Case

Pakistan’s First Successful Launch Asian Journal of Management Cases

15(2) 129–146
of a Real Estate Investment Trust- © 2018 Lahore University of
Management Sciences
Dolmen City (REIT)—(Shariah SAGE Publications
sagepub.in/home.nav
Compliant Rental REIT Scheme) DOI: 10.1177/0972820118780740
http://journals.sagepub.com/home/ajc

Fazal Jawad Seyyed1

Salman Khan2
Yasir Mir3
Zeeshan Amir3

Abstract
It was the start of November 2015. Muhammad Ejaz, the CEO of Arif Habib Dolmen REIT Management
Limited (AHDRML), was preparing for a presentation to the Board of AHDRML for the following week.
The presentation was to recount the story of Dolmen City REIT (DCR), launched a few months back in
June 2015, highlighting the regulatory and legal challenges faced during the process and many lingering
issues still confronting this nascent sector. Ejaz realized that the group, as a leading player in the sector,
had a crucial role to play in lobbying for further changes in the regulation to pave the way for future
launches. More importantly, Ejaz wanted a nod from the Board for launch of a different REIT structure
in 2016 to capitalize on the immense opportunity in the real estate sector of Pakistan.

Keywords
Real Estate Investment Trust (REITs), rental REIT, developmental REIT, hybrid REIT, Islamic REITs,
Shariah Compliance, REITs valuation

1
Visiting Faculty, Suleman Dawood School of Business, Lahore University of Management Sciences, Lahore, Pakistan.
2
Assistant Professor, Suleman Dawood School of Business, Lahore University of Management Sciences, Lahore, Pakistan.
3
Student, Suleman Dawood School of Business, Lahore University of Management Sciences, Lahore, Pakistan.

Corresponding author:
Fazal Jawad Seyyed, Visiting Faculty, Suleman Dawood School of Business, Lahore University of Management Sciences, Lahore,
Pakistan.
E-mail: fazal.jawad@lums.edu.pk
130 Asian Journal of Management Cases 15(2)

Introduction
As Ejaz was jotting down notes, memories of this historic journey went through his mind. The satisfaction
evident on his face was a reflection of the effort that he and his team had put in over the past several years
to achieve something as big as the launch of Pakistan’s first-ever Real Estate Investment Trust (REIT).
A copy of the recently published financial statements of the Dolmen City REIT (DCR) was resting on his
workstation as he occasionally referred to it to reaffirm some of the factual details for the presentation.
His noticeable attention to detail in preparing the presentation was a clear indication of the significance
of the upcoming meeting with the Board. Ejaz realized that his presentation could possibly sway the
Board’s opinion regarding the future launch of another REIT by the Group in 2016.
Ejaz organized his presentation into different phases, from conception to launch, starting from as
early as 2005 when the idea of introducing a REIT Regime in Pakistan was floated by the government,
to the eventual initial public offering (IPO) of Pakistan’s first REIT in June 2015. He planned to address
the regulatory issues that delayed the launch of REITs in Pakistan and how the regulatory framework
evolved over time to pave way for the launch of DCR. While the REIT regulations had significantly
evolved over the years, several challenges remained or resurfaced constricting the development of the REIT
sector. Ejaz; however, was very optimistic about the future of REITs in Pakistan. As he conceptualized
the upcoming presentation, Ejaz reflected on the global trends and developments in REITs to underscore
the immense potential in this sector of Pakistan. Exhibit 1 provides an overview of REITs, common
REIT structures, Islamic REITs (iREITs) and the historical perspective on the development of REITs.

Pakistan’s Commercial Real Estate Market

Pakistan’s commercial real estate sector1 had generally remained underdeveloped and failed to attract
significant long-term investments because of security concerns and an unstable political environment.
Although the situation was unlikely to change dramatically in the short term, significant opportunities
existed to expand and modernize Pakistan’s stock of commercial real estate, offering investors high
yields and considerable growth potential in the long term. Improved law and order situation could
give a significant boost to the commercial real estate sector of Pakistan. In addition, a more favourable
regulatory environment for the creation of REITs could further pave the way for increased investment
in this sector through pooled funds and provide Pakistani investors a valuable channel to direct their
investments into the home market rather than seeking opportunities overseas.
The office properties segment had seen robust demand, offering investors fairly high yields. The retail
real estate sector was expected to be supported by a young and increasingly urban population, and with
low organized retail segment penetration levels, there was plenty of room for growth. However, gener-
ally low-income levels and the preference of many Pakistanis to shop in traditional smaller outlets for
grocery purchases had deterred many international retail chains from entering the Pakistani market. Most
shopping malls and Western-style retail stores were primarily located in more affluent neighbourhoods
in major cities.
The industrial segment of commercial real estate, comprising warehousing and industrial facilities,
was likely to get a major boost from improvements in the country’s cargo shipment facilities, by way
of port expansions and new rail links, especially due to CPEC (China–Pakistan Economic Corridor),
the demand for premium-quality space in industrial zones and growing demand for manufacturing and
logistics space.
Seyyed et al. 131

