Real estate investment trusts (REITs) are due to be listed for the first time on Bahrain Bourse (BHB) this year, following new rules which came into effect in May last year.
This latest initiative will have significant benefits for BHB, the investment community, and the real estate sector.
For the bourse, it will help improve liquidity and enhance regional competiveness.
For investors, it will enable investment in real estate with even small amounts of capital, and without having to own or manage properties.
And for the real estate sector, which is a significant contributor to Bahrain’s GDP, it will add greater depth and stability through institutionalisation.
But what exactly is an REIT?
An REIT is a regulated legal structure that holds income-generating real estate assets and issues units to investors.
The unit holders effectively become the beneficial owners of the real estate assets in proportion to their unit holdings, and receive a proportionate amount of rent available after paying expenses.
In Bahrain, REITs are currently restricted to income-generating properties that can include any sub-sector such as offices, residential units and hotels.
REITs listed on BHB offer investors a wide range of benefits, including low cost exposure and accessibility to real estate; a stable, regular income stream and liquidity: and diversification and performance.
Real estate as an asset class normally requires large sums of capital to acquire property, whereas listed REITs provide low price exposure, enabling investment in large, high-value real estate projects at low ticket sizes.
In terms of accessibility, investors interested in buying a unit in a listed REIT just need to set up a brokerage account with a BHB-registered broker, and acquire the quantity of units in the REIT of their choice.
Listed REITs also provide stable income through regular dividends together with liquidity, as units can be easily bought and sold.
Another important benefit is diversification, since listed REITs provide investors with a new alternative investment asset class that has historically shown little correlation to the returns of the broader stock market.
A listed REIT differs from a real estate fund or a company involved in real estate in a number of ways, but most significantly in terms of regulation.
A listed REIT is generally open to all individuals to acquire units and trade on BHB.
Because of this openness and accessibility, the Central Bank of Bahrain (CBB) and BHB have strict regulations for oversight.
Real estate funds, which have been active in Bahrain and the region for many years, are normally offered on a private basis to high net worth individuals and institutions.
Furthermore, they are usually subject to significantly less regulatory oversight than a listed REIT, as the assumption is that institutions will be suitably qualified to assess the risks and rewards.
A company involved in real estate usually has more complicated operations, since it may function across the real estate investment spectrum such as land trading and real estate development projects.
A company may also choose to withhold or reinvest its profits, use high levels of debt, or acquire other companies, all of which are restricted in REITs for the protection of the average investor.
Whilst REITs can be established by any institution or individual who own or can secure income generating assets, a number of safeguards are mandatorily required to protect investors.
These protections stem from the requirement of all REITs being approved and registered by the CBB prior to establishment and listing; together with the pre-appointment of locally established, independent and regulated third parties that include trustees, custodians, administrators, REIT managers, property valuers and auditors.
REITs can only acquire completed properties that are income generating and are required to distribute at least 90 per cent of their net profits to investors, while debt finance has to be limited to a maximum of 60 per cent of the property’s value.
To provide some level of risk diversification, REITs must have at least two income-generating properties with a minimum valuation of $20 million.
Bahrain-based REITs are permitted to acquire income-generating properties globally.
Currently, local market return expectations are for REITs with net distributable yields to unit holders of 6pc and above.
Unit holders can also benefit from any increase in the price of their units that would result from a growth in market demand for such units, rental increases on the underlying properties, and general real estate price appreciation, among other factors.
Unlike most of the regional fixed income securities which have fixed rate distributions regardless of an inflationary environment, REITs can respond well to inflation with increases in rents.
Furthermore, REITs offering distributions that are higher than alternative yielding investment options and that are less leveraged, would outperform and be more resilient to increasing interest rates, as are REITs with fixed leverage costs.
Due to more stringent leverage restrictions on REITs listed in Bahrain (at a maximum of 60pc of the underlying properties’ value) and generally less attractive debt structures locally available compared with the US and Europe, local REITs would likely be less affected by increasing interest rates.
Investors keen on investing in REITs should assess a number of features and not just the annual yield, which can be increased significantly but unsustainably by over-leveraging and over-valuing the underlying properties.
The author is the head of corporate finance at Sico