begin to draw the attention of these FIIs. Local investors most probably will overlook the issue of yield competitiveness in the hope of price appreciation and the other positive features mentioned above. For foreign investors, they represent another proxy for the Kenyan economy and will almost certainly provide yields which are attractive compared to their own domestic choices.

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Christopher T. Grune
Jua Miradi Kampuni Ltd.
P.O. Box 79809-00200
Nairobi, Kenya

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