Arif Habib Group and Dolmen Group Forging a Partnership

Arif Habib Group had diversified businesses in the areas of financial services and solutions, fertilizers,
cement, steel, energy and real estate. The Group commenced brokerage services in 1970. Arif Habib
Limited (AHL), a subsidiary of the group, was engaged in providing brokerage and corporate finance
services to a large number of institutional clients, high net-worth individuals and retail clients.
AHL had a significant market share in the financial services business. The company provided
financing and investment solutions related to equity and debt capital markets, mergers and acquisitions,
financial advisory and structured finance. MCB Arif Habib Savings and Investments Limited was a
leading asset management company in Pakistan catering to institutional and retail investors.
Dolmen Group  was one of Pakistan’s leading real estate organizations, primarily engaged in the
development, construction and management of prime commercial real estate, including shopping malls,
office towers and residential apartment blocks. Since its inception in 1984, the group had continued its
expansion with several projects in the planning and construction phase as well as an available land bank
for future developments. The Group currently owns and/or manages the largest portfolio of shopping
malls in the country which include Dolmen City Mall, Dolmen Mall Hyderi and Dolmen Mall Tariq
Road, all in Karachi.
Arif Habib Dolmen REIT Management Limited (AHDRML), a joint venture of the Arif Habib Group
and the Dolmen Group, was incorporated as a public limited company in 2009 (unquoted) under the
Companies Ordinance 1984 and was registered under NBFC Rules with the Securities and Exchange
Commission of Pakistan (SECP). The objective of the company was to launch and manage REITs on
carefully selected and commercially viable real estate with the aim of bringing real estate investment
within the reach of common investors. The company combined the expertise of Arif Habib Group and
Dolmen Group, bringing together strength in financial markets, real estate and property management.
Pakistan’s first REIT, DCR, was launched by AHDRML. The IPO took place on 12 June 2015 with
the stock listed on all three stock exchanges of Pakistan. The successful launch of a REIT in Pakistan was
the outcome of a long period of regulatory adjustments by the SECP and concerted efforts made by Arif
Habib Group and Dolmen Group.

REIT Regulatory Evolution and Issues

Activities to establish a REIT regulatory regime in Pakistan started in 2005, when Prime Minister
Shaukat Aziz showed interest in bringing this global investment vehicle to Pakistan. While the real
estate market in Pakistan was growing, the sector remained capital starved. A need was felt to provide
finance to this sector through the capital markets and to provide investment opportunities in real estate
to small investors. REITs seemed to be a suitable vehicle for these objectives. In an attempt to introduce
this instrument in Pakistan, the REIT Regulations 2008 were issued by SECP. However, no REIT could
be launched under these regulations which were considered very stringent for the sponsors and fund
managers. Ejaz described the situation thus:

REIT Regulations 2008 were not very practical. The minimum fund size required was PKR 5 billion, which
was quite large. The regulations also required that the real estate property must be approved by SECP prior to
bringing it into the REIT Scheme. This was problematic since public knowledge of strong interest in the property
before the transaction was likely to impact the negotiation dynamics and property prices. This requirement was
132 Asian Journal of Management Cases 15(2)

seen by major investment bankers as over-regulation and detrimental to the development of REITs in Pakistan.
Due to some of these regulatory and technical issues, the regulatory framework failed to generate sufficient interest
of property owners, REIT management and property management companies to establish REITs in Pakistan.

Based on the market response and feedback, SECP amended the REIT regulations in June 2010.
Under these amendments, some of the stringent requirements were relaxed for the REIT Management
Companies (RMCs). For example, the fund size and capital requirements were reduced. However, many
problems still remained. There was a restriction on REITs borrowing, which could hinder their growth.
In addition, Ejaz commented:

Under the REIT regulations 2010, 20 per cent of the real estate fund had to be owned by the RMC, effectively
making a fund manager a significant investor as well. If a real estate was to be brought into a REIT scheme,
payments for it could generally be made either through cash or issuance of REIT units. However, the regulation
restricted ownership by any single investor to a maximum of 10 per cent. Hence, a REIT could not issue more
than 10 per cent units for any property and payment had to be made mostly in cash. This was another impediment
in establishing REITs. It became obvious that an outside property could be brought into a REIT scheme primarily
through direct ownership of property.

AHDRML submitted an application under the 2010 amended regulations in an attempt to provide lead
in this important catalyst of real estate development in Pakistan. However, a major challenge for the
RMC was to offer an attractive yield to excite investors’ interest in the REIT. Recalling his professional
experiences, Ejaz observed:

Throughout the world rental REITs yield 150–200 basis points above the five-year government bonds. In the
case of Pakistan, the yield on five-year Pakistan Investment Bonds (PIBs) in 20102 was between 12 per cent–
14 per cent. This was a tough benchmark for any rental REIT to meet. For a Developmental REIT, risks were
even greater since the project had to be developed first before any income was generated, which under the interest
rate scenario would be even less attractive for investors. Hence, this attempt to launch a REIT by Arif Habib-
Dolmen did not materialize and in fact no other REIT could be launched in Pakistan even after the regulatory
amendments.

