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REIT: Another financial product for the OFW

(Article published in the Apr 19, 2006 issue of Manila Standard Today)

             To date, the most common investment in Philippine real estate by the overseas Filipino is in the form of outright purchase of single units, such as residential house-and-lots or condominium flats, in anticipation of the day when, as a green card holder or dual citizen, “home is the hunter, home from the hills; and the sailor home from the sea.”  The item on reverse mortgage which I wrote for this column on 05 April 2006 spoke of how, with the financial institutions of the country permitting, capital could be made available for the OFW to withdraw gradually from such investment upon coming back.

The unspoken premise of this purchase now and withdraw capital later plan  is the assumption that the OFW has, at an early stage, reasonable opportunity and enough information to make a good choice of the specific real property to store his savings in.  But what if the OFW is not yet in a position to make a prudent selection, is there a financial product that can be offered to him that would enable him, in the meantime, to contribute and to share in the benefits of the “OFW phenomenon”?

          I suggest, to my friends in the trust industry, revisiting the opportunities to be derived from promoting for the OFW’s consideration the real estate investment trust (REIT).

The REIT is a form of trust within the broad category of “business trust”. As distinguished from “personal trust” where the basic objective is the attainment of benefits relating to the person or family of the beneficiary, a “business trust” is intended to achieve a commercial or economic benefit, per se, of usually many beneficiaries.  Hence, as a business trust, the REIT appears to be very much like a business corporation. The owners are more than one; management is centralized; and the purpose is for common profit of the equity holders.

  But the REIT, unlike a “living trust” or “reverse mortgage” is true to its name.  It is in the legal form of a trust and its funds are invested in real estate.

Assembling trust funds specifically for the development of real estate is not new in the Philippines.  As early as the ’70s, there was “FEREIT”, which was a corporation the majority stockholders of which were trust accounts managed by the trust department of Far East Bank and Trust Company.  It was thus “Far East Bank’s Real Estate Investment Trust.”  FEREIT disappeared from the radar screen decades ago when the smoke cleared after the first condominium boom in the country, but its true believers are still in town.  Among then is Eric Villegas, the poet-economist or vice versa, who I was told is into pocket real estate development projects but nevertheless still walks around like a surviving straggler of the Flower Revolution. Also, Digoy Fernandez who is presently a member of  a religious order of sorts, busy spending his time on earth building his treasure in heaven.

FEREIT, however, even if owned by trusts, was in the legal form of a business corporation; a true REIT is a real trust, in both legal form and economic substance.

In the United States, the REIT has good credentials.  To the REIT is attributed to a substantial degree the greatest growth in the development of Boston during the latter part of the nineteenth century.  At about the same time, it was also very popular in the Middle West and Far West contributing to the development of Detroit, Chicago, Minneapolis, St. Paul, Kansas City, Omaha, Duluth, and Seattle.  The REIT, however, suffered a temporary set back with the passage of the Revenue Act of 1913, from which our National Internal Revenue Code got many of its original provisions (including those that initially discouraged the trust industry from setting up local REITs) but was reinvigorated in 1960 when the US Congress passed the Real Estate Investment Trust Act amending the National Internal Revenue Code of 1954.  This law formally introduced a new federal tax entity called the REIT.

There is no need, nor benefit, to adopting in the Philippines the American concept of REIT (to use an American expression) lock, stock and barrel, but it would be helpful to adopt in a local version its strongest features.  Undoubtedly the key selling point of the REIT to trust departments (and the real estate industry) is its ability to accumulate funds from periodic remittances of OFWs that can then be pooled and invested as one big fund in a real estate development project or projects.  The relationship of the bank to the OFW clients can be governed by the terms of a “Participating Trust Agreement” and the management and operations of the pool can be pursuant to a sort of plan documented under a “Declaration of Trust”.

The terminology I propose, undoubtedly, resonates with what is already familiar to the trust industry and its clientele. Indeed, it is no secret that, at its core, an REIT is the common trust fund that they used to know, only that it is designed to be primarily invested in real estate.

I submit that two forms of REIT can be easily provided by the local trust industry specially geared towards the OFW. The first is a collective trust pool of funds from OFW trustors that can be organized along the lines of current Bangko Central regulations relating to Unitized Investment Trust Funds (UITFs).  If the investments are limited to selected real estate companies listed in the Philippine Stock Exchange, I see no reason why trust departments would not be able to crank out an REIT product almost at the click of the mouse or stroke of a key at the word processor.  This product can rightfully be called a REIT even if its assets are primarily in shares of listed stock because said stock are equity of real estate companies.  Since there is no substantial difference between this form of REIT and UITFs now in operation that are invested in equities, no wheel has to be reinvented. There are no new issues to address in its establishment, in securing the approval by the BSP, and in its operations.  Only the challenge of marketing the concept and confronting the risk of a portfolio concentrated in real estate need be addressed specifically.

The second form of REIT, which is a more direct involvement in real estate and thus more in line with the REIT in the United States, is an REIT specifically intended to invest in construction projects.  For instance, the construction of a road in a province can be undertaken by a trust department (as financier) and a reputable contractor of the locality on a build-operate-and-transfer (BOT) arrangement with the local government.  Financing the project will be supplied by an REIT whose funds are specifically (though not exclusively) raised from OFWs from that province.  The project can then be named after a dead hero of that place.

I must say that death of the hero is a requirement to prevent that man or woman, no matter how noble, from running for an elective office. 

The concept of a pool of trusts investing in a business used to be unattractive because of the probability (certainty, according to Cora Buenconsejo, then the head of corporate trusts of Far East Bank and Trust Company) of the REIT being considered an “unincorporated association” by the Bureau of Internal Revenue.  That treatment makes the REIT taxable as a corporation, and thus a separate and distinct taxable entity from its interest holders.  This, in turn, removes the competitive advantage of an REIT, which is the conduit treatment of its income, i.e. similar but not identical to the treatment of the income of a general professional partnership, over a business corporation.  In a general professional partnership, the partnership is not a separate taxing entity; the partners report in personal income tax returns their respective shares in the net income of the partnership.

However, that concern has been removed when the definition of what is subject to the corporate income tax (during the time, if I am not mistaken, of Ferdinand E. Marcos, who seeming to be gradually appearing to be better in comparison to you might know who)  excluded “a joint venture or consortium formed for the purpose of undertaking construction projects”.  In effect, this exclusion can be invoked as basis for saying that the conduit treatment may be accorded to an REIT for construction projects.  The income of the pool is thus reportable only in the tax returns of the separate trusts contributing to it.

         Undoubtedly, this form needs the guiding hand of one who knows both the REIT, the local trust industry, the real estate market, and the appetite of the OFW constituency.  I understand there is at least one good lawyer, with that combination of expertise, at the Romulo Mabanta Buenaventura Sayoc and De Los Angeles who could perform that role.  Ehem.