The lingering pandemic has spurred governments across the globe to continue expanding the money supply, ostensibly to keep interest and borrowing costs low for businesses and support faltering economies. However, too much money circulating in a depressed economy has the unwanted consequence of inflation. To combat inflation and preserve wealth, investors can purchase income-generating assets such as real estate, but this requires substantial capital and can therefore be pursued only by well-funded institutions or high net worth individuals.
The average person has fewer options. While readily available, the yields of time deposits, bonds, and similar instruments are limited in the face of suppressed interest rates and will not keep up with inflation. On the other hand, owning income-generating property may be out of the question, as for most, even owning a home is far from attainable due to shrinking income and swelling prices.
At this critical time, an option has recently opened up for investors to participate in the real estate industry — the Real Estate Investment Trust or REIT.
In the simplest of terms, a REIT is an investment vehicle, generally a corporation organized to purchase and own income-generating property. Other requirements for forming a REIT include a minimum number of shareholders, public ownership, and listing on the stock exchange.
The advantages of putting up a REIT include tax incentives, such as a tax deduction on dividends. Since REITs are required to regularly declare 90% of their distributable income as dividends, this would result in substantially lower taxes on income. The savings may then be passed on as higher payouts or dividend yields to the investors.
REITs also offer advantages to various stakeholders. For property owners, transferring their property to a REIT helps liquidate the value of their properties. They can readily divest partly or fully by selling and trading their shares. Also, stock transactions will be taxed at a rate lower than the 15% capital gains tax since the sale will be coursed through a stock exchange.
On the part of developers, a REIT also provides a better way to raise capital for new investment and developments through the listing and public offering, removing the obligation to pay interest in the event of borrowing while also eliminating the risk of default.
A REIT has the most to offer to conservative investors, as it essentially allows almost anyone to invest and participate in income-generating real estate assets without the steep costs and capitalization of actually purchasing, registering, and owning real estate assets. An investor would only need to purchase shares in a REIT to co-own a portion of it. Since REITs are required to invest in income-generating property, the REIT will have stable revenue streams distributed regularly to investors as dividends, which need to be issued annually if the net distributable income is positive. Finally, the investment should also retain its value since the REIT holds assets whose prices will generally adjust to inflation.
Due to its clear-cut advantages and desirable features, REITs have long been a staple in highly developed capital markets such as the US and Japan. In the ASEAN region, Singapore, Hong Kong, Malaysia, and Indonesia have REIT industries. As a result, REITs have the potential to contribute to the healthy development of the capital markets and make them more attractive for investors.
However, while the Philippines passed a REIT law as far back as 2009, the market failed to materialize until recently. The lack of a REIT industry may be one of the reasons the Philippines was seen as a less attractive market, despite experiencing a boom in construction and real estate.
The hurdles a decade ago involved the 12% value-added tax (VAT) for developers looking to transfer their assets into a REIT, as well as substantial estate taxes for property owners seeking to contribute inherited property. The implementing rules also required REITs to comply with a 67% minimum public float by their third year, which was much higher than the 33% minimum threshold provided in the law. This constraint effectively discouraged would-be proponents of REITs as they would have to divest majority ownership in the REIT very early on.
Fortunately, such hurdles were recently overcome by reforms such as the TRAIN law, which now specifically exempts from VAT those properties transferred via a tax-free exchange. The estate tax rate was likewise lowered to 6%, and an estate tax amnesty was passed, which helped reduce the cost of transferring and developing inherited property. Finally, the implementing rules were revised to lower the public float requirement to a minimum of 33%.
As a result of these reforms, real estate companies have moved forward with setting up REITs. The first REIT by Ayala Land was successfully listed in 2020, followed by Double Dragon early this year, and most recently, Filinvest. Other major players such as Megaworld, SMDC, and Robinsons Land have also made public their intention to establish REITs.
Given these developments, REITs present a solution to the need for higher returns to preserve the value of an investor’s hard-earned savings. Despite the pandemic, putting one’s extra savings in REITs now may be the “REIT” investment for the future.
The views or opinions expressed in this article are solely those of the author and do not necessarily represent those of Isla Lipana & Co. The content is for general information purposes only, and should not be used as a substitute for specific advice.
Jaffy Y. Azarraga is a Director at the Tax Services Department of Isla Lipana & Co., the Philippine member firm of the PwC network.