Based on the experience and fund managers’ reluctance to launch REITs under the 2010 regulatory
framework, SECP repealed the earlier regulations and replaced them with the REIT Regulations 2015.3
REIT Regulations 2015 brought down the minimum fund size requirement in line with the listing
requirement on the stock exchanges. Other regulatory changes provisioned an REIT scheme to be
registered before the transfer of property, enabling the REIT to carry out the purchase transaction by
issuing units to the seller of the real estate. The RMCs unit-holding requirement was also reduced from
20 per cent to 5 per cent. According to REIT Regulations 2015, an ‘REIT Scheme’ had to be a listed
closed-end fund. Mortgage REITs were not allowed. Only equity REITs classified into the following
three categories were permitted to fund sponsors: Developmental REIT, Rental REIT and Hybrid REIT.
Ejaz lauded the new regulations as a significant advancement over the previous, and a step in the right
direction. However, he noted that there were several areas in the regulatory framework that still required
improvement. Ejaz reflected:

For example, there is still a lacuna—minimum 25 per cent of the units must be issued through an IPO. If some-
one transfers a real estate to the REIT, only 75 per cent of units could be issued to it, remaining consideration
(in cash) could be paid after the IPO and it takes about 2–3 months for the process to complete. Another area
that required to be revisited by the regulator was the SECP approval requirement before a property could
be brought into the REIT. SECP as a regulator should provide the necessary guidelines related to property
Seyyed et al. 133

acquisition, but leave the business decisions to the fund managers—removing the requirement of SECP approval
before it could be incorporated in the REIT. In addition, not allowing the use of leverage under the new regula-
tions significantly limited the financing opportunities for REITs.

AHDRML filed the application for the registration of DCR, comprising Dolmen Mall and Harbour
Front properties, two premier properties in Karachi’s Clifton area. However, many challenges had to be
overcome in launching the first listed REIT in Pakistan.

Other Challenges
During the development of the real estate projects, many challenges emerged for Arif Habib Group and
Dolmen Group. The model for the two properties was built-to-rent. Recalling those circumstances, Ejaz
said, ‘In our experience, if you develop and sell a plot, after five years the adjacent undeveloped plot’s
value would be the same as the developed property, thus reducing incentive for developers’, referring
to the steep upward trend in real estate prices in Pakistan. Traditionally, the general preference of small
local businesses in Pakistan was to own shops rather than rent them. Even if a business was not very
successful, the rise in the real estate price would generate positive returns. Hence, starting a shopping
mall and corporate tower based on the rental model, especially on such a large scale, was the first-of-its-
kind project involving significant risks. During Dolmen City Mall’s construction there were widespread
concerns regarding its commercial viability. The project was a testimony to the two groups’ resolve.
The first corporate tenant, Engro, moved into the Harbour Front building in 2008, and rented six out of
seventeen floors of the building, while it took five years to fill the remaining eleven floors.
The challenges encountered in launching of the REIT were even more daunting. Transfer taxes that
accrued on the transfer of a property to the REIT scheme were quite high, reaching around 5 per cent–
6 per cent of the value of the property. If the property was transferred on the basis of valuation tables,
taxes would amount to about PKR 225 million, while if it was transferred on the transaction value basis,
taxes would amount to as high as PKR 1 billion, making the transaction unfeasible. To facilitate the
launch of DCR, the first REIT Scheme in Pakistan, the government of Sindh approved concessionary tax
rates on property transfer to the REIT, which made the transaction feasible.
Another challenge was to inform the public and stimulate investor interest in the REIT units.
Traditionally, investor dynamics in the real estate sector and the capital markets of Pakistan were quite
different. There were relatively few investors participating in the capital markets compared to the real
estate sector, which had a bigger and diverse investor base. REITs; however, blended some of the
features of both markets. To offer such an instrument for the first time and attract investors was not easy.
The timing of the launch compounded the problems, considering the fact that the yields on risk-free
government securities were quite high compared to rental yields. Structuring the offer to yield attractive
returns was another challenge. A capitalization rate of 10 per cent was; therefore, used for the valuation
of the property based on income capitalization.
As per the regulations, the real estate had to be approved by the SECP which was quite a tedious
process. To establish the ownership of the property, SECP required a written confirmation from Karachi
Development Authority (KDA), the lessor of the property. It also required a confirmation about whether
construction was completed as per requirements of the Sindh Building Control Authority. Apart from
this, No Objection Certificate (NOC) from environmental protection agencies and confirmation of the
property being encroachment-free were also required. Hence, complying with the regulatory approval
requirements made the process long and complex. Since the confirmations were required from
134 Asian Journal of Management Cases 15(2)

government authorities and offices, the approval processes took a long time. In the case of Dolmen City
Project, two out of the five buildings were to be acquired under the REIT, which resulted in undivided
share of land. This further delayed the approval process.

