Real Estate Investment Trusts (REITs) have been in existence for more than 50 years, ever since US President Eisenhower activated the REIT Act title in the Cigar Excise Tax Extension in 1960. These products fundamentally seek to provide investors with exposure to real estate at very low minimum investment amounts. REITs are essentially income-generating structures that either own real estate properties (Equity REITs), have financing exposures to real estate properties (Mortgage REITs) or operate under a combination of both (Hybrid REITs). REITs usually receive significant tax benefits that are unavailable to regular companies, but one of the major requirements to qualify as a REIT is to distribute at least 90 per cent of the taxable income annually to shareholders as dividends.
The US REIT market has witnessed significant growth and as of the end of 2015, the FTSE NAREIT All REITs index had a market capitalisation of $939 billion (Dh3.4 trillion), with equity REITs comprising 94.4 per cent of the index. Since the economic crisis of 2008, the market capitalisation of the FTSE NAREIT All Equity REITs has grown at a compounded annual growth rate of 26 per cent, from $176 billion to $886 billion. Despite the lower demand for real estate during the crisis, this growth in REITs is not surprising. The reasons for this are mainly that they provide attractive risk-return profiles when using returns data over the past 20 years (as shown below) and that REITs have historically generated higher dividend yields when compared to the 10-year constant maturity US treasury yield. In addition, REITs have been regarded as having a relatively low correlation with other instruments, such as stocks, although recent trends suggest that these correlations are increasing; albeit still imperfectly.
With the continuous growth of Islamic banking in the GCC and the significant interest of investors in the region’s real estate market, products such as Islamic REITs (I-REITs) have started to emerge. While Malaysia has been the pioneer of I-REITs, as it was the first country to issue regulatory guidelines in 2005, several GCC countries, such as Bahrain, Kuwait and the UAE, have subsequently issued REIT regulations. As a result, Al Mahrab Tower REIT became the first private I-REIT in Kuwait in 2007. Following that, Dubai launched its first I-REIT (Emirates REIT) in 2010 and Bahrain listed its first public I-REIT (Eskan REIT) in 2017. Emirates NBD has also recently listed “ENBD REIT” and due to strong demand the offer was oversubscribed. Even though the I-REIT industry is still in its infancy, there are strong signals that indicate a rising demand for these products, such as the oversubscribed listing of Al-Salam I-REIT by Johor Corp Bhd in 2015. Firms responded to this growing demand, including IdealRatings, which launched its first Sharia-compliant REIT index in 2015. This comprised of approximately 45 REITs that comply with Sharia principles across different sectors and countries in Asia.
A study performed by Case and Wachter in 2011 calculated that REITs provided an inflation hedge in portfolios 66% of the time, using six-month investment periods. This ranked second, after commodities, which provided a hedge 70% of the time. As oil prices remain low with the S&P revising oil forecasts until 2018, down to $40-50 per barrel, oil-producing tax-free governments such as the GCC countries will earn lower oil revenues. As a result, they may resort to the reduction/removal of subsidies, in addition to the implementation of taxation — such as VAT or some form of corporate fees — as a means to cover the shortfall in government revenues. Such actions may naturally lead to higher inflation levels in the GCC over the next few years, which is expected to increase the local demand for products that provide strong hedges against inflation, such as I-REITs.
Having said that, it is not only local demand that is expected to drive the growth of I-REITs in the GCC, but rather a combination of local and increased international demand in the region’s real estate. Studies have found that including international real estate, rather than just local real estate, in a portfolio reduces portfolio risk from 5-10 per cent to 10-20 per cent. JLL’s 2014 MENA Investor Sentiment Survey showed that the UAE’s residential real estate market has the highest demand among regional investors. However, it also indicated that the Saudi Arabian residential sector has the highest potential for future growth and, therefore, the region is expected to witness an increase in international demand for its real estate.
While the future of I-REITs may seem positive, there are many challenges that lie ahead which I-REIT asset management firms should address. In addition to building campaigns that increase investor awareness for I-REITs, it is important for asset management firms to devise efficient and logical I-REIT investment methodologies. This needs to be supplemented by sound ethical principles in order to increase trust in these products and ensure the sustainable growth of I-REITs in the region.
Hamed Yousef Mashal, CFA, Member of CFA Society Bahrain