Attracting Capital To The Real Estate Sector

- A Case For The Reit Structure In Ghana.

Real estate is a capital-intensive industry and an investment in this sector is a function of the availability of capital either in the form of debt or equity. As a result of the huge capital requirement, most real estate projects are usually beyond the reach of potential individual investors. Even in advanced economies, this problem exists and attempts have been made over the years to get round it by facilitating the pooling of resources from individual investors. The problem becomes acute in developing economies where access to capital in general is a major constraint to investment. Many brilliant ideas never get accomplished as a result of the lack of capital. Investment vehicles such as limited partnerships and other syndication forms have been used to allow investors to combine their financial resources with the expertise of a real estate professional for the common purpose of carrying out a real estate project.

To facilitate the pooling of capital for real estate investment, the concept of Real Estate Investment Trusts or REITs (pronounced "“reets”) was introduced in the United States. This was the result of the passing of the REIT enabling legislation by the US congress in 1960. REITs, which are similar to mutual funds that invest in real estate, were designed primarily to provide the public with a vehicle to participate in the equity ownership of commercial real estate. They allow small investors to acquire shares or interest in a professionally managed real estate asset portfolio thus enabling shared ownership in properties either residential or commercial. There are basically three types of REITs, viz, equity REITs, where at least 75% of the REIT’s investment portfolio must consist of income-producing real property; mortgage REITs, which must have at least 75% of their assets made up of mortgage instruments; and hybrid REITs which are mixtures of equity and mortgage. As pass-through entities, whose main function is to pass profits on to investors, a REIT's business activities are generally restricted to the generation of property rental income or mortgage interest. REITs do not necessarily increase and decrease in value along with the broader market. However, they pay dividends no matter how the shares perform.


A distinguishing feature of REITs is that they do not pay corporate income tax thus enabling shareholders to avoid the double taxation of corporate income that characterises most stocks. But, of course, as pointed out by one author, when an internal revenue service giveth, it usually also taketh. In order to maintain this favourable tax treatment, REITs are subject to some unique restrictions on their operations and activities. Prominent among these is the fact that 90% or more of the REIT’s annual taxable income must be distributed to shareholders as dividend each year. Also important is the requirement that 75% or more of the REIT’s total assets must be real estate, mortgages, cash or government securities and 75% of the REITs yearly gross income must be derived directly or indirectly from real property ownership (including mortgages, partnerships and other REITs).


It is important to note that since 1960, REITs have played a leading role in attracting capital to the real estate sector in the United States. As of 1st June 2003, the total market capitalisation of REITs listed on the major stock exchanges stood at approximately $178 billion with a total asset value of $375 billion. Such a huge capital flow to the real estate sector could not have been possible without the REIT vehicle. In fact, the REITs of the 1990s have spearheaded the revolution that has occurred in the real estate industry in the US leading to the integration of the sector with the capital market. This has been of immense benefit to the US economy and partly explains why the economy is in such a robust state. As shown by research, about 56-60% of the world’s wealth is in real estate and a nation’s ability to tap and make efficient use of this resource is no doubt crucial to its development. Additionally, shares in REITs provide opportunities to invest in diversified portfolios of real estate properties with liquidity similar to other publicly traded shares but much greater liquidity than direct ownership of real property.


Real estate has become a booming investment market, but investors have to choose between direct and indirect real estate ownership. The latter refers to real estate investment through REITs and the former, ownership in properties through static property portfolios. Direct real estate investments demand that investors have adequate knowledge of the local market, which is usually costly and time consuming to build up. It, however, affords the investor direct and instant control over the assets in question. However, since local market knowledge is essential in making real estate investment decisions, it may be ideal for individual investors particularly foreign investors to invest in real estate via indirect means. Outside investors can never compete with well-informed local market players, and the liquidity of indirect real estate is of great benefit to such investors. REITs provide a proper conduit for pooling capital from investors who do not wish to invest directly in real estate.