The Offering of First REIT in Pakistan

Arif Habib Group had a stake in the Dolmen Mall and Harbour Front through a 20 per cent shareholding
in International Complex Projects Limited (ICPL), the original holder of the properties (while the other
80 per cent was with Dolmen Group). The Mall became operational in 2011 and was almost fully occupied
by 2014. This raised the Group’s confidence that these state-of-the-art properties would be ideal for a
REIT. As a result, Arif Habib Dolmen REIT Management remained committed to the launch of the DCR.
One of the impediments to the launch of the REIT earlier was the prevailing high interest rate scenario in
the country which made the return on a rental REIT unattractive for investors. The falling interest rates
in 2014–2015; however, created a favourable environment for the launch of the REIT. The combined
capital market expertise of Arif Habib Group and real estate expertise of Dolmen Group (the property
manager) also contributed to investor confidence in the REIT venture.
The REIT registration documents were subsequently filed with the SECP and approved in June 2015.
The book building and the IPO process commenced in the same month. Limited roadshows were
conducted primarily targeting institutional investors who were believed to be major potential investors
in the IPO. The book building portion of the IPO of DCR was conducted during 8–9 June 2015. The issue
was oversubscribed 1.7 times, resulting in the strike price of PKR 11 per unit. Banks with provisional
allocation of 63.7 per cent units were the largest recipients of units in the book building phase. The IPO
shares were made available for general public subscription on 12 June 2015. Table 1 shows the factsheet
of DCR and Exhibit 2 shows the initial set of financial statements of DCR. Figure 1 shows the structure
of DCR REIT.

Table 1. Factsheet of Dolmen City REIT

Name of the REIT Dolmen City REIT

Nature of the scheme Perpetual, rated, listed, closed-end Shariah compliant rental REIT
REIT management company Arif Habib Dolmen REIT management limited
Listing Karachi Stock Exchange Limited (KSE), Lahore Stock Exchange Limited (LSE)
and Islamabad Stock Exchange Limited (ISE)
Instrument Units of Dolmen City REIT (In PKR 10 denominations)
Purpose The REIT Scheme has acquired two components of the Dolmen City Project
with the objective of generating rental income for unit holders
The REIT Scheme may further generate gains for the unit holders from selling
the real estate or parts thereof, with prior written approval from the SECP
Project snapshot The project is located at commercial plot No. HC-3, Block 4, Scheme No. 5,
Marine Drive, Clifton, Karachi. The REIT scheme comprises:
The Harbour Front, a 19 storey Office Building with a built area of
approximately 270,273 square feet
Dolmen City Mall, an international standard shopping mall with a built area of
approximately 1.29 million square feet
(Table 1 continued)
Seyyed et al. 135

(Table 1 continued)

Name of the REIT Dolmen City REIT

Fund size PKR 22,237 million
(Property value PKR 22 billion plus other expenses of PKR 237 million)
Pre-IPO portion of the fund PKR 16,677,750,000/- (equivalent to 75 per cent of the fund size)
IPO portion of the fund PKR 4,169,437,500/- (75 per cent of the IPO portion through book building
process); and
PKR 1,389,812,500/- (25 per cent of the IPO portion through initial offering
to the general public)
Remaining lease period of 61 years (starting from 1975 till 2075)
the real estate
Trustee and unit registrar Central Depository Company of Pakistan Limited (CDC)
Property manager Dolmen Real Estate Management (Pvt) Limited
Property valuer National Engineering Services Pakistan (Pvt.) Limited–NESPAK
Premium over cost
Valuation Valuation approach Value (PKR Billion) approach
Cost approach 18.16 –
Sales comparison 51.40 183 per cent
approach
Income capitalization 43.21 138 per cent
approach
Negotiations/transaction 22.00   21 per cent
value
Legal counsel Mohsin Tayebaly & Co., Advocates & Corporate Legal Consultants
Shariah advisor Mufti Muhammad Ibrahim Essa (Fazil Jamiah Darul Uloom, Karachi)
Auditor KPMG Taseer Hadi & Co., Chartered Accountants
Rating agency JCR-VIS Credit Rating Company Limited, JCR-VIS
REIT rating ‘RR1’
‘Funds rated in the “RR1” category are judged to be of highest investment
quality. Assurance of returns over the foreseeable horizon is excellent’.
JCR-VIS
Anticipated return Best Case: Based on full occupancy and 100 per cent pay-out and 10 per cent
growth in rent rates per annum; Dividend Yield is expected at 9.49 per cent
in the first year, which grows to 13.86 per cent in the fifth year and
22.55 per cent in the tenth year;
Worst Case: Based on 85 per cent occupancy and 90 per cent pay-out and
5 per cent growth in rent rates per annum; dividend yield is expected at
6.56 per cent in the first year, which grows to 8.36 per cent in the fifth year
and 11.51 per cent in the tenth year;
In addition to cash yield as stated earlier, capital appreciation is conservatively
projected at 5 per cent per annum. This will be reflected in Net Asset Value
(NAV) and would be realizable through sale of units at the stock exchange
Source: Dolmen City REIT Prospectus.
136 Asian Journal of Management Cases 15(2)

Figure 1. Structure of Dolmen City REIT

Source: Dolmen City REIT Prospectus.

