Real-estate Investment Trusts

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3 Disclaimer All information contained in the Companies Guide is for information purposes only. Nothing herein constitutes an offer, solicitation or recommendation to invest or conduct any transaction in any kind of securities listed on Abu Dhabi Securities Exchange (ADX). ADX is not liable for any claims, losses, or damages of any nature, arising directly or indirectly from use of the data found in this report. ADX endeavors to ensure that the data and other materials found in this report are correct and complete, but does not accept liability or responsibility for any error made or omission in this report. All materials contained in this guide, including all data, information and content are the property of the Abu Dhabi Securities Exchange (ADX). 3

4 Real-estate Introduction During the past few decades, REITs have become one of the most sought-after investment channels worldwide, thanks to their unrivaled investment privileges and hundreds of billions of dollars in estimated real-estate assets. However, the presence of REITs is still limited throughout the Arab world and related governing legislations are still in their early stages. REITs cannot be separated from Mutual Funds (MFs) in the general form. REITs, in essence, represent one of many different forms of MFs. From this aspect, we encourage our readers to have a look at the basics of investment funds before reading this booklet. This booklet has been drafted to generally comply (not in all details) with the Fund System (IFS) issued by the UAE Securities and Commodities Authority (SCA). We consulted the IFS during the writing process to ensure that the content of the booklet is in conformity with local legislations. This is the fifth version of the booklets published by ADX in 2014, aiming at enriching the knowledge of our readers and raising their awareness with regard to the principles of investment and the role played by financial markets. 4

5 The Concept of REITs The majority of individuals cannot own a deluxe residential complex, luxurious hotel, elegant building, medical complex or any other form of precious properties. Yet, this is not the end for ambitious persons who look for, and interested in, real-estate acquisitions. REITs provide individuals with a unique opportunity to partly own exclusive real-estate projects via its multiparty investment. Accordingly, what are REITs? REITs are investment funds that raise cash money from investors for the purpose of investing in real-estate projects, in exchange for units equal in value and ownership rights for those investors. The ownership proportions in REITs are calculated in accordance with the number of owned units compared to the total number of units in the REIT. For example, an ordinary investor might buy ten thousand units issued by a closed REIT and thus becomes an owner in the fund in accordance with the number of owned units compared to the total units issued by the REIT. If the total number of units is one million units, then this investor owns 1% of the REIT, and, therefore, he owns the same percentage of the REIT s assets in the form of a residential complex, commercial complex or otherwise. From this aspect, the general idea here is similar to buying shares in a public shareholding company, where the investor acquires a percentage equals to the number of owned shares compared to the company s total number of shares. As we have said, REITs raise funds from investors to invest in real-estate assets, such as residential towers, for the purpose of building, selling or leasing. REITs may also invest in shares issued by joint stock companies specialized in real-estate projects. REITs can also establish or own real-estate companies as part of their investments. As per statutory regulations, REITs own their money and enjoy full legal capacity to conduct investment activities in accordance with their issued licenses. The money of REITs practically guarantees investors rights and may not be pledged as a guarantee or confiscated to pay any dues owed by the founding company. By and large, investment funds, whether real-estate or non-real-estate, operate under two main forms: Open- End Funds and Closed-End Funds. Open-End Funds are funds with a variable capital that differs according to newly issued units. Its capital drops when unites are redeemed by the owners in exchange for cash. Therefore, it is evaluated depending on the value of the fund s net assets during the redemption time. The Closed-End Funds are fixed-capital funds that allow redemption (unites redeemed in exchange for cash) only after the end of its predefined duration, or as outlined in the Offering Memorandum. Units of closed-end funds can be traded in the financial market if they are listed. Normally, the majority of REITs are closed funds due to the nature of their investments, focusing on long-term projects, and therefore takes time to complete and generate revenues. For example, completing, renting or selling a residential complex may take several years. Therefore, REITs requires that cash be kept in their possession for a long period of time. Hence, it is not practical to allow redemption in a short period time compared to open-end funds. This is also reflected in the methodology adopted by REITs in publishing the so-called net asset value (NAV), which is the REIT s assets minus liabilities. The open-end funds publish the NAV daily or weekly in newspapers, magazines or via other agreed-upon communication means, so as to inform the investors about the REIT s current financial position and outline the NAV of units for shareholders who opt for redemption in exchange for cash. However, the case is entirely different with Closed- End Real-Estate Funds. These funds may publish the NAV every three or four months due to the nature of their long-term investments, making it more difficult to determine the NAV on a daily or even weekly basis. Furthermore, Closed-End Real-Estate Funds require evaluators or appraisers to determine the value of realestate projects to correctly calculate the NAV and this cannot be done on a daily basis. 5

