capital-market development

The Philippines is finally on the track to economic recovery. The Philippine economy exhibited this year its strongest growth in 30 years. The BusinessMirror reported recently that the country’s economy is expected to grow by 7.1 percent for 2007 and expand further by 6.8 percent in 2008 in view of increased inflow of investments, huge domestic demand and high private consumption.

Sustained economic growth in the Philippines requires support from a strong and active capital market which will bring an inflow of foreign and domestic investments into the country. Looking upon the experience of its Asian neighbors, the Philippine capital market can realize its growth potential by introducing Real-Estate Investment Trusts (REITs) as an economically viable security instrument in the Philippines.

REITs are entities formed for the sole purpose of investing in income-producing real-estate assets and real estate-related securities, such as commercial and residential properties and real estate-secured mortgages.

Through REITs, investors, whether small or institutional, can invest in large-scale ventures that would otherwise be reserved for bigger entities. Instead of directly owning real-estate properties, investors can, in a more flexible and convenient way, directly participate in the ownership of significant commercial real-property ventures.

By investing in REITs, investors no longer have to go by the traditional method of directly buying and selling real-estate properties themselves and dealing with the administrative and commercial problems that come with it.

There are generally three types of REITs, namely, equity REITS, mortgage REITS and hybrid REITS.

Equity REITs, which are the most common, invest in real estate and generate income from rents collected. Mortgage REITs grant loans or invest in financial instruments secured by mortgages on real estate, with revenues generated primarily by interests earned on mortgage loans. Hybrid REITs are a combination of equity and mortgage REITs.

REITs became a significant investment vehicle in the 1960s when the United States Congress passed legislation that made real-estate investments more widely available to small investors. REITs proved to be a viable industry in the US, growing phenomenally in the 1990s.

According to the Ernst and Young 2007 Global REIT Report (EY 2007 REIT Report), the total market capitalization of publicly listed REITs worldwide has reached $764 billion this year, reflecting a growth of more than 20 percent as compared with the market capitalization of $608 billion last year. Significantly, the total real estate owned by REITs worldwide has now reached $1.273 trillion.

Based on the EY 2007 REIT Report, Asian REIT markets showed a very strong performance for 2007, particularly in terms of stock prices and in total returns and dividend yields. Asian REITs increased in number at a rate higher than that of other regions.

In 2006 alone, 27 new REITs were reported to have been established in Asia. Before the launch of the first Japanese REIT in June 2001, the initial REIT market capitalization in Asia was approximately $2 billion. Within five years, it had grown to approximately $50 billion.

The EY 2007 REIT Report notes that the Japanese REIT market had an outstanding performance in 2007 since the trade volume in the Japanese capital market doubled this year, increasing from $20 billion to $45 billion on a per REIT basis, while individual stock trading also manifested a 100-percent increase from $0.5 billion to $1 billion.

The performance of the Singaporean REITs is worth noting, which can boast of having the best-performing REIT market in 2007. The EY 2007 REIT Report indicates that the market capitalization of Singaporean
REITs registered at $22 billion in 2007, almost threefold the previous year’s $8 billion.

On June 30 Sen. Edgardo Angara filed Senate Bill 63 (the proposed Real-Estate Investment Trust Act of 2007) to establish a legal and regulatory framework for Philippine REITs and provide for a favorable market environment for their development.

In a position paper on Angara’s REIT Bill, Mr. Peter Mitchell, CEO of Singapore-based Asian Public Real- Estate Association, observed that the attraction to REITs lies in its five major benefits, namely, diversification, dividend distribution, liquidity, performance and tax transparency.

Since REITs allow investors to invest in a portfolio with different properties, locations and property types, REITs provide diversification for portfolios of investors. Moreover, since the value of REIT stocks depends on the underlying real estate, REITs become more valuable as the real estate appreciates. Notably, REIT stocks enjoy lower volatility compared with equity stocks since real estate is not greatly affected by inflation and interest rates.

The dividend distribution from
REITs is characteristically high. Asian REITs are generally required to distribute at least 90 percent of their taxable income as dividends in exchange for their tax-exempt corporate status.

Liquidity is another attractive benefit of REITs. REIT securities can easily be transferred and liquidated as opposed to holding the real properties themselves, which are difficult to sell and transfer.

The performance of the global REITs market has measured impressively well against all key indices, including market capitalization, volume of trading over the year and total rates of return. The tax transparency of REITs attracts investors since most of the REITs’ revenues are exempt from corporate taxes as long as they are distributed to shareholders.

Mr. Mitchell notes that REITs will have the potential to attract a huge amount of new capital into an economy if REITs possess all of the expected benefits and characteristics and have the right regulatory underpinning.

The introduction of REITs in the Philippines will benefit the country’s economy through the enhanced flow of income it will generate as investments in the capital market increase. The development of a market-oriented and investor-friendly REIT legal and regulatory framework in the Philippines is critical in attracting funding for much-needed infrastructure projects such as residential, industrial and office buildings; housing and retirement communities; school buildings; hospitals and medical facilities; hotels and resorts; malls and shopping centers; warehouses; and infrastructure projects.

Since the REIT stocks are required to be listed and traded on the stock exchange, REITs are also expected to boost activity in the securities market and provide more options to investors.

The enactment of the Philippine REIT law will certainly enhance the standing of the Philippine real-estate industry in the Asian region and may possibly establish the Philippines as a strategic player in the global real-estate market. A REIT law in the Philippines will help address the current gap in the country’s infrastructure development.

REITs can spur the phenomenal growth of the national economy by enhancing the country’s macroeconomic standing, as well as revitalizing the capital market and attracting foreign direct investments. Clearly, REITs are the key to the development of a world-class capital market in the Philippines.

Atty. Sylvette Y. Tankiang (sy.tan-kiang@cvclaw.com) is a senior partner of the Villaraza & Angangco Law Offices (web site: www.cvclaw.com) and the head of its Corporate and Special Projects Department. Her areas of legal practice include commercial law, taxation, banking and finance, corporate reorganization, and mergers and acquisitions.

Disclaimer:

This article has been prepared for informational purposes only and should not to be treated as legal advice.

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