The total fund size was PKR 22.237 billion with property value comprising PKR 22 billion; other
expenses accounted for the remaining PKR 237 million. The pre-IPO portion of the fund was PKR
16.677 billion (equivalent to 75 per cent of the fund size), whereas PKR 4.169 billion (75 per cent of
the IPO portion) was raised through the book-building process. The remaining PKR 1.389 billion
(25 per cent of the IPO portion) was raised through offering to the general public. The expected return
on the REIT in the best case scenario was estimated at around 10 per cent per annum. The optimistic
scenario assumed full occupancy, 100 per cent pay-out with rent rates growing at 10 per cent per annum.
Dividend yield was expected at 9.49 per cent in the first year, which would grow to 13.86 per cent by the
fifth year and 22.55 per cent in the tenth year. On the other hand, in the pessimistic scenario, the expected
return was based on 85 per cent occupancy, 90 per cent pay-out with rent rates growing at 5 per cent per
annum. In the pessimistic case, dividend yield was expected at 6.56 per cent in the first year, which
would grow to 8.36 per cent in the fifth year and 11.51 per cent in the tenth year.
The REIT was rated by JCR-VIS as RR1 which represented the highest fund quality. Different
valuation models yielded different values for the REIT. The value estimated (in PKR billion) ranged
from 18.16, 22, 43.21 and 51.4 based on cost basis, negotiations/transaction value, income capitalization
approach and sales comparison approach, respectively. Exhibit 3 presents an outline of two approaches
commonly used for the valuation of REITs. Exhibit 4 provides the relevant forecast assumptions useful
in the valuation process. The property value assessor of the REIT was National Engineering Services
Pakistan (Pvt.) Limited (NESPAK).
Since the launch of DCR, the unit price hovered at around PKR 10, as markets generally came under
selling pressure.
Seyyed et al. 137

The Way Forward

As Ejaz reflected on the experience of the past several years and successful launch of the first rental
REIT in Pakistan, he recognized the immense potential for different REIT structures that would appeal
to investors in Pakistan. He mused, ‘Unleashing the full potential; however, in Pakistan would require
improvement in the REIT regulations and a supportive environment.’ He also deliberated on the impact
of high tax rates on property transfer for the future REITs in Pakistan. His compliance team had sent him
two new provisions introduced through the Finance Act 2015 which could have an impact on new REIT
offerings. These were:

1. Through addition of second proviso in Clause 99A of Part-1 of the Second Schedule, Income Tax
Ordinance, government had limited the exemption of income tax on profit and gains on sale of
property to ‘Developmental REITs for Residential purposes’ only till 30 June 2020. This exemp-
tion was previously available to all types of REITs till 30 June 2015.
2. Under the Second proviso of Division III of Part-1 of the First Schedule, Income Tax Ordinance,
the word ‘REIT Scheme’ was added, making dividend received by a company from a collective
investment scheme, REIT Scheme, or a mutual fund other than stock fund be taxed at the rate of
25 per cent, for tax year 2015 and onwards. Also the Division I of Part-III of the First Schedule
on Advanced Tax on Dividends had introduced the word ‘REIT Scheme’ together with mutual
funds, making dividends received by companies liable to deductions at the rate of 25 per cent.

While Ejaz focused on the regulatory aspects, he asked his research team to prepare a detailed analysis
of an alternative REIT structure that would appeal to investors in Pakistan and make economic sense.
In addition, he asked the team leader to prepare a preliminary fundraising teaser for the fund sponsors
within the next two days so that he could incorporate the relevant analysis and recommendations in his
presentation to the Board.

Exhibit 1. Overview of REITs

1.1 REIT Structures

REITs were companies that own or finance income-producing real estate properties. REITs were
modelled after closed-end mutual funds and operated under specified guidelines to qualify for REIT
status. They facilitated widespread public ownership of commercial real estate and provided investors
with the benefits of diversification, regular income streams and long term capital appreciation. REITs
usually pay out almost all of their income as dividends to unit holders.
The units of a REIT were traded on stock exchanges like company shares, and provided investors
opportunity to own shares in a pool of real estate without purchasing or managing property themselves.
REITs were exempted from corporate income taxes, subject to meeting the specified regulatory require-
ments, and only unit-holders of a REIT pay tax on their dividends. The two main types of REITs found
globally were Equity REITs and Mortgage REITs. Equity REITs owned properties and generated regular
income primarily through the collection of rent on these properties. Equity REITs market were classified
into different property subsectors: rental apartments, offices, malls and shopping centres, storage, industrial
138 Asian Journal of Management Cases 15(2)

facilities, etc. Globally, equity REITS represented a major category of REITs in terms of market capital-
ization. Broadly, equity REITs can be classified as:

1. Developmental REIT: A REIT Scheme to develop real estate for industrial, commercial or resi-
dential purpose through construction or refurbishment.
2. Rental REIT: A REIT Scheme investing in commercial or residential real estate to generate rental
income.
3. Hybrid REIT: A REIT Scheme that had both a portfolio of buildings for rent and property for
development.