6 REITs: Establishment Normally, major shareholding companies, banks or financial investment companies establish REITs. After studying the project and identifying its goals, share capital, nature, policies, requirements, work plan, targeted audience, etc., and after obtaining official approvals necessary for effecting the establishment process, the Founding Company usually offers realestate units for investment through an initial public offering (IPO). This investments is governed by terms and conditions outlined in the Offering Memorandum. Some REITs They may be limited to certain parties and not offered through an IPO. The Offering Memorandum contains all information needed by investors to enrich their knowledge about the subscription details, such as the REIT s name, duration, objectives, policies, risks of investment and share capital if it is a closed fund as well as its nature, especially if it is a Shariah-compliant fund. This is in addition to methods of subscription, redemption, members of the Board of Directors, the Manager, the method of NAV calculation and assessment, and other relevant information. Investors subscribe in units offered for investment under terms and conditions outlined in the Offering Memorandum. Ownership percentages are equal to 6 the number of subscribed units as distributed after the IPO closure. In accordance with their ownership percentages, investors enjoy equal rights and share profits and losses resulting from the REIT s activities. The REIT s units can be listed in the financial market if its establishment nature allows so. These units are traded in accordance with the standards laid down by financial markets. REITs: Related Parties and Their Roles Several parties have a direct relationship with REITs and play their roles in accordance with relevant laws and regulations as well as the nature of REITs and offering memorandums. It is highly important to avoid any overlapping in powers and functions of each Party. Their roles shall be clearly determined to ensure the success of the REIT and maintain the interests of investors on one hand, and to ensure the commitment to integrity and standards of governance on the other hand. Names, classifications and roles of these parties may vary between countries and may differ by the legislative environment, but they are similar in key concepts and roles. The nature of these roles must be determined by relevant authorities entrusted to specify legislations required for the organization of REITs, if any. REITs: Most Relevant Parties: The Founding Company, Board of Directors, the Management Company, the Manager and the Real-Estate Appraiser.

7 REITs: The Founding Company: In order to ensure the institutional and professional operation of REITs, put them under control and ensure the rights of subscribers, regulatory authorities have put forward certain requirements for the establishment of REITs in general. However, these requirements vary from one place to another according to different laws, regulations and legislative environment. At the local level, regulatory authorities have established a set of conditions, top of which requires that the founding company must be a shareholding company or a branch of a licensed foreign company. Its capital shall not be less than AED 10 million dirhams, its statute shall include the activity of establishing investment funds with enough solvency necessary for conducting its business and meeting its obligations. Furthermore, the founding company is required to invest an amount of money equal to or exceeding 3% of the REIT s capital. REITs: Board of Directors (BOD): The founding company appoints the BOD and they shall be qualified, experienced and independent. The independent member here means any member who is not, his spouse or any of his first-class relatives, part of the executive management of the founding company or relates to any of the REIT s service providers during the last two years, directly or indirectly. The REIT s BOD contracts with service providers, evaluate their performance, eliminate any conflict of interest between the contracted parties and the organization of work-related relations between them and follow up the actual performance of all parties to make sure that all tasks entrusted to them are performed as required. BOD also approves the REIT s financial statements. It ensures the commitment to disclosure and prevent concealing any material information that may affect the investment decisions. Regulations typically require that the BOD appoints qualified persons to implement the REIT s projects in accordance with the defined timetable and prescribed cost limits. BOD shall make sure that real-estate assets are covered properly by insurance, contract with service providers and legal advisers to conclude and follow-up contracts and other legal tasks. In addition, BOD enjoys the capacity to contract with loan providers, if any, under the REIT s feasibility study, and the approval of all work-related contracts. If the investment fund is a Shariah-compliant fund, BOD shall establish appropriate regulations and follow-up the implementation procedures, including compliance with decisions, fatwas and guidelines issued by the Islamic Committee of the Fund. This committee shall be completely independent from the Fund. BOD shall issue a report attached to the semi-annual financial statements, including all of the Fund s investments, its market value, its nature, business type, location of assets and real-estate investments and credit rating of the investments bonds, if any. 7

