In some developing countries like Nigeria, the interest rate on construction loan is double digit in the midst of other charges that goes with development and higher than the return on property. There is low property stock for REIT acquisition and the property portfolio of Nigeria REITs is more of residential properties. In order to grow REITs property portfolio, will it be good to embark on financing property development as an investment option?
This is really a finance and economics decision. Usually the cost of financing is reflective of the risk being taken and repackaging of the risk (from "construction loan" to "investment") will not reduce that risk; the cost should be the same.
From a legal standpoint, in the US marketing investments is highly regulated in an attempt to prevent fraud. Before financing property development as an investment option it would be necessary to contact a lawyer with experience in the legal requirements. Detailed disclosures of the risks including marketing analysis are usually necessary.
Thank you Nancy. I am aware that at a point, the 5/50 rule was relaxed and that increase the institutional investors participation in REIT. Again the law on strict external manager for REIT was relaxed to allow internal management. My research is seeking to make a portfolio return and risk analysis of REITs investing in real estate acquisition and real estate development financing. This I believe will increase property stock in my case study, Nigeria.
Based on US law, it is challenging for REITs to invest in development due to constraints on sources of income and distribution. REITs must derive 75% of their income from real estate sources and pass through 90% of net income to shareholders. http://www.sec.gov/answers/reits.htm
Thus, REITs have little money to organically grow. REITs in fund raising could theoretically invest in development efforts but they tend to operate/own more established properties.
However, if I understand your question correctly, you are wondering whether REITs can lend to developers. If so, then yes. Mortgage income is considered real estate related income.
Unfortunately, an investment committee would likely not recommend lending in a country like Nigeria with both weaker enforcement of property laws and lesser ability to realize value from a bad investment. What happens if the development doesn't work out? What recourse does the REIT have? Could they foreclose as an external entity? Unlikely. Do they have the NIgerian relationships to get a substitute developer?
Most likely, the banks are pricing risk appropriately as they see it.
Sorry for the discouraging answer.
At the end of the study, it seems divesting into real estate financing can increase revenue to REITs in Nigeria considering high interest rates (23%-30%). However the points raised by Spencer is critical, the weal enforcement of laws, which is detrimental to investments in Nigeria. This issues will be a focus of an investigation soon
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