Mortgage REITs invest in mortgages or mortgage-backed securities tied to commercial and/or residential
properties. Regulations in Pakistan did not allow offer of Mortgage REITs till 2018.

1.2 Islamic REITs (iREITs)

In recent years, Shariah Compliant REITs or iREITs had become an important alternative to conventional
REITs for investors seeking Shariah compliant exposure to real estate. The unique characteristic of
iREITs was that they invest primarily in income-producing Shariah-compliant real estate or in single-
purpose companies whose principal assets were Shariah-compliant real estate.
iREITs had started gaining mainstream acceptance as a viable alternate for Shariah compliant invest-
ment. Nevertheless, the extent to which iREITs would enter the trillion dollar Islamic Finance industry
remained to be seen in the future. An iREIT was unique in that it invests primarily in income-producing,
Shariah-compliant real estate and/or single-purpose companies whose principle assets comprise Shariah
compliant real estate. The iREIT model was easily comparable to the Ijarah financing (sale and lease-
back financing) in Islamic banking and finance. Some guidelines for iREITs issued by Malaysia, one of
the major Islamic REIT Regimes, are as follows:

Non-permissible activities must not yield more than 20 per cent of rental incomes
iREIT cannot own any property where all tenants run non-permissible activities
Shall never accept any new tenants who participate in fully non-permissible activities
Non-permissible activities must not acquire more than a fifth of the area. Decisions on non-space
utilizing activities must be made using Ijtihad
All investment, deposit and financing instruments must comply with Shariah principles.
Property insurance must only be based on takaful schemes, unless no such schemes are available.

Rental activities classified as non-permissible are:

Interest (riba) based financial services

Gambling/gaming
Production or sale of haram products
Conventional insurance
Shariah non-compliant entertainment activities
Manufacture or sale of tobacco-based or related products.
Seyyed et al. 139

1.3 Historical Perspective on REITs

On 14 September 1960, a legislation was passed in the United States that created the legal framework
for REITs, which, for the first time, brought the benefits of commercial real estate investment to all
investors—benefits that previously had been available only through financial intermediaries and to high
net worth individuals and institutions.
Over time, investors responded to this opportunity and more than five decades after the first listing of
REITs on the US stock exchanges, the industry had grown to a $1 trillion market capitalization and nearly
$2 trillion in real estate assets as per the National Association of Real Estate Investment Trusts (NAREIT).
REITs had become an investment of choice vehicle for pooled investments in real estate. REITs
provided investors with an opportunity to invest in large-scale diversified portfolios of real estate
property. REITs gained extensive recognition during the 1990s in the United States when banks
and the government used REITs to liquidate non-performing real estate of financial institutions.
Widespread acceptance of REITs enhanced real estate markets growth, liquidity and performance over
time. Figure 2 shows the rapid growth of the US REIT market between 1971 and 2010.
A REIT was a tax-efficient company that owned income-producing properties. Three main types
of REITs in terms of investor access were: publicly listed, non-listed public and unlisted private
REITs with limited owners. Publicly listed REITs were the most transparent and visible, whereas unlisted
REITs were less transparent. Listed REITs shares were traded on the exchanges like other stocks, whereas
unlisted REITs shares were not traded on exchanges and therefore lack liquidity. The key differences in
these three categories were in terms of liquidity, transaction costs, management, minimum investment
amount, independent directors, investor control, corporate governance, disclosure obligation and perfor-
mance measurement.
As of 2015, more than thirty-eight countries around the globe had introduced REIT regimes and their
widespread acceptance improved the liquidity of investment in real estate. Globally, REIT regulatory
requirements varied in terms of the minimum share capital requirement, allowed leverage and minimum
profit distribution obligations.

Figure 2. Growth of the US REIT Market

Source: NAREIT (based on annual data).
140 Asian Journal of Management Cases 15(2)

Figure 3. Percentage Share in Global REIT Market

Source: Based on data from British Land and the European Public
Real Estate Association (EPRA).

Figure 4. Total Return Index Comparision

Source: NAREITs.

The United States was the largest REIT market measured by market capitalization as of 2015, repre-
senting 61 per cent of the global market (Figure 3). The FTSE NAREIT All REITs Index, a market
capitalization-weighted index that included all tax-qualified REITs that were listed on the New York
Stock Exchange, the American Stock Exchange and NASDAQ had a market capitalization of $890 billion.4
As of November 2015, 198 REITs traded on the New York Stock Exchange. The twenty-year compound
annual total return on the FTSE All REITs Index was 10.41 per cent, compared with 8.91 per cent for
S&P 500. In addition, the low correlation of real estate with other asset classes had been a valuable
source of portfolio diversification. REITs generally did not have a high leverage; the average debt
ratio of the US Equity-only REITs was 32.3 per cent while that for Equity-and-Mortgage REITs was
43.5 per cent, showing low credit risk for these investment vehicles.5
Figure 4 compares the total return on the FTSE NAREIT All Equity REITs Index, an index
comprising top US Equity REITs with the S&P 500 and the Russell 2000 indices, from December 1989
to June 2015. REIT index clearly outperformed the equity indices, with 1,259.12 per cent total return
over the period compared to 905.74 per cent for the S&P and 971.63 per cent for the Russell 2000 index.
Seyyed et al. 141

