In 2009, Congress passed the Real Estate Investment Trust Act of 2009 in a bid to boost the development of capital markets by introducing a brand new asset class. REITs were expected to boost financial inclusion among the masses with people actually being exposed to and benefit from the soaring prices of real estate. It was also seen to help further improve the country’s infrastructure development.
Ten years after the passage of the law, there are still no REITs in the Philippines. Just this January 2020, the Department of Finance, the Bureau of Internal Revenue, the Securities and Exchange Commission as well as the Philippine Stock Exchange came up with the issued IRR (implementing rules and regulations) to encourage real estate companies to offer REITs. Before tackling the changes created by the new IRR it’s important to first tackle the basics.
What are REITs and how do they work?
Much like mutual funds and stocks, REITs involve the pooling of funds from many different investors. Investing in such a fund would give you units or stocks, which would entitle you to returns in the future. Money invested in the fund is managed by a team of professionals tasked in identifying and investing in income-generating properties such as residential projects, subdivisions, shopping centers, and office complexes.
There are two ways for the REIT to earn. First, is by means of capital appreciation or when the value of the invested property increases. Second, is by way of rentals. The management team would be the one tasked with looking for leasees. Income generated by REITs are then given back to shareholders as a return on their capital.
Advantages of Investing In REITs
Oftentimes, potential investors would ask why they should invest in REITs instead of actually owning a real estate property and leasing it out instead as you need not pay the trust management fee.
Owning real estate has a lot of disadvantages. You need to complete a lot of paperwork before the title is actually transferred in your name.
Likewise, buying a real estate property requires a lot of capital most of which a lot of people do not have. REITs break down the gigantic cost by dividing it among several people in such a way that it becomes more accessible and affordable. Common people can now stand to also benefit from surges in real estate prices and the booming property market.
REITs are also professionally managed, meaning that all you have to do is shell out capital and wait for the company to declare dividends. You no longer have to do all the administrative matters such as finding lessors, negotiating lease contracts, and collecting rent. All these are taken care of by the REIT issuer.
They also offer a steady stream of income to investors as their main source of revenue comes from rentals. Lease contracts tend to be long term in nature and are not as susceptible to fluctuations brought about by economic events. REITs are mandated by law to give out a certain percentage of their income yearly as compared to stocks wherein dividends are only declared whenever its board of directors deem it fit.
While investors can’t be as hands-on with REITs as compared to if they bought the property themselves, they would still be kept up-to-date with their investment as REITs should be listed in the local stock exchange and as such need to make periodic disclosures about material transactions and events affecting them.
Different types of REITs
Much like other pooled funds, investors likewise have a choice as to where their capital is invested in when it comes to REITs. First, there are equity REITs, which are the most common type of REITs. These invest in income-generating projects and give out returns through the rentals they earn. Next are mortgage REITs wherein the pooled funds are lent out to property owners and in the event they are not able to repay the loan, their properties are foreclosed and sold. The main source of revenue for such REITs is interest income. Lastly, there are hybrid REITs which offer a combination of the two and offer much more diversification.
Real Estate Investment Act of 2009
As mentioned earlier, the REIT Act of 2009 was passed to encourage the listing of REITs by offering tax incentives for companies that would offer such. Under the law, the income generated by REITs would be tax-free provided they comply with certain requirements.
First, the pooled funds should be invested in real estate. It must also be listed in the Philippine Stock Exchange and distribute to its shareholders 90% of its net income. It must also meet the required minimum public ownership set by the SEC.
Why are there no REITs up to now?
In light of the tax exemption, you would expect there to be a lot of REITs already but in reality, there has yet to be a REIT in the Philippines. Analysts point to two hurdles that are discouraging companies from offering REITs.
First is the transfer tax of 12% when the property is transferred from the developer to the REIT as this would be subject to VAT. This would cause the asset’s cost to be a lot more expensive.
Second is the issue with the minimum public ownership. Under the 2009 law, minimum public ownership should be at least 67%. Companies are discouraged from issuing REITs as they might lose control over the fund if there would be several large stockholders, who would side together.
Overcoming these hurdles and the outlook for REITs
The passage of TRAIN Law last 2018 took care of the transfer property tax of 12% with it making the transfer no longer VATable and as such not subject to tax.
The issuance of the amended IRR lowered the required minimum threshold of public ownership from 67% to only 33%. With both hurdles out of the way, it is expected that there would be more REIT listings in the Philippines.
Large conglomerates such as Ayala and the SM Group as well as Double Dragon are being rumored to offer REITs in the coming months. Investing in Philippine REITs are highly encouraged as the country is in a real estate boom. In 2019, prices of condominium units in the country’s capital rose by 34% due to the influx of POGO workers. Colliers and Morgan Stanley both expect the property sector to continue its double-digit growth in the coming years.