Real Estate Investment – The Colombo Stock Exchange and the Securities Exchange Commission establish regulatory frame work for Real Estate Investment Trusts

Real Estate Investments Trusts, known as ‘REIT’ is a Unit Trust that will invest principally in income generating real estate. REIT has been established within the existing Sri Lankan legal framework. It appears to have been structured from a local investor perspective and the Sri Lankan environment in which it will operate; as well as in the context of the other legislation already in force and relevant to aspects of REITs such as laws concerning the sale and purchase and lease of real estate and the Trust Ordinance and the Companies Act.

REIT has as its enabling legislation the Securities and Exchange Commission of Sri Lanka Act No.36 of 1987 (the ‘SEC Act’) and the Companies Act, No. 7 of 2007 (the ‘CA’). The SEC Act establishes the Securities and Exchange Commission (‘SEC’) which for the purposes of its objectives is mandated inter-alia to make necessary rules and regulations, licence body corporates to operate as a stock exchanges and also to licence any managing company to operate a Unit Trust and to ensure the proper conduct of such licensees – the SEC having licensed the Colombo Stock Exchange (‘CSE’) established under the CA and issued the Unit Trust Code Rule – 2011 applicable and regulations in term of the Unit Trust operate in Sri Lanka.

REIT has been established as an extension to the Unit Trust Code -2011 by way of the Rules cited as ‘The Unit Trust Code for Sri Lanka Real Estate Investment Trusts – No.1 of 2020’ dated 31st July 2020 (‘Unit Trust Code for REIT – 2020’) to function ONLY as ‘listed’ REIT’s under license by the SEC, on the CSE in terms of inter-alia the listing and trading rules of the CSE accordingly the Regulator of REIT being the SEC.

The fundamental features of REIT:

1. Establishment of a REIT

• A REIT must be created by a TRUST DEED. No provision of the Trust deed shall be in conflict with Unit Trust Code for REIT – 2020’ and any and all other relevant laws and include any provision so as to have the effect of exempting the Managing Company, the Trustee or the Auditor of the REIT from any duty required under or indemnifying such persons against any liability for failure to perform any duty in terms of the ‘Unit Trust Code for REIT – 2020’                                                                          

  A REIT shall be a newly created with a life of more than 5 years from the date of establishment and be listed on the CSE; with the objects limited to –

  1. The Purchase of a property with intent of leasing residential or commercial units of a building standing on the property for identified period of time and terminating the REIT on the sale of the Property;
  2. The leasing of a property with the intention of sub-leasing leasing residential or commercial units of a building standing on the property for identified period of time and terminating the REIT on the expiry of the lease;
  3. Any other property approved by the SEC                                                                                                 

  ‘Property’ is defined to include residential properties, commercial buildings, warehouses, hospitals, hotels and infrastructure projects to include power generation projects.

• The requirements for the public offering and primary listing of REITs on the CSE or any other exchange licensed by the SEC are as follows –
  
  1. The buildings on a property shall be constructed and completed; be occupied with an occupancy of not less than 20% of its total capacity and be income generating;
  2. Be listed within 03 months of obtaining approval from the SEC;
  3. Offer no less than 20% of its units to the public at the time of listing;
  4. Have a minimum of 100 unit holders at the time of listing;
  5. Maintain a minimum of 50 unit holders at all times to be eligible to claim any applicable tax benefits.
     
      

     The number of units issued should not exceed 70% of the Net Asset Value (NAV) of the REIT. The units issued to the public shall constitute at least 20% of the approved fund size for the REIT with total minimum asset value of LKR 500 million.

     Additionally –

  6. The REIT shall be managed by a Managing Company licensed by the SEC;
  7. The listing application shall be submitted to the CSE within 01 month of obtaining approval from the SEC;
  8. The listing shall be for all units issued pursuant to a REIT with all units being fully paid, free from all lien and freely transferable;
  9. The value of the real estate assets owned by the REIT at the time of listing shall not be less than Sri Lanka Rupees Five Hundred Million (LKR 500,000,000/-);
  10. The Sponsor/Strategic Investor shall hold a minimum of 30% of the total units, which shall be locked-in for a period of 06 months from the date of listing;
      Additionally the obligatory requirements of buildings on a property to be constructed and completed, be occupied and be income generating as a pre-condition for a listing is a salutary provision, in that it safeguards the situation of sub-standard and ill-fated construction projects being brought into the market with the high risk of failing its investors.                                              

2. The Principal Stakeholders –

• • The ‘Managing Company’ – shall manage and operate the REIT in terms of the Unit Trust Code for REIT – 2020.                                                                                                                                       

    It shall be a body corporate body incorporated in Sri Lanka with a minimum of a 50% of its Stated Capital consisting of local equity; have entered into the necessary contracts with the Sponsor for the purchase or lease of the identified Real Estate to form the EIT; have entered into the Trust Agreement with a Trustee approved by the SEC and maintaining a minimum of LKR 50 Million as Shareholders’ Funds s at any time.

