REITs are breaking new ground in Dubai with potential for more in the region to soak up the vast excess of liquidity. Simon Gray reports

In many of the world's major capital markets, REITs have become a favoured method for attracting public ownership in property investments. They provide a convenient forum for listed and traded property ownership, with transparent pricing and abundant liquidity.

In the context of a booming real estate sector within the Gulf and wider regional markets, there is huge scope for Real Estate Investment Funds. The Middle East as a region has a relatively high exposure to real estate investments in private portfolios but thus far very little exposure to REIT-style property investment.

Investing in property is also culturally very attractive to the Muslim investor. These were just some of the key factors in the Dubai Financial Service Authority's (DFSA) decision to introduce its internationally benchmarked REIT regime in 2006. Although REITs are not a new phenomenon, in the MENA region the DFSA regime is the first of its kind.
According to Ernst & Young's 2006 Global REIT report, REITs have a global market capitalisation of US$608bn (€422bn) which is rising fast worldwide. Including leverage, the value of the assets held is US$890bn.

There has been significant growth in countries adopting REIT regimes since 2000. The sudden interest has been fuelled by the post-9/11 repatriation of revenues from the West to the Middle East and consequent massive liquidity bolstered by high oil prices. In addition, there is a desire within Dubai to invest in the future, with oil now only constituting a small percentage of its GDP. The growth in financial free zones within the UAE which is being replicated in other parts of the Gulf Co-operation Council (GCC) countries has facilitated this - more stock exchanges to create primary and ultimately secondary markets and greater "financial democracy".

The REITs regime within the Dubai International Financial Centre (DIFC) was established using a rigorous process of benchmarking with the best. As its regulator, the DFSA was established using a blank sheet of paper, negating the need to adapt existing legislation and rules.

Its zero tax regime meant that fiscal legislation did not need modification. There were, however, a number of challenges.

In 2006 new laws and rules were introduced including the Collective Investment Law, the Investment Trust Law and amendments to the Companies Law to ensure international familiarity. Accordingly the regime has a number of core characteristics - many of which will be familiar to REIT investors across the world.

The regime only applies to closed ended public funds which may distribute over 80% of income;
The REIT must not invest in a single property and borrowing is limited to 70%; There is also a cap of 30% on investments in property under development; The ban on single-property REITs provides additional investor protection by avoiding concentration of risk; The DFSA regime also has the flexibility to allow investment in infrastructure projects which provide core services to private and commercial property developments. 

International benchmarking ensured challenges were overcome with creative solutions.

First, it was important to make the new regime attractive without having the normal tax incentive - with a zero tax regime, one of the principle incentives for a REIT was missing.

Secondly, it was vital for the DFSA to achieve the correct regulatory balance given that it is a wholesale environment for sophisticated investors rather than retail.

Thirdly, the REIT regime in Dubai had to be recognisable as a REIT for an overseas investor. This meant acceptance that, while Muslims like property investment, culturally a REIT is very much a new type of investment vehicle for this region. As a principle-based regulator, the DFSA handled these challenges via benchmarking through in-depth consultation with industry practitioners.

This brings us to the general approach under the DFSA's regime to regulating Islamic
finance. The DFSA provides an integrated regulatory framework with due modification to reflect the specificities of Islamic finance.

Mindful of some of the differences in opinion in Shari'a interpretation, the DFSA has implemented a Shari'a systems approach to regulation. Islamic firms operating in the DIFC must implement systems and controls to ensure that the firm operates in compliance with Shari'a and this includes the appointment of a Shari'a supervisory board.

The DFSA has a specific category to cover a wholly Islamic financial institution - acknowledging this defined market. However, the DFSA's regime is flexible enough to allow the use of ‘Islamic windows' - effectively providing conventional financial houses with the flexibility of continuing with what they know and do best but allowing them also to offer Islamic financial services, thus accommodating both conventional and Islamic
REITs and avoiding any particular interpretation of Shari'a.

In addition, the DFSA requires the same degree of disclosure for Islamic transactions as it does for conventional products. Transparency through disclosure is an obligation on all authorised firms, with regulatory arbitrage not being an option.

Although the DFSA regime was the first REIT regime in the Middle East North Africa region, more regulatory regimes should be put in place to soak up the liquidity within the market. Alternative REIT regimes should not be seen as competitors but rather as complementing the current regime. As REITs develop to provide an additional investment vehicle they should help create a secondary market for these types of securities. With real estate growing exponentially around the GCC region, there is no shortage of investment potential.

The DFSA believes that it is a very good time to introduce REITs to the GCC market. They are a means by which to open up the real estate sector as an avenue for investment without the investor having to take specific property risk. It has nothing to do with where the market is in the real estate cycle in terms of prices, but has much more to do with how developed and mature the market is becoming.

The DFSA approach with the introduction of its REITs regime has been to create a commercially acceptable system of regulation that satisfies the needs of both regulator and regulated.

Simon Gray is director, supervision at the Dubai Financial Services Authority