8 REITs: The Manager Usually, Manager is a legal person entrusted to manage the REIT s funds and projects, maintaining its assets and financial independence in exchange for receiving a management fee as outlined in the Offering Memorandum. The Manager evaluates real-estate assets before buying or selling via certified real-estate appraisers, making sure that these assessments are updated whenever necessary and unit prices are accurately calculated as well as covering all assets by an appropriate insurance policy. In addition, the Manager shall insure that the necessary degree of liquidity is ready in hand to meet any contingent liabilities. REITs: the Management Company The Management Company is a legal person that offers many services, including regular calculation of the REIT s net assets value (NAV), unit prices and sending notification to investors regarding that value, as outlined in the Offering Memorandum and via the agreed-upon notification means. This is in addition to keeping records of the REIT s unit owners, reviewing bank accounts as well as taking all necessary measures to ensure the fulfillment of the REIT s obligations and rights. The Management Company is also responsible 8 for opening bank accounts, collecting profits and following-up dividends distribution, preparing financial statements, make sure that the REIT s has a full control over its assets and supervising transactions made by the Manager along with other administrative services. REITs: the Appraiser The Appraiser or Property Evaluator is a person specialized in evaluating real-estate projects that fall under the REIT s attention and interest. He should have a deep knowledge of real-estate details in the geographical area in which the REIT intends to invest. The Appraiser assesses and evaluates real-estate assets for the benefit of the REIT on a regular basis when needed, especially during the time of buying, selling and periodic disclosure of the REIT s assets. The Real-estate Appraiser is responsible for providing the REIT s management, Manager and service providers with a copy of his evaluation reports, including any existing or potential risks that may affect the REIT s real-estate assets. The REIT s BOD is responsible for contracting with real-estate appraisers. Appraisers should work independently from each other to ensure independence, impartiality and accuracy of the assessment as much as possible. REITs: Advantages and Disadvantages There are many advantages for investing in REITs. No doubt, these advantages are the driving force behind the spread of investments funds globally, enhancing their ability to attract large numbers of institutional and individual investors. Key Advantages of REITs: Providing low-income individuals with investment opportunities to own properties in mega real-estate projects, such as large residential and commercial complexes. Providing investors with investment opportunities to diversify their portfolios, especially in this type of investment. Bu nature, it has no strong association with fluctuations in stock prices in general, as confirmed by researchers. Even though market index may dramatically rise or fall, share prices of listed REITs are much less affected by fluctuations. This is due to the nature of real-estate investment. If the income of an REIT is generated from returns of rented apartments and shops, then it is easy to know financial situation and projected revenues because these revenues cannot change overnight. This fact effectively contributes to the stability of unit prices and, therefore, make it less volatile in the market. This, however, does not prevent REITs from being

9 affected by other factors that hit and negatively affect markets. Providing investors with a stable revenue in the form of regular and irregular dividend because REITs have concrete and genuine investments in real estate. It normally achieves stable returns and constantly collect rents, etc., and this definitely insure continuous returns to shareholders from dividends. On the other hand, global experts note that returns of REITs normally exceed the ratio of inflation index, and, therefore, there is a tangible profit for investors from their investment. Easiness of buying and selling real-estate units in listed closed-end funds in the financial market. This flexibility enable investors to amend their investment portfolio at any time. Units of these funds can also be traded greater than or less than the NAV, providing a distinct opportunity to achieve profits. REITs generally appoints professional management teams that are able to assessing risks and finding out best investment methods and tools. REITs are subject to supervision and follow-up by official bodies, and are governed by regulations imposed by standards of governance, transparency, disclosure and independence between service providers. Some Disadvantages of REITs: This type of investment is not completely risk free. In spite of its relative stability, the real-estate market is exposed to impairment and crises, negatively affecting their performance. Real Estate Closed-End Funds listed in the market are also exposed to the risks faced by other shares in the market. Some types of fees imposed by some REITs on investors may be relatively high 9

10 Investing in REITs Investing in REITs can be done via subscribing in the offered units through an IPO. In some countries, IPOs of REITs are privately held and not offered to the general public. Subscription in REITs is greatly similar to subscription in the shares of public jointstock companies. REITs identify all the necessary details relating to their investment in the Offering Memorandum, including the value of units upon subscription, number of units offered for subscription, subscription mechanism, method of returning subscription surplus, if any, and the duration of REITs. The investment in REITs can also be attained after the end of subscription period through the purchase of units and reselling them in the financial market, provided that the REIT is listed in the financial market. Licensed brokers can complete this procedure, typically as in the case of buying and selling normal shares. It is not necessarily, however, for closed-end funds to be all listed in the financial market. For REITs, the majority are closed-end funds and, therefore, their listed units in the market can be acquired through licensed brokers, as in the case of buying and selling normal shares. It is also easy to buy and sell units of Real-Estate Exchange-Traded Funds (ETFs) through the financial market similarly to buying normal shares. The units of ETFs are also subject to the clearing and settlement procedures, bearing in mind that ETFs has their own independent nature and legislations. If the fund is an open-ended, permissible by some countries, its units are traded via the company and the Offering Memorandum determines its prices. The execution price for the fund s unit is the unit NAV in the fund s net assets, calculated and announced from time to time as outlined by Offering Memorandum. Investing in REITs is a sought-after target for ordinary individuals or institutions such as insurance companies, banks, pension funds and many others. Individual investors in particular are advised to thoroughly read the REIT s Offering Memorandum, its information and know more about BOD before buying its units. In addition, the investment should be directed to REITs with a great record of accomplishment and established reputation. Diversification of investments is highly recommended as well. Individual real-estate investments shall not be limited to a specific country or city in order to avoid potential risks. Individual real-estate investors are advised to opt for officially registered and government-monitored REITs as well as other investment funds that abide by disclosure and corporate governance. 10

11 Real-estate