    The Board of Directors of the Management Company shall comprise a minimum ratio of at least a one – third independent directors at all times; with prescribed appointments of a Chief Executive Officer, a Property Manager to manage the properties of the REIT, a Real Estate Portfolio Manager and Fund Management Manager for non-real estate related assets (where applicable), a Compliance Officer and a Construction Contractor.

    The independence of the Managing Company being emphasised such being a sine-qua- non for good governance.

    The Code whilst making provision for a Managing Company to withdraw, limiting the circumstances to its liquidation or on a finding of a lack of competence, in the latter situation a proposal by it to the SEC to appoint another in its stead having more competencies and resources in managing REIT’s being obligatory to be submitted, to be assessed by the SEC at its discretion.

  • The ‘Sponsor’ – A Person having title to the property to be transferred or leased to the REIT there maybe more than one Sponsor as identified by the Management Company.

    A Sponsor shall hold no less than 30% of all Units at all times which Units shall not be traded on the CSE EXCEPT on the Sponsor exiting the REIT in full or part on selling and transferring the whole or part of such holding to a strategic investor. Provided that, in the event of the sale of the whole the Strategic Investor shall at no time exceed 80% of the total Units issued and if part the Strategic Investor and the Sponsor in aggregate shall not exceed 80% of the total units issued, in both instances maintaining the minimum 30% threshold.

    In the above situation, the Managing Company is required to make an announcement on the following market day to the listed stock exchange with the minimum details of this new strategic investor and the unit price of the transaction providing for transparency.

  • The ‘Trustee’ – A Licensed Commercial Bank (‘LCB’) appointed with the prior approval of the SEC – the primary duty of the Trustee being the exercise of due diligence in monitoring the operation and the management of the REIT by the Managing Company. The Trustee shall not be entitled to hold units or any other interest in the REIT but may receive a fair and reasonable remuneration.

  • A LCB an otherwise strictly regulated body being under the supervision and control of the Central Bank of Sri Lanka a more than safe and secure body to hold the real estate in ‘trust’ being the core of a REIT.

  • ‘Investment Committee’ and ‘Advisory Panel’ – the Management Company shall establish and maintain additional operational arrangements to provide oversight by way of the appointment of and Investment Committee and where applicable a panel of advisors for a REIT to be managed according to specific rules.

3. Investments –

• Subject to the proviso a REIT may invest only in real estate up to a maximum of 80% of the REIT’s value with the balance 20% to be invested only Government Securities and/or in Cash or Near Cash. Provided that an exceeding of the limit of 80% in real estate would require prior approval of the SEC; with however a 5% allowance in excess of the prescribed limit permitted if being due to an appreciation or depreciation of the Net Asset Value (NAV) of the REIT.

  The Unit Trust Code for REIT – 2020 having comprehensive and strict regulation on the real estate to be invested in to include, the requirement of clear and acceptable title to the land free of encumbrances, validity of title deeds, due compliance with all necessary regulation concerning the construction of buildings and having in place all necessary approvals, licenses and permits from the relevant authorities in conformity with all laws otherwise in effect and relevant to real estate.

4. Borrowings-

• REITs may borrow for the purposes of acquiring real estate and capital expenditure, in the form of the issue of listed debentures (in compliance with the rules of the CSE) or loans subject to a maximum of 30% of the NAV of the REIT ; with no right of pledge of the REIT property thus ensuring that the real estate of the REIT remains free of encumbrance                                                                                                

5. Income Distribution-

• Distributions shall be made of collected and realized gains or realized income unless approval of the unit holders (excluding the Sponsor, Strategic Investor and any party acting in concert with any or or more of such parties) have been obtained by way of a resolution to decline to receive the distributable income in a given year or circumstance, of not more than 90% of the distributable income.

  A deviation from the dividend distributions which is less than 90% resulting in disentitlement to tax benefits available to Unit Trusts.

  The fixed distribution of approximately 90% of the income is currently not a requirement for any otherwise listed entity in keeping with the intent of the legislators to seek to have the REIT as an attractive investment option

6. Other important features:

• The Unit Trust Code for REIT – 2020 also making provision in comprehensive terms for the following:

  Requirement of rigorous valuations of all assets and liabilities of REITs, audits both internal and external inter-alia on managing operations and financials, insurance against all risks and stringent reporting requirements by the Managing Company. Limitation on fees chargeable by the stakeholders and related party transactions.

Sri Lanka has as a first step established a comprehensive and suitable legal and regulatory framework. It is anticipated that the legislators and the judiciary will strive to further develop and have a more prepared legal framework to support the product of the REIT now in its infancy, learning with the challenges that may come before them in the interests of the all stakeholders and the Country.