In the dynamic realm of capital markets, Real Estate Investment Trusts (REITs) have emerged as transformative instruments, democratizing real estate investments and augmenting market liquidity.
Despite their proven success in various global markets, Zimbabwe's REIT sector is yet to reach its full potential. However, with significant policy enhancements, the sector holds the promise of robust growth and enhanced effectiveness.
REITs are specialised investment vehicles that own, operate, or finance income-producing real estate. Structured as corporations, they must distribute at least 80% of their taxable income to shareholders as dividends. This unique structure allows investors to diversify their portfolios with various real estate asset classes, including residential, commercial, industrial, and healthcare properties, providing stability, liquidity, and a steady income stream.
Regulatory reforms are essential. Zimbabwe must establish clear, detailed REIT regulations covering formation, operation, taxation, and compliance. Simplifying these regulatory requirements can make it easier for new REITs to enter the market and for existing ones to operate efficiently.
The significance of REITs in capital markets cannot be overstated. By offering tradable securities, REITs enable broader participation in the real estate sector, allowing investors to access commercial properties that would otherwise be out of reach.
This democratisation of real estate investment enhances market liquidity, facilitates efficient capital allocation, and improves price discovery.
Additionally, REITs are subject to stringent transparency and disclosure requirements, which bolster corporate governance and investor confidence.
On a global scale, REITs operate within well-defined regulatory frameworks encouraging investment and providing tax benefits.
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These frameworks typically mandate diversified ownership structures, substantial investments in real estate assets, mandatory income distributions, and leverage restrictions.
However, in Zimbabwe, the REIT market is still in its nascent stage, grappling with numerous hurdles due to an underdeveloped regulatory framework, inadequate tax policies, limited access to capital, and a lack of investor awareness.
The inadequate regulatory framework is one of the primary barriers to REIT growth in Zimbabwe.
Currently, Zimbabwe lacks comprehensive legal and regulatory guidelines explicitly tailored for REITs. This absence creates uncertainty, deterring potential investors and complicating operations for existing REITs.
Moreover, the complex compliance requirements within the existing regulatory environment may discourage new market entrants.
Whilst seven REITs have been licensed by the Securities and Exchange Commission of Zimbabwe (SECZIM) since the introduction of the tax incentives, only two have been listed to date (which is the ultimate stage for attaining REIT status). The slow pace of listing is partly due to challenges encountered in implementing the conditions set and some practical challenges in putting together an attractive REIT offering for investors in the capital markets.
Acknowledging ZimREIT's infancy, the ultimate target is the development of a comprehensive legal framework for the setting up, governance, and operations of REITs, as is the case in other countries. This paper will draw attention to grey areas that require amplification and other proposed tax enhancements that would help smoothen the operationalisation and listing of REITs.
Section 17 (a) (k) (A) of the amendments to the Third Schedule (Exemptions to Income Tax) specify that for REITs being promoted by investors other than pension funds, the income subject to tax exemption must accrue from real estate investment projects commenced after the effective date (1 January 2021).
The definition of a “real estate investment project” is unclear and may be subject to different interpretations. For instance, does it entail a completely new building, or can it include substantial renovations to an old building or completion of an incomplete real estate construction project?
Would demolishing an old building and constructing a new one be considered a new actual investment project?
To avoid subjectivity in interpretation, there is a need to set a threshold of development costs relative to the total cost of the development, including land value, for instance, 70%.
Section (a) (k) (D), as amended by Finance (No. 7) ACT, 2021, restricts the ownership of the shares by five or fewer individuals to less than 50%, except where the shareholders are pension funds. The requirement is silent, where the owner is a body corporate or trust with many other beneficiaries beneath. We propose that the latter be explicitly exempted.
The understanding is that the onus to claim tax exemptions under the Third Schedule is on the taxpayer.
However, given the number of potential grey areas associated with REITs and the fact that these will be listed and attract investors who would ordinarily assume that the promoters have fully satisfied all the requirements for a REIT status, there is a risk that the entire REIT industry may lose credibility once one is then found at the end of a tax year not to be eligible for tax exemption.
As such, we propose that an upfront approval or REIT certification be granted by the tax authorities as confirmation that, indeed, the REIT has satisfied all the requirements for tax exemption status, which becomes a pre-requisite for a public listing.
Any loss of such REIT status should also be promptly communicated to the investing public, in line with the practice in other jurisdictions.
The current tax incentives only apply to income tax for income earned on properties within the REIT.
The legislation is, however, silent on other forms of taxation applicable to property investments, such as Value Added Tax (VAT) and Capital Gains Tax (CGT), as well as Stamp Duty on the transfer of the properties.
Although VAT is refundable, for properties, it represents a considerable cash outflow and opportunity cost, such that the time lag between paying the VAT and getting the refund can be prejudicial to investors within the REIT.
This has become a significant stumbling block, especially for pension funds that sought to transfer their properties into a REIT.
One pension fund had to be granted a specific exemption only applicable to that pension fund. It is proposed that VAT be scrapped on all transfers of properties into a REIT.
Similarly, imposing stamp duty on the “purchase” of properties by REITs has significantly hindered the development of REITs in the country.
This again adds an extra cost which, for instance, pension funds seeking to transfer their properties into a REIT, would otherwise not incur if they didn’t choose to go the REIT route.
We believe that a pension fund should be indifferent, from a tax perspective, between continuing to own their properties directly or transferring them into a REIT. REITs' liquidity and governance advantages should then tilt their decisions to go the REIT route.
Over time, it is envisaged that some REITs may sell some properties to other REITs or third parties, either to crystalise returns, dispose of non-performing properties or as part of a general portfolio restructuring strategy. Any benefits accruing from such would ordinarily be enjoyed by the REIT unit-holders either as special dividends or capital gains.
As such, we propose that REITs also be exempted from Capital Gains Tax to avoid double taxation in the same manner they are exempted from Income Tax, which is also in line with standard practice in other REITs globally.
The ability to defer payment of capital gains tax into the next generation of capital deployment, that is, upon disposal of units by unitholders, would significantly benefit the REIT strategy in Zimbabwe.
REITs have immense potential to accelerate the country’s infrastructure development drive, grow the economy through regulated investment channels, and foster employment creation.
In conclusion, a well-designed policy framework can have a profound impact on the growth and development of capital markets cannot be understated.
By fostering an environment that encourages investment, provides tax incentives, and establishes apparent regulatory oversight, Zimbabwe can harness the full potential of REITs, driving substantial growth and development in its capital markets.
The strategic reforms proposed here are not just theoretical. Still, they are grounded in the successful experiences of other markets, offering a roadmap for Zimbabwe to follow in its quest to develop a robust and dynamic REIT sector.
- Juru is the chairperson of the REIT Association of Zimbabwe.
