Before the onset of the financial crisis, investing in Gulf-based real estate all but guaranteed a healthy return. More recently it has been considered risky. Real estate values in the Gulf have fallen significantly and in Dubai by as much as 30 per cent. However, real estate continues to be an important asset class and investors are likely to continue to capitalise on the expected resurgence of the Gulf economies. Indeed, there has been evidence of a recent trend to utilise trust-based products for investment in real estate-related products in the region.
During a period of continued economic growth, investors focus on building successful businesses and focus their resources on lucrative investments – and it is no different for wealthy businesses in the Middle East. During a downward trend investors will place more focus on achieving cost efficiencies and begin to place increased emphasis on corporate governance issues so as to limit further financial deterioration. Gulf institutions are yet to recover from the global economic crisis and the resultant fallout from the Saad and Al Gosaibi groups. Such events emphasise the need to adhere to strict corporate governance principles.
Question of trusts
There has been much talk about trusts in the Middle East. However, the reality to date is that they are not utilised widely as they are not well understood and are perceived as more expensive than other more traditionally adopted structures.
Trust structures separate investment managers from possible conflicts and provide comfort to investors in relation to safe custody of assets, independence, objectivity and transparency.
Nervousness regarding security of assets following the economic crisis has resulted in renewed interest from Gulf-based investors regarding the use of trust structures to ringfence assets for both private and corporate purposes.
Peace of mind
The Bahrain Financial Trusts Law (FTL) was promulgated in August 2006. Under the FTL trustees must be approved and regulated by the Central Bank of Bahrain (CBB), which is widely regarded as the best regulator in the Gulf region. The transfer of assets to a trustee that is regulated by the CBB gives clients and investors a large degree of comfort in relation to the protection of their assets.
The use of offshore trusts to hold Gulf- based assets can pose difficulties due to foreign ownership provisions. Also, Gulf-based clients may want to have close relationships with their trustees. This often means that clients will want to utilise a Bahraini trustee in order to hold Gulf-based assets.
To date, Gulf-domiciled fund vehicles have been established as companies, for example under Bahrain’s Commercial Companies Law. However, these vehicles pose a risk of being on the balance sheet and the owners and directors of these vehicles are often directors or senior executives of the promoter. While such structures may continue to be established, the financial crisis has meant that promoters are obliged to review structures from a corporate governance perspective and consider alternative structures that meet the requirements of international best practice.
Recently there has been significant interest in the use of trusts under the FTL in order to structure funds in line with the following features:
• the trustee of a Bahraini trust will be regulated by the CBB;
• the CBB will authorise and register the trust;
• the trust structure will be off balance sheet;
• investors draw comfort from having a professional, regulated trustee that operates to international standards to protect their interests; and
• the FTL provides a larger degree of flexibility in relation to registration, transfer and redemption of units compared with the Commercial Companies Law.
Establishment of Reits
A Real Estate Investment Trust (Reit) is typically a company that invests in income-generating real estate or property-related assets. The principal advantage of a Reit is that it enables the investor to acquire interest in a real estate portfolio that generates significant rental income and provides a high degree of liquidity in view of the fact that units in a Reit may be traded on a listed stock exchange.
The Reit market in the Gulf is still in its nascency. As of July this year there were no listed Reits in Dubai. Reits planned by developers such as Nakheel have been shelved pending a return of greater stability in the financial markets. The CBB announced recently the approval for Two Seas Trust to act as trustee to the Inovest Reit, an $80m (£48.56m) Islamic-compliant Reit structured as a Bahraini unit trust. The Inovest Reit is the first to be structured under the FTL. Its units will be listed primarily on the Bahrain Stock Exchange, for which a new category will be created.
Under the unit trust arrangement, the investment manager is appointed by the trustee to manage the portfolio of real estate on behalf of the trustee. The real estate assets are held in special purpose vehicles (SPVs), which are owned by the trustee for the beneficial interest of the investors. The trustee would typically have majority control of the board of each asset-holding SPV and would act in the best interest of the investors, which is likely to give additional comfort to investors from a corporate governance perspective.
A trend appears to be emerging with the promoters and investors to explore the use of trust vehicles to hold interests in Gulf Cooperation Council (GCC)-based assets.
Bahrain plays host to approximately 400 financial institutions and banks, and a robust financial services industry is key to its economy. The CBB has recognised the importance of the trust industry in supporting the development of its financial services industry. Also, given the demand for real estate and Islamic financial products, Reits and other trust-based products are certain to generate interest, and therefore there is little doubt that the trust industry has a leading role to play in deal and fund structuring in the future.
The immediate success of such structures will, however, be driven by investors’ appetite for GCC real estate, increased liquidity and the level of transactional activity.
Paul Perris is director of Ogier Fiduciary Services and managing director of Two Seas Trust in Bahrain