Dubai: Real Estate Investment Trusts, or commonly referred to as REITs, came into being in 1960 in the US with an aim to give investors of all types access to regular income stream through a portfolio of underlying properties in a tax-efficient manner. The most common form of REIT is an equity REIT, wherein the investors can buy the units in REIT, just like any other shares, offering them a liquid and an affordable vehicle to gain exposure to otherwise typically illiquid real estate assets. Since its introduction in the US in 1960s, the global REIT framework gained limited traction for about half a century, however, since 2010, driven by enhanced regulations globally and an appetite for recurring yield it is gradually going mainstream.

Since 2010, the global market capitalisation of REITs more-than-doubled to over USD 1.6 trillion but remain concentrated in the US, which currently accounts for around two-third of the total market capitalisation of global REITs. Looking ahead, we believe changes in regulations and increased appetite for real estate as an asset class will further fuel the REIT development globally. In September 2016, Global Industry Classification Standard (GICS) reclassified real estate and other stock exchange listed equity REITs from financials to a new sector — real estate. This is testimony to a broader acceptance of real estate as an asset class, and more specifically equity REITs which accounts to over 90 per cent of the total real estate sector market capitalisation. This classification change significance is exemplified by the fact that MSCI and S&P Dow Jones indices are based on GICS standards, while FTSE Russell also announced in September 2017 that it will create a new classification for real estate, separate from financials. Overall, 36 countries now offers REIT framework, and we expect more countries to join to take advantage as REITs offer diversification while bear a relatively lower correlation with traditional asset classes.

Market capitalisation

Closer to home, the first REIT is the GCC was listed in 2014 — with a USD 175mn offering by Emirates REIT on Nasdaq Dubai. A total of nine REITs are now listed in the GCC, with two in the UAE, six in Saudi Arabia, and one in Bahrain, with a total market capitalisation of around $1.4 billion. However, compared to the global parlance, GCC REIT market is still very nascent with REITs accounting for just 0.2 per cent of the total market capitalisation compared to over 2 per cent globally. We anticipate significant growth of the GCC REIT sector in coming years driven by a) wide acceptance of real estate as an asset class in the region, b) increasing appetite for yield- focused products among local investors, and 3) Sharia compliance nature of the offering.

Regulatory framework evolving, mixed investment returns since listing

Within the GCC markets, the UAE, KSA and Bahrain have developed regulatory framework for listing of the REITs on the local exchanges, while Qatar and Kuwait have yet to establish such regulations. Oman earlier this year announced draft regulations to list REITs, however, have yet to finalise a framework for this. Among the major listing requirements, Abu Dhabi Global Market (ADGM) and Dubai Financial Services Authority (DFSA) obligates the issuer to pay a minimum of 80 per cent of audited net income as dividends, while Saudi Arabia and Bahrain has an 90 per cent obligation — broadly in line with general 90 per cent obligation globally. On borrowing ability, DFSA and KSA regulations allows a maximum borrowing of 50 per vet of the total fund assets, while ADGM allows up to 65 per cent of the total assets and Bahrain has a leverage cap of 60 per cent of net asset value (NAV). The access to affordable and long-term financing, with minimal amortisation during the term of the loans, is pivotal to the growth of REITs in the region, as high dividend payouts imply that leverage is an important tool to generate return and increase fund size. We believe that the charm of REITs will continue to grow in GCC — a region well known for real estate as an investment class for local investors, further underscored by improving listing framework. Additionally, Saudi Arabia’s aim to double real estate sector contribution to GDP (10 per cent by 2020) under National Transformation Program (NTP) will further support REITs growth in the country. Resultantly, IPO pipeline within REITs remain strong, with two REITs, Etihad REIT, Gulf Islamic Investments (GII) REIT, to significantly increase the market capitalisation of UAE-listed REITS over the next year, while specialised REITs, Hospitality REIT by Five Holdings and Residential REIT by Equitativa, to further enhance the REIT landscape in the UAE in the coming years. In Saudi Arabia, Riyad REIT has already announced capital increase, while one more REIT IPO, Mulkia REIT, is in the pipeline and we expect many real estate owners to utilise REIT route to monetise portion of their erstwhile illiquid real estate portfolio in the Kingdom.

Offering price

All the nine listed REITs in the GCC thus far were offered to the investors at either a slight discount, in the range of 2 per cent to 7 per cent, or at the NAV. However, the investment returns since listing demonstrates significant variance, with both the UAE REITs still trading below their offering price, while KSA REITs, in general, have offered double-digit annualised returns, and Bahrain’s only listed REIT has given a total nominal return of a low-single digit. We consider that the major variance in the returns profile was driven by: a) UAE’s more developed real estate market, implying difficulty in sourcing of high-yield good quality asset for the REIT manager — well reflected in ENBD REIT’s latest $76 million acquisition of The Edge office building at a 7.4 per cent gross yield, and b) lower occupancy for UAE REITs, and thus, higher risk and lower support from recurring distributable income to support dividends — translating into a total capital loss of 9 per cent — to-date for Emirates REIT IPO investors.

In a nutshell, like all that glitters is not gold, all REITs are not created equal, and investors should be wary on the assets that comprise the underlying REIT portfolio, specifically from the perspective of desired diversification, contractual agreements for these assets and manager’s track record in sourcing and enhancing asset returns. We also believe that REITs could potentially emerge as a tool for better estate planning for UHNW families in the region while offering large developers a way to monetise their income generating portfolio.

— Ankit Gupta is a vice-president at Shuaa Capital and is a part of the Shuaa Investment Management team. He can be reached at im@shuaa.com.