CAPITAL MARKETS AUTHORITY

A Study on the Viability of Real Estate Investment Trusts in Kenya

Submitted by

Vista Capital Limited

December 2008

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Executive Summary Vista Capital Limited was hired by the Capital Markets Authority to undertake a
study on the Viability of Real Estate Investment Trusts in Kenya. As part of the Study a market survey and workshop were undertaken to seek opinions of the investing public as well as research undertaken to understand how a REITs market operates in other more developed capital markets.

The objective of the Study was to the foundation towards putting in place a policy
and regulatory framework so as to: a) Introduce real estate investment trusts; b) Facilitate the listing of the established schemes; and c) Promote investments in property by small, medium and large size investors.

REITs in developed capital markets have been in existence in their present format
since the 1960s, however, were actually originally introduced in the 1800s. Corporate tax exemption was a critical element in the development of the REIT industry. REITs are typically exempt from corporate tax as long as 90% of net income is distributed to shareholders. REITs are commonly structured as closeended trusts due to the illiquid nature of property.

Kenyas capital markets can play a strong role in the further development of the
real estate sector. The introduction of REITs is viable given the demand for real estate, and the need for additional financial instruments. As a result, it is recommended the CMA introduce REIT regulations and work with the Kenya Government to give fiscal incentives. Housing should be given extra incentives to help the government meet their 2030 Vision goals.

The capital markets can help mobilize and allocate resources, as there is a strong
demand and cultural bias towards property investments. Retirement Benefit Schemes as well as many individuals are already investing in property but many are very limited in their ability to do so in that they cannot afford direct investments that are not liquid.

With the introduction of REITs it is felt property developers would come to the
capital markets to raise funds. It is also likely that through a higher level of participation through the capital markets, bank financing would be forced to become more competitive thus helping to further reduce development costs.

The following is the recommendations made as a result of the survey, workshop

and global research to meet the CMA objectives:

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- The CMA develop new REIT regulations, as the CIS regulations are not
applicable to the specialized nature of REITs.

- The CMA work with other regulatory bodies such as the CBK, RBA and the
IRA to allow REITs to be an accepted investment so there are no regulatory barriers to investment demand.

- The CMA must also ensure the KRA recognizes any fiscal incentives given by
the government. Without this level of cooperation, the REITs industry will not perform.

- REITs should be structured as close-ended trusts and encouraged to list on the

Nairobi Stock Exchange, although private placements should also be allowed, if the number of shareholders is over 50. Non-listed REITs must still allow free transferability of shares and be approved by CMA for tax incentives.

- Specialized REITs should be allowed (particularly those involved with low

and medium cost residential properties) so as to benefit from the specialized areas of property management. Disclosure should be very strict though to ensure investors realize the specialization and the risk involved with such specialization.

- Development property should be restricted to 15% of the REIT value to help

restrict the much higher risk involved with development property. REITs should be allow to leverage on the basis interest cover (EBITDA/interest charge) is equal or more than 2.0 times.

- REITs should be allowed to invest in long-term tradable fixed income

securities related to property, other local REITs, as well as property related equity stakes while all other investments should be short term money market related to provide working capital requirements of the REITs.

- REITS should be allowed to invest offshore both directly and through offshore
REITs with the asset allocation restricted to 30%. However, if invest directly offshore, must have a professional property manager in each country invested.

- To encourage existing property management companies and property

investment companies to convert to REIT structures, majority ownership should be allowed up to 50% for the primary sponsor. All other investors stake should be restricted to a maximum of 25%. However, a minimum of 100 shareholders should be required for a publicly listed REIT to help ensure liquidity. For private REITs, shareholding must be a minimum of 50 to qualify for any fiscal tax incentives.

- As mentioned earlier, specialized REITs should be allowed (particularly those

involved with low and medium cost residential properties) so as to benefit from the specialized areas of property management.

- Disclosure should be very strict though to ensure investors realize the

specialization and the risk involved with such specialization.

- The CMA should dictate a minimum asset allocation for real estate of 75% to
ensure the REITs remain a property investment. In addition, 75% of the Page 3

portfolio must be rental generated income and 90% of that income distributed to shareholders as dividends.

- Development property should be restricted to 15% of the REIT value to help

restrict the much higher risk involved with development property and to ensure a high level of income generating property.

- REITs should be allowed to invest in local REITs, real estate related equity,
and long-term tradable fixed income securities related to property while all other investments should be short-term money market related to provide working capital requirements of the REITs.

- REITS should be allowed to invest offshore both directly and through offshore
REITs with the asset allocation restricted to 30%. However, if invest directly offshore, must have a professional property manager in each country invested.

- The CMA should set the minimum value of a publicly listed REIT to Ksh 50
million for those REITs specializing in low and medium cost housing. For those investing in high-end housing and/or non-residential properties, the minimum asset value should be Ksh 500 million. These values are set to help ensure the REITs are able to provide a well-diversified property portfolio.

