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CAPITAL MARKETS AUTHORITY

A Study on the Viability ofReal Estate Investment Trusts in Kenya

Submitted by

Vista Capital Limited

December 2008

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1.0 Executive Summary

Vista Capital Limited was hired by the Capital Markets Authority to undertake astudy on the Viability of Real Estate Investment Trusts in Kenya. As part of theStudy a market survey and workshop were undertaken to seek opinions of theinvesting public as well as research undertaken to understand how a REITs marketoperates in other more developed capital markets.

The objective of the Study was to the foundation towards putting in place a policyand regulatory framework so as to:

a) Introduce real estate investment trusts;b) Facilitate the listing of the established schemes; andc) Promote investments in property by small, medium and large size investors.

REITs in developed capital markets have been in existence in their present formatsince the 1960s, however, were actually originally introduced in the 1800s.Corporate tax exemption was a critical element in the development of the REITindustry. REITs are typically exempt from corporate tax as long as 90% of netincome is distributed to shareholders. REITs are commonly structured as close-ended trusts due to the illiquid nature of property.

Kenya’s capital markets can play a strong role in the further development of thereal estate sector. The introduction of REITs is viable given the demand for realestate, and the need for additional financial instruments. As a result, it isrecommended the CMA introduce REIT regulations and work with the KenyaGovernment to give fiscal incentives. Housing should be given extra incentives tohelp the government meet their 2030 Vision goals.

The capital markets can help mobilize and allocate resources, as there is a strongdemand and cultural bias towards property investments. Retirement BenefitSchemes as well as many individuals are already investing in property but manyare very limited in their ability to do so in that they cannot afford directinvestments that are not liquid.

With the introduction of REITs it is felt property developers would come to thecapital markets to raise funds. It is also likely that through a higher level ofparticipation through the capital markets, bank financing would be forced tobecome more competitive thus helping to further reduce development costs.

The following is the recommendations made as a result of the survey, workshopand global research to meet the CMA objectives:

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- Disclosure should be very strict though to ensure investors realize thespecialization and the risk involved with such specialization.

- The CMA should dictate a minimum asset allocation for real estate of 75% toensure the REITs remain a property investment. In addition, 75% of the

- The CMA develop new REIT regulations, as the CIS regulations are notapplicable to the specialized nature of REITs.

- The CMA work with other regulatory bodies such as the CBK, RBA and theIRA to allow REITs to be an accepted investment so there are no regulatorybarriers to investment demand.

- The CMA must also ensure the KRA recognizes any fiscal incentives given bythe government. Without this level of cooperation, the REITs industry willnot perform.

- REITs should be structured as close-ended trusts and encouraged to list on theNairobi Stock Exchange, although private placements should also be allowed,if the number of shareholders is over 50. Non-listed REITs must still allowfree transferability of shares and be approved by CMA for tax incentives.

- Specialized REITs should be allowed (particularly those involved with lowand medium cost residential properties) so as to benefit from the specializedareas of property management. Disclosure should be very strict though toensure investors realize the specialization and the risk involved with suchspecialization.

- Development property should be restricted to 15% of the REIT value to helprestrict the much higher risk involved with development property. REITsshould be allow to leverage on the basis interest cover (EBITDA/interestcharge) is equal or more than 2.0 times.

- REITs should be allowed to invest in long-term tradable fixed incomesecurities related to property, other local REITs, as well as property relatedequity stakes while all other investments should be short term money marketrelated to provide working capital requirements of the REITs.

- REITS should be allowed to invest offshore both directly and through offshoreREITs with the asset allocation restricted to 30%. However, if invest directlyoffshore, must have a professional property manager in each country invested.

- To encourage existing property management companies and propertyinvestment companies to convert to REIT structures, majority ownershipshould be allowed up to 50% for the primary sponsor. All other investors’stake should be restricted to a maximum of 25%. However, a minimum of100 shareholders should be required for a publicly listed REIT to help ensureliquidity. For private REITs, shareholding must be a minimum of 50 toqualify for any fiscal tax incentives.

- As mentioned earlier, specialized REITs should be allowed (particularly thoseinvolved with low and medium cost residential properties) so as to benefitfrom the specialized areas of property management.

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portfolio must be rental generated income and 90% of that income distributedto shareholders as dividends.

- Development property should be restricted to 15% of the REIT value to helprestrict the much higher risk involved with development property and toensure a high level of income generating property.

- REITs should be allowed to invest in local REITs, real estate related equity,and long-term tradable fixed income securities related to property while allother investments should be short-term money market related to provideworking capital requirements of the REITs.

- Withholding tax on any underlying interest income- Dividends must be distributed with withholding tax withheld at source on

the final tax on individuals

- REITS should be allowed to invest offshore both directly and through offshoreREITs with the asset allocation restricted to 30%. However, if invest directlyoffshore, must have a professional property manager in each country invested.

- The CMA should set the minimum value of a publicly listed REIT to Ksh 50million for those REITs specializing in low and medium cost housing. Forthose investing in high-end housing and/or non-residential properties, theminimum asset value should be Ksh 500 million. These values are set to helpensure the REITs are able to provide a well-diversified property portfolio.