Exhibit 2. Financial Statements for 2015

Balance Sheet
As on 30 June 2015
2015
(PKR in ‘000)
ASSETS
Non-current assets
Total non-current assets—Investment property 22,237,000
Current assets
Rent receivables 34,514
Advances and other receivables 173
Interest accrued 97
Bank balances 912,718
Total current assets 981,502
Total assets 23,218,502
REPRESENTED BY:
Unit holders’ fund
Issued, subscribed and paid up
(2,223,700,000 units of PKR 10 each) 22,237,000
Reserves:
  Premium on issue of units 281,346
  Unappropriated profit 169,977
Total unit holders’ fund 22,688,323
Liabilities
Non-current liabilities
Formation costs payable to REIT management company 215,087
Security deposits 108,036
Total non-current liabilities 323,123
Current liabilities
Payable to REIT management company 58,259
Security deposits 44,543
Accrued expenses and other liabilities 104,254
Total current liabilities 207,056
Total Unit Holders Fund and Liabilities 23,218,502
  (PKR)
Net assets value per unit 10.20

(Exhibit 2 Continued)
142 Asian Journal of Management Cases 15(2)

(Exhibit 2 Continued)
Statement of Changes in Unit Holders’ Fund
Statement of Changes in Unit Holders’ Fund
For the period from 20 January 2015 to 30 June 2015
Reserves
Premium on Unappropriated Unitholders’
Units issue of units profit Sub total Fund
(PKR in ‘000)
Transactions with owners
Issue of units 22,237,000 – – – 22,237,000
Premium received on – 555,925 – 555,925 555,925
units subscription
Formation costs – (274,579) – – (274,579) (274,579)
  22,237,000 281,346 – 281,346 22,518,346
Total comprehensive income for the period
Profit for the period – – 169,977 169,977 169,977
Other comprehensive – – – –  –
income
Total comprehensive – – 169,977 169,977 169,977
income for the period
Balance at 30 June 2015 22,237,000 281,346 169,977 451,323 22,688,323

Cash Flow Statement

For the period from 20 January 2015 to 30 June 2015
2015
(PKR in ‘000)
CASH FLOW FROM OPERATING ACTIVITIES
Profit before tax 169,977
Adjustments for: Mark-up on bank deposit (98)
  169,879
Increase in current assets
  —Rent receivables (34,514)
  —Advances and other receivables (16,797)
Increase in current liabilities
  —Payable to the REIT management company 6,222
  —Security deposits 44,543
  —Accrued expenses and other payables 104,254
Cash generated from operations 273,587
Taxes paid (17,376)
Formation costs paid (7,455)
Security deposits received 108,036

(Exhibit 2 Continued)
Seyyed et al. 143

(Exhibit 2 Continued)
Net cash generated from operations 356,792
CASH FLOWS FROM INVESTING ACTIVITIES
Payment for investment property (5,559,250)
Mark-up received 1
Net cash (used in) investing activities (5,559,249)
CASH FLOW FROM FINANCING ACTIVITIES
Net cash flow from financing activities, Proceeds 6,115,175
from issuance of units
Cash and cash equivalents at end of the period 912,718

Profit and Loss Account

For the period from 20 January 2015 to 30 June 2015

2015
(PKR in ‘000)
Income
Rental income 193,662
Marketing income 6,282
  199,944
Administration and operating expenses (18,619)
181,325
Other income, mark-up on bank deposits 98
  181,423
Management fee (5,300)
Sindh Sales Tax on management fee (922)
Federal Excise Duty on management fee (848)
Trustee fee (907)
Provision for Workers Welfare Fund (3,469)
  (11,446)
Profit before taxation 169,977
Taxation –
  169,977
  (PKR)
Earnings per unit—Basic and diluted 0.08
Source: Annual Report of DCR.
144 Asian Journal of Management Cases 15(2)

Exhibit 3. Valuation of REITs

The use of traditional valuation metrics was not appropriate for the valuation of REITs. There were; however,
two main approaches used in the industry for valuation of REITs: (1) Funds from Operations (FFO) and (2) Net
Asset Value (NAV) based approach.

1. Funds from Operations (FFO) Approach

The Funds from Operations (FFO) is a commonly used metric for the valuation of REITs. FFO is calculated
as follows:
Net income computed in accordance with GAAP
+ Depreciation on real estate
+ One-time losses on real estate
– One-time gains on real estate
= Funds from Operations (FFO)

