A primer to understanding the P-REIT

(Fourth of five parts)

B. INVESTMENTS

6. ALLOWABLE INVESTMENTS

As mentioned previously, REITs are the average man’s strategy for investing in real estate. To protect these “unsophisticated” investors, the REITs are given only a narrow scope as to the type and location of investments they can enter into as well as the borrowings they can obtain.

The REIT Act requires the P-REIT to invest 75 percent of its Deposited Property (fair market value of the total assets of the P-REIT) in income-generating real estate. At least 35 percent of the Deposited Property should be invested in income-generating real estate located in the Philippine while those invested outside the Philippines should not exceed 40 percent and upon special authority from the SEC.

Aside from income-generating real estate, the REIT Act enumerates a number of low-risk, highly-liquid bonds and equities which the P-REIT is allowed to invest in. The Act also allows the P-REIT to invest in synthetic investment products subject to the condition that: a) it is not more than 5 percent of its Investible Funds (funds allowed to be invested in non income-generating real estate); b) solely for the purpose of hedging risk exposures; c) accounted in accordance with Philippine Financial Reporting Standards; d) issued by authorized financial institutions in accordance with BSP rules; and e) disclosed in the REIT plan and under special authority from the SEC.

7. PROPERTY DEVELOPMENT RESTRICTION

The P-REIT, as in other Asian REITs, is generally not allowed to undertake property development activities. This is because property development activities involve anticipation of future demand and assumptions of market conditions exposing the REIT to a risk that these assumptions would change by the time the property is developed. (Monetary Authority of Singapore, 2005, Consultation Paper - Review of the Regulatory Regime Governing REITs, June 2005, Monetary Authority of Singapore: Singapore)

Therefore, the REIT Act and its Implementing Rules does not allow a P-REIT to undertake property-development activities unless: a) it intends to hold the developed property for at least three years after completion; b) purchase of property is subject to the completion of the building with proper cover for construction risks; c) development shall be under terms no less favorable to the P-REIT than in an arm’s length transaction with independent parties; d) prospects upon completion are reasonably expected to be favorable; and e) should not exceed 10 percent of the Deposited Property.

8. SINGLE ENTITY LIMIT

To minimize the P-REIT’s risk exposure that the entity which it invested in will go bankrupt or cannot make the required payments, a P-REIT is not allowed to invest more than 15 percent of its investible funds in any one issuer’s security or managed fund. As an exception, the single entity limit for government securities is increased to 25 percent.

9. BORROWING RESTRICTIONS

Substantial borrowings by a REIT can result in a high debt servicing cost which, in turn, affects the profitability of the REIT and the dividend distribution to its stockholders. Therefore, to protect the investing public, the REIT Act imposes a total borrowing limit of 35 percent of the P-REIT’s Deposited Property. This 35 percent limit may, however, be increased to 70 percent provided the P-REIT’s investment grade credit rating (made by an accredited or internationally recognized rating agency) is publicly disclosed. This way, the investing public is properly made aware of the risks involved when they invest in a particular P-REIT. (To be concluded)

(Evelyn Garcia-Cantre is a senior manager of Tax of Manabat Sanagustin & Co., CPAs, a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity.

The views and opinions expressed herein are those of the author and do not necessarily represent the views and opinions of KPMG in the Philippines. For comments or inquiries, please email [email protected] or [email protected])