Real estate just could be the last ‘living fossil’ among assets classes. Whilst money eventually evolved into instruments like debt and bonds, and the value of cooperation’s into stocks; real estate had not budged one-inch. Until now. Just a month ago, the final green light on Real Estate Investment Trusts (REIT) was issued by the Colombo Stock Exchange, making it a muchawaited reality. Kanishke Mannakkara, Chief Executive of CAL Investments, an asset manager with Rs50 billion under management, believes the introduction of REITs could upend the real estate investment landscape as we know it.

EXCERPTS OF THE INTERVIEW.

What is a REIT?

REIT stands for Real Estate Investment Trust. A REIT is a single asset or pool of real estate assets which are held in the form of a trust, for the benefit of the REIT investors. The REIT is compelled by regulation to pay out 90% of the income earned by the real estate assets each year, and share the proceeds of any capital gains with investors upon the liquidation of any such assets.

Why do you think REITs will be an attractive investment option for Sri Lankan investors?

REITs give investors the opportunity to invest in a diversified, professionally managed real estate portfolio at a very low entry cost. I believe this is a very attractive proposition to many Sri Lankan investors. There are two reasons why people have always liked real estate. The first is that it is something tangible, and there is a sense of security and safety people feel investing in real estate.

Secondly, and perhaps more importantly, real estate provides steady, inflation-protected returns. Fixed annual interest paid in a fixed deposit becomes less valuable over time as inflation takes its toll. This is not true of rental income, which increases in line with inflation over time. Whilst these are admittedly huge positives, there have also historically been three big drawbacks with real estate.

First, the entry costs are high-taking any meaningful exposure into commercial real estate, for example costs billions. Second, it is not very liquid-it can sometimes take months or years to sell a property. Third, you need to maintain real estate-it is anything but hassle free. REITs can help overcome all three of these drawbacks. The minimum investment in a REIT will be small-maybe just a few thousand Rupees.

REITs will be listed on the stock exchange, so it will be possible to buy and sell REIT investments relatively easily. With effective SEC regulation and a competent management company running the REIT, you can also rest easy knowing that the hard work of maintaining a property portfolio is being done by professionals.

How exactly will a REIT work?

The SEC has will regulate and license REIT managers who will be authorised to launch REITs. The REIT manager – CAL Investments plans to be one – will create a REIT with a portfolio of real estate held within it, and launch an Initial Public Offering (IPO) for the REIT on the Colombo Stock Exchange. Investors will then be able to invest in the REIT. The REIT will be administered in line with the introductory memorandum and issue documents presented to investors during the IPO.

The REIT manager will be responsible for managing the property in the REIT, and all investment decisions relating to the REIT. The REIT will generate rental income on an ongoing basis. The SEC regulations stipulate that at least 90% of the profits of the REIT must be distributed to investors annually. This will take the form of an annuity, with stable, inflation protected returns.

If any properties are sold, then a minimum of 90% of the capital gains arising from such a sale will also be distributed to investors. If it is a closed ended REIT, all assets of the REIT will be sold on or before a stipulated date, and all proceeds distributed to the investors.

What kind of properties will a REIT invest in?

REITs are permitted to invest in any completed, income generating property. Eventually, the SEC plans to allow REITs to invest in ‘greenfield sites’ which need to be developed, but this is not allowed at present. Current regulations, also permit REITs to invest in infrastructure projects generating regular returns-like power plants or highways.

Often, a REIT will buy an occupied building from a business, and continue to have the business stay on as a rent paying tenant.

Why would a company agree to something like this?

Why go from owning the building to paying rent on it? There are many successful companies who have a relatively high level of Return On Investment (ROI) on their core business. But capital is limited. We know several companies who have hurdle rates of 20% or more on new investment projects.

Rental yield on a building doesn’t need to be anything near that kind of figure. Unlocking, say, Rs1 billion of value in a building, and then paying 60 million per year in rent sounds like a great deal if your core business can use that Rs1 billion of capital to generate 200 million in additional profits each year.

What are your hopes for REITs? How would you like to see this asset class evolve and grow in the future?

I don’t like using the word ‘revolutionise’ lightly, but I really do feel this is something that can revolutionise real estate. First, this will democratize real estate. No longer will upside be the exclusive domain of the super rich. Second, it will professionalise the market and make it more efficient. All the unoccupied apartments you see in high-end developments in Colombo is a sign of market failure. It does not benefit the owners, who get no rent, or the thousands of families looking for hoems in the city. A professionally managed REIT would ensure any real estate it owns is rented out at the highest possible level of occupancy.

This is good for investors, tenants, and the community at large. Finally, it will bring a sense of vibrancy into a very slow-moving industry. Real estate in Sri Lanka is illiquid, opaque and difficult to navigate. The introduction of REITs can kick off a spurt of market activity as informed, competent market players start buying and selling or properties with good title. This is exactly the kind of thing you need to make a market-or in this case, fix a broken one.