- Properties must be valued by a professional manager prior to any private or

public placement. At least three valuation methodologies must be utilised and a detailed valuation report be part of the offer documentation.

- Thereafter, properties should be valued every three years with one-third of the
portfolio valued each year. However, any major changes in cash flow expectations of the income generating property (e.g. due to changes in rent values, vacancy rates etc.) must be disclosed in the REITs annual report.

- CMA should work with the Government of Kenya to offer the following fiscal
incentives: REITS are exempt from all taxes including: - VAT on all rental income - Corporate tax - Any capital gains tax - Stamp Duty on purchase/sale/transfer of properties - VAT on professional services

- Withholding tax on any underlying interest income - Dividends must be distributed with withholding tax withheld at source on
the final tax on individuals

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- To qualify for these incentives a REIT must distribute 90% of its net income
and undertake annually two public forums (minimum of 50 individuals each) for educational purposes with the CMA present.

- The following is suggested to be the minimum listing requirements: - Minimum of Ksh 500 m paid up capital (Ksh 50 million for housing specialist funds) Minimum number of shareholders at 50 Shares freely transferable No track record for REITs but fund managers must have a five year track record REIT IPO to be underwriten REIT IPOs allowed to run blind pool but full disclosure regarding intended portfolio and investment policy statement Directors and all professional service providers to be vetted by CMA Property manager must be a member of a property-related professional association does not need to be licenced by CMA Auditor and Lawyers to give opinions on IPO Full disclosure in regards to investment philosophy, investment horizon, existing portfolio details (type, values, regional diversification etc), risk management, etc. REIT may be traded on NSE, but will also allow non-listed public REIT Professional indemnity insurance for all professionals related to the issue/fund

- A REIT must have a professional property manager (registered with a property

related professional association) with at least five years experience, CMA licensed fund manager to manage all assets, a Board of Trustees, CMA approved custodian bank to hold all assets, an independent Professional valuer (must belong to professional property related association) ICPAK member auditor, LSK member legal counsel. Full and detailed disclosure is required with the introduction of REITs to the Kenyan market.

- Disclosure to the CMA should be on a quarterly basis with the following

disclosed: - Net Asset Values (NAVs) based on last know valuation and marked to market values for tradable securities - Names of top 10 shareholders and amounts invested and any change within the quarter - Description of property portfolio with details of type, location, income stream, vacancy, maintenance costs, expenses, etc - Description of all Development Property - Description of all Offshore property interests - Description of non-property asset portfolio with details regarding asset type, terms, maturity, market value, income expected, location, etc. - Description of all Offshore non-property interests Page 5

- Names of all managers and evidence of qualifications of new management as well as professional indemnity insurance Description of all risk highlighted any changes in risk levels from previous quarters and methods to mitigate risk exposures Semi-annual Disclosure to the Public/Investors should be: Net Asset Values (NAVs) based on last know valuation and marked to market values for tradable securities Management accounts including balance sheet and cash flow statements Detailed description of investment portfolio similar to that required to be submitted to CMA on quarterly basis Evidence of Diversification of property and non-property assets Risk profiles and measures taken to mitigate Any changes in management or professional advisors Dates of last property valuations List of top 10 shareholders and their percentage holding

- Annual Disclosure to the Public/Investors should include: - Same as semi-annual with exception accounts should be audited - A statement from the professional valuer to state whether any major changes in the property market would likely change the underlying value of the properties within the REITs property portfolio. Every three years a full professional valuation to be undertaken with a report included in the annual report with one-third of the portfolio valued annually.

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Reliances and Limitations

In preparing the Study on the Viability of Real Estate Investment Trusts in Kenya (herein referred to as the Study), Vista Capital Limited and its director, relied on information and opinions given by the CMA staff and directors, representatives of the Governement of Kenya, Capital Market Stakeholders, and Capital Market Participants in other markets as well as undertaking extensive Internet research. This confidential Study is intended solely for use by the CMA, the sponsor of the Study. Vista Capital Limited does not take any responsibility for any use of this Study nor does it take any responsibility for the consequences of acting on this Study. The CMA and its stakeholders must assess for themselves the appropriate actions needed and applicable to their environment to achieve its objectives. It may also be prudent to seek legal council in determining the legal suitability of suggestions made within the Study. It is of utmost importance for the CMA to continually undertake assessments of the changing environment within the local capital market as well as globally, particularly as it strives to achieve its mission and objectives, recognising that capital markets are dynamic. As a result, the CMA, its staff, and its development partners must recognise the changing environment, both internally and externally, and the impact it could have on the operations of Kenyas Capital Markets.

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Vista Capital Limited shall not be responsible for the results of any action of the CMA in following or declining to follow any advice or recommendations Vista Capital Limited might make to it. In accepting this Study the CMA indemnifies Vista Capital Limited and holds it harmless against all costs, expenses, damages, loss or any liability of whatever nature. Vista Capital is not an agent of the CMA nor is this Study an offer of management and/or financial consultancy on the part of Vista Capital or any of its affiliates.

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