In our previous article (Towards a sustainable Mortgage Market in Ghana-Issues and Concerns), we pointed out the importance of a well-developed mortgage market in channelling capital to small and medium enterprises. It is important to note, that mortgage REITs (MREITs) facilitate the development and growth of a vibrant mortgage market. Since MREITs invest at least 75% of their investable capital in mortgages, mainly through the secondary mortgage markets, they provide liquidity to primary market lenders, and enable them to originate more mortgages. The cumulative effect is that, individual property owners could realise equity from their static properties to set up small and medium scale enterprises. Similarly, prospective homeowners can have easy access to funds to acquire their own housing units. It is a fact that the Ghanaian economy is suffering from severe cash flow problems. But, a vibrant mortgage market and MREITs would provide a way out for the cash flow difficulties in Ghana. Property owners can easily obtain liquidity by taking out mortgages secured on their properties. Moreover, there will be no need for mortgage lenders to keep mortgages in their books for a longer period of time. A well-established secondary mortgage market (SMM) would afford them the opportunity to sell the mortgages and keep it off their balance sheet. A vibrant secondary mortgage market will, certainly, require a ready demand for mortgage-backed securities. MREITs will provide one source for such securities alongside the demand by other institutional and individuals investors. This will ensure circular flow of funds in the economy for rapid development.

In addition, the benefits that equity REITs (EREITs) would provide to the economy cannot be over-emphasised. Ghana currently faces acute housing problems (a deficit of about 1,232,000 at the close of 2002). The rental market is characterised by high rental levels and excessive rent premium. The Chronicle, for instance, reported (in its 20th June 2003, edition) that thousands of people in the Kumasi metropolis are homeless, since they cannot afford the exorbitant premiums demanded by landlords in the metropolis. The paper further reported that offices in the main central business district of Adum are let for between 50 and 100 million cedis. We believe that this problem exists because of inadequate supply, which has created a sellers market, and provided landlords with superior bargaining power. In as much as we appreciate attempts by government at legislating (see 2003 budget) to curb this trend, we wish to point out that a legislation that is not supported by increased production of affordable properties would only succeed in compelling landlords to withdraw properties from the market. This will further constrain the supply side of the market, encourage black market activities in the rental sector, and worsen the plight of tenants. EREITs would go a long way in helping Ghana to increase the production of both residential and commercial property. Since most REITs rely on the capital markets, they have access to long term sustainable capital for property development. REITs may also enjoy economies of scale and would thus be able to provide properties at relatively cheaper cost than individual investors. There would be no need for excessive, if any, premiums due to the large rental sector that REITs would create. It would be easy to regulate the activities of institutional investors in the rental sector than the scattered individual landlords. Such institutions would also set up standards for the market and pull the individual landlords along.


It is important to note that REIT is not a new concept in Ghana. Home Finance Company established the first REIT in 1995 and has since grown from a total fund value of 1.9 billion in 1996 to 9.6 billion cedis as of 1999. The successes chalked by HFC REIT in mobilising funds for investment in real estate projects clearly demonstrates the potential that this investment vehicle has in attracting capital to the real estate sector. Government’s role should be that of a facilitator. The key role in this regard is to pass the necessary REIT enabling legislation and encourage the setting up of these structures. Other incentives such as facilitating the acquisition of land from traditional authorities would be very much desirable. This will provide a conducive environment for increased investments in real estate, which is crucial for sustainable development. Many countries such as Japan have already adopted the REIT structure in a way that suits their peculiar circumstances. This is evidenced in the establishment of JREITs in Japan.


It is our hope that government will give the attention that this sector deserves by facilitating the establishment of the REIT structure in Ghana. This, obviously, should not be a difficult task as experiences of other countries, particularly the US, can provide a useful guidance.

Views expressed by the author(s) do not necessarily reflect those of GhanaHomePage.