This figure approximated the cash flows from operations. However, one weakness with this measure was that
it did not adjust for capital expenditures used to maintain the existing portfolio of properties. As such,
FFO did not reflect the true residual cash flows since all expenditures have not been accounted for.
The Adjusted-Funds from Operations (AFFO) metric, which deducts capital expenditures for property
maintenance from FFO, overcomes the deficiency. Analysts focus on AFFO because it was a better measure
of residual cash flows to shareholders and provided a better base number for the estimation of value.
These metrics can be used for valuation through Discounted Cash Flow (DCF) as well as in relative
valuation methods.
• Discounted Cash Flows (DCF). Project the expected stream of AFFO based on growth estimates and
discount the cash flows at an appropriate discount rate to determine the present value. The cost of
equity capital is typically used for discounting FFO and AFFO cash flows.
• AFFO multiple = price/AFFO (benchmarked against industry peers). Other relative measures of valuation
were also widely used in practice.
A primary weakness of the AFFO approach was that it did not incorporate property appreciation or depre-
ciation. In periods of falling property values, separating depreciation from the analysis could inflate REIT
shares and hide risks posed to investors as a result of falling prices.
2. Net Asset Value (NAV) Approach
Most analysts use the Net Asset Value (NAV) as a metric for the valuation of REITs. This was calculated as
the market value of the assets of a REIT minus the value of all liabilities and divided by the number of units
outstanding. The value of the real estate assets was generally calculated by taking the REIT’s forward Net
Operating Income (NOI) and dividing it by an appropriate capitalization rate.Then other assets were added
to arrive at the market value of assets. A REIT can trade at or below/above NAV; however, in the long
run the average discount/premium to NAV for the market has been roughly 0 per cent.The NAV per share
is a widely used metric to assess the value of a REIT.
Source: Authors’ research.
Seyyed et al. 145

Exhibit 4. Forecast Assumptions

Income statement assumptions
Mall
Total Built area 1,3M
June 2016 June 2017 June 2018 June 2019 June 2020
Leasable area (sqf) 0.56 M 0.56 M 0.56 M 0.56 M 0.56 M
Occupancy rate 94 per cent 97 per cent 97 per cent 97 per cent 97 per cent
Leased out area (sqf) 0.53 M 0.54 M 0.54 M 0.54 M 0.54 M
Avg rent (sqf) 3,150 3,465 3,811 4,192 4,612
per cent increase 10 per cent 10 per cent 10 per cent 10 per cent
Office Tower  
Total Built area 0.3M
June 2016 June 2017 June 2018 June 2019 June 2020
Leasable area (sqf) 0.25 M 0.25 M 0.25 M 0.25 M 0.25 M
Occupancy rate 100 per cent 100 per cent 100 per cent 100 per cent 100 per cent
Leased out area (sqf) 0.25 M 0.25 M 0.25 M 0.25 M 0.25 M
Avg rent (sqf) 2,848 3,133 3,446 3,791 4,170
per cent increase 10 per cent 10 per cent 10 per cent 10 per cent
Property M.fee ( per cent of rev) 6 per cent 6 per cent 6 per cent 6 per cent 6 per cent
Insurance exp. (PKR) 63 M 66 M 70 M 73 M 77 M
per cent increase 5 per cent 5 per cent 5 per cent 5 per cent
Marketing exp 50 M 53,292 58,622 64,484 70,932
per cent of rev. 2 per cent 2 per cent 2 per cent 2 per cent
Property tax 21 M 22 M 22 M 22 M 22 M
per cent increase 1 per cent 1 per cent 1 per cent 1 per cent
Other operating exp 41 M 42 M 43 M 44 M 44 M
per cent increase 2 per cent 2 per cent 2 per cent 2 per cent
RMC fees 67 M 73 M 81 M 89 M 97 M
Trustee fees 11 M 12 M 1M 15 M 16 M
Preliminary exp. 48 M 48 M 48 M 48 M 48 M
FV Adjustment: Land & Building 1,112 M 1,167 M 1,226 M 1,287 M 1,351 M
per cent of Land & Building 5 per cent 5 per cent 6 per cent 6 per cent 6 per cent
Return on surplus cash 16,990 16,990 16,990 16,990 16,990
Balance sheet assumptions June 2016 June 2017 June 2018 June 2019 June 2020
Land & Building 22,237 M 22,237 M 22,237 M 22,237 M 22,237 M
FV Adjustment Land & Building 1,112 M 2,279 M 3,505 M 4,792 M 6,144 M
per cent of Land & Building
Payable to RMC 192 M 144 M 96 M 48 M
1st Yr 10th Yr
Dividend Yield 9.5 per cent 22.6 per cent
RE growth/annum 5 per cent
DPO 90 per cent
Source: Authors’ estimates.
Note: M: million.
146 Asian Journal of Management Cases 15(2)

Declaration of Conflicting Interests

The author(s) declared no potential conflicts of interest with respect to the research, authorship and/or publication
of this case.

Funding
The author(s) received no financial support for the research, authorship and/or publication of this case.

Notes
1. See Pakistan Real Estate Report, January 2015. BMI Research. A Fitch Group Company.
2. See http://www.sbp.org.pk/ecodata/Pakinvestbonds.pdf
3. See http://www.secp.gov.pk/corporatelaws/pdf/2015/REIT-Regulations-2015.pdf
4. National Association of Real Estate Investment Trusts®.
5. Debt ratio equals total debt divided by total market capitalization. Total market capitalization is the sum of total
debt and implied equity market capitalization (common shares plus operating partnership units).