Real estate - a life for the stock exchange

With pension funds on their way out as stock exchange players, could REITs be used to stimulate the seriously crippled stock market? What’s standing in the way? By Beata Socha Come July, the government is set to start talking about the 2017 budget. One of the questions that it will have to answer is how to finance its generous social policies. Market analysts bet on private pension funds (OFEs) as the most likely source of capital. The previous government has already created a precedence of taking money from pension funds. In 2013, then-ruling Civic Platform took out most of their assets (including all their bond holdings) in order to balance the 2014 budget. Though controversial, the move has been sanctioned by the Constitutional Tribunal as legal. OFEs have henceforth been forbidden from investing in bonds, in order to channel their remaining assets to the stock market. This “incentive” did little to soften the blow to the stock market that was suddenly robbed of over PLN 1 billion as OFEs had to sell shares en mass to free up cash for the transfer. Several scenarios are considered for this year’s budget planning: from a moderate transfer to the utter annihilation of OFEs. Even in the more favorable scenario, many believe that OFEs, as an investor in the stock market, might soon cease to matter, which poses a serious question that the leaders of the stock exchange have been racking their brains trying to answer: Is there another player that could replace them and pump money into the stock exchange? Big money [caption id="attachment_98698" align="alignleft" width="300"] Image: Mediadem Consulting[/caption] Enter REITs. Long has the Polish financial and real estate industry discussed why REITs would be a great instrument in Poland. “It’s an ideal instrument for pensioners. It’s safe, transparent and long-term,” said Radosław Świątkowski, president of the board at REINO Partners. The ben­efits would be two-fold: REITs could help provide for the 25 million Poles that will soon reach retirement age, as well as filling the void that the departure of OFEs from the stock exchange has left. “Polish small and medium-sized investors would be given the opportunity to invest in safe Polish commercial real estate, which would allow them to move some of their funds from bank deposits for example,” said Szymon Renkiewicz, senior associate at Linklaters. Market makers are well aware of the huge and untapped potential in the deposits owned by households. “The value of the Polish real estate market is some PLN 200 billion, whereas bank deposits are now at PLN 680 billion,” stressed Świątkowski. “Even if a mere 1 percent of those funds were redirected to the real estate market, it would be a reason to rejoice,” added Włodzimierz Kocon, deputy president of state-controlled lender BGK. Tax myths What’s standing in the way of REITs coming to Poland is legislation, or the lack thereof. “The biggest obstacle, it seems, which is preventing REITs from being introduced into Poland’s legal system is the fear of lowering the state’s tax revenue, as well as the current unpopularity around introducing new tax breaks for large companies (including those controlled by foreign entities or with their significant financial involvement),” said Renkiewicz. The ruling Law and Justice party has esPolish property. The money is not taxed here. From the point of view of the state budget, it’s pure profit,” he added. Simple calculation According to estimates by the stock exchange, as much as PLN 1 billion is lost in taxes, as they are paid outside Poland due to tax optimization schemes. The projections also posit that Polish REITs could potentially draw as much as 25 percent of the total profits from the Polish real estate market. If, in turn, individual investors’ holdings amounted to 30 percent of all the REITs’ holdings, that could produce an extra PLN 25-50 million in taxes that would go directly to state coffers. That’s far better than what the state gets from capital gains tax on bank deposits. After all, “REIT dividend is significantly higher than the interest paid on bank deposits. It’s a simple calculation,” commented Świątkowski. So, once the myths about tax avoidance are debunked, REITs, as a way for Poles to invest in Polish real estate, should be perfectly aligned with the policies of the current government and Deputy PM Morawiecki’s development plan to increase the involvement of domestic capital in Polish investments. Risk perception However, even if the legislation was already in place, who’s to say it would immediately lead to a surge in real estate investment levels? “The law on reverse mortgages has been in force for 18 months and there is still no coherent product,” pointed out Bolesław Meluch, board advisor at the Polish Banks Association. The popularity and success of REITs in the Polish market is largely a question of how Poles perceive risk involved n real estate. After getting burned in the 2008 crash and given their brief affair with investing, Poles have become highly cautious about investing. When a typical “Kowalski” hears “alternative asset classes,” he or she immediately sees a red blinking warning light. It doesn’t help that “alternative” encompasses almost anything other than stocks and bonds, from stable income-generating real property, through highly volatile resource markets, to the currency market, which many would classify as gambling rather than investment. In order to understand the real estate market, Poles will need a lot of education and time. However, there are signs of slow improvement in investors’ perception of risk. Some instruments related to the real estate market have been extremely popular lately. “Developers’ corporate bonds are sold out within 3-4 days,” said Dorota Latkowska-Diniejko, managing director at REINO Partners. Residential too? Experts’ opinions differ when it comes to whether or not REITs should be able to invest in residential properties. “The exclusion of residential property is a mistake. It’s an asset just like any other,” said Michał Koślacz, board member at developer Capital Park. Świątkowski disagrees. “A REIT is a business model which, regardless of its legal structure, allows investors, mainly individuals, access to income-generating real estate investments at a scale that is inaccessible to them on their own. That’s why I believe that the residential market is not what we should focus on. Any ‘Kowalski’ can buy an apartment on his own, but a REIT would allow him to invest in an office building,” he said. REIT-alike Even if REITs are a song of the future, developers, asset managers and other market players are making do with the existing regulations, creating REIT-alike vehicles. REINO Partners operates two FIZs (closed-end investment funds) and one joint-stock company that will have its IPO by the end 2016. The first FIZ, REINO Dywidenda FIZ, has already paid their investors a dividend of 6 percent a year for the first two years of its operations. The funds are as close as it gets to being “Polish REITs,” without the legal framework: their investors are individual Poles who own Polish office schemes: Kapelanka 42 in Kraków (purchased from Skanska in 2014), Malta in Poznań and Alchemia I in the Tri-City. Recently, the most talked-about REIT in the Polish market is Griffin’s, which was formed in partnership with South African REIT Redefine, although it is difficult to call it Polish. Redefine (in conjunction with some of its clients) took over 75 percent of the fund, while Griffin kept the remaining 25 percent. Still, it showcases the potential of the Polish market. Meanwhile, Capital Park, a Polish developer and investor, is also becoming increasingly active, having delivered one fund and working on two more. Its first fund has been generating a dividend of 7 percent annually. Whether or not more companies will decide to join the REIT club is now up to the legislators. Poland seems to be on the right track. “In 2006, in South Africa, it was estimated that the legislative process of introducing REITs could take 3-6 years. The draft bill was announced by the South African Finance Minister in February 2012 and came into force in May 2013,” explained Renkiewicz. He also added that given the growing interest in the subject of REITs in Poland and the WSE’s involvement, we could expect the legislation within the current term of the government.