- Properties must be valued by a professional manager prior to any private orpublic placement. At least three valuation methodologies must be utilised anda detailed valuation report be part of the offer documentation.

- Thereafter, properties should be valued every three years with one-third of theportfolio valued each year. However, any major changes in cash flowexpectations of the income generating property (e.g. due to changes in rentvalues, vacancy rates etc.) must be disclosed in the REITs annual report.

- CMA should work with the Government of Kenya to offer the following fiscalincentives:

REITS are exempt from all taxes including:- VAT on all rental income- Corporate tax- Any capital gains tax- Stamp Duty on purchase/sale/transfer of properties- VAT on professional services

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- To qualify for these incentives a REIT must distribute 90% of its net incomeand undertake annually two public forums (minimum of 50 individuals each)for educational purposes with the CMA present.

- Professional indemnity insurance for all professionals related to theissue/fund

- A REIT must have a professional property manager (registered with a propertyrelated professional association) with at least five years experience, CMAlicensed fund manager to manage all assets, a Board of Trustees, CMAapproved custodian bank to hold all assets, an independent Professional valuer(must belong to professional property related association) ICPAK memberauditor, LSK member legal counsel.

- Full and detailed disclosure is required with the introduction of REITs to theKenyan market.

- Disclosure to the CMA should be on a quarterly basis with the followingdisclosed:- Net Asset Values (NAVs) based on last know valuation and marked to

market values for tradable securities- Names of top 10 shareholders and amounts invested and any change

within the quarter- Description of property portfolio with details of type, location, income

stream, vacancy, maintenance costs, expenses, etc- Description of all Development Property- Description of all Offshore property interests- Description of non-property asset portfolio with details regarding asset

type, terms, maturity, market value, income expected, location, etc.- Description of all Offshore non-property interests

- The following is suggested to be the minimum listing requirements:- Minimum of Ksh 500 m paid up capital (Ksh 50 million for housing

specialist funds)- Minimum number of shareholders at 50- Shares freely transferable- No track record for REITs but fund managers must have a five year track

record- REIT IPO to be underwriten- REIT IPOs allowed to run “blind pool” but full disclosure regarding

intended portfolio and investment policy statement- Directors and all professional service providers to be vetted by CMA- Property manager must be a member of a property-related professional

association – does not need to be licenced by CMA- Auditor and Lawyers to give opinions on IPO- Full disclosure in regards to investment philosophy, investment horizon,

existing portfolio details (type, values, regional diversification etc), riskmanagement, etc.

- REIT may be traded on NSE, but will also allow non-listed public REIT

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- Names of all managers and evidence of qualifications of new managementas well as professional indemnity insurance

- Description of all risk highlighted any changes in risk levels from previousquarters and methods to mitigate risk exposures

- Semi-annual Disclosure to the Public/Investors should be:- Net Asset Values (NAVs) based on last know valuation and marked to

market values for tradable securities

- Annual Disclosure to the Public/Investors should include:- Same as semi-annual with exception accounts should be audited- A statement from the professional valuer to state whether any major

changes in the property market would likely change the underlying valueof the properties within the REITs property portfolio.

- Every three years a full professional valuation to be undertaken with areport included in the annual report with one-third of the portfolio valuedannually.

2.0 Reliances and Limitations

2.1 In preparing the Study on the Viability of Real Estate Investment Trusts in Kenya(herein referred to as the “Study”), Vista Capital Limited and its director, relied oninformation and opinions given by the CMA staff and directors, representatives of theGovernement of Kenya, Capital Market Stakeholders, and Capital Market Participantsin other markets as well as undertaking extensive Internet research.

2.2 This confidential Study is intended solely for use by the CMA, the sponsor of theStudy. Vista Capital Limited does not take any responsibility for any use of thisStudy nor does it take any responsibility for the consequences of acting on this Study.The CMA and its stakeholders must assess for themselves the appropriate actionsneeded and applicable to their environment to achieve its objectives. It may also beprudent to seek legal council in determining the legal suitability of suggestions madewithin the Study.

2.3 It is of utmost importance for the CMA to continually undertake assessments of thechanging environment within the local capital market as well as globally, particularlyas it strives to achieve its mission and objectives, recognising that capital markets aredynamic. As a result, the CMA, its staff, and its development partners must recognisethe changing environment, both internally and externally, and the impact it could haveon the operations of Kenya’s Capital Markets.

- Management accounts including balance sheet and cash flow statements- Detailed description of investment portfolio similar to that required to be

submitted to CMA on quarterly basis- Evidence of Diversification of property and non-property assets- Risk profiles and measures taken to mitigate- Any changes in management or professional advisors- Dates of last property valuations- List of top 10 shareholders and their percentage holding

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2.4 Vista Capital Limited shall not be responsible for the results of any action of theCMA in following or declining to follow any advice or recommendations VistaCapital Limited might make to it. In accepting this Study the CMA indemnifies VistaCapital Limited and holds it harmless against all costs, expenses, damages, loss or anyliability of whatever nature. Vista Capital is not an agent of the CMA nor is thisStudy an offer of management and/or financial consultancy on the part of VistaCapital or any of its affiliates.