INDONESIAN REAL-ESTATE INVESTMENT TRUSTS (DANA INVESTASI REAL ESTAT/DIRE) AND SUFFICIENT PROTECTION FOR INVESTORS

Annisa Suci Ramadhani[1]

 

The Dana Investasi Real Estat (DIRE) or Real Estate Investment Trust (REIT) remains unpopular in Indonesia, while in terms of growth, it still lags behind other ASEAN countries such as Singapore and Malaysia. Even though a number of policies aimed at supporting the issuance of DIRE are set out in the government’s 11th Economic Policy Package, while several tax regulations have been issued in order to offer a number of tax incentives to DIRE,[2] to date, only three DIRE have been issued in Indonesia. The largest and most recent DIRE to be issued was Simas Plaza Indonesia (PT Sinarmas Asset Management) in 2019, while Jakarta Landmarks Plaza Indonesia, FX Mall and the Grand Hyatt have been defined as the underlying assets of this DIRE.

However, across the global marketplace, REIT continue to attract a positive outlook from investors as a result of various factors, including: (i) The risk arising from investing in one property decreases when investors invest in REIT, which can comprise diverse property portfolios; (ii) Through the ownership of REIT participation units, an individual investor who has relatively limited capital available can afford to invest in high-value properties such as hotels, malls and convention halls, in comparison with buying/investing directly in high-value assets which require large amounts of capital; (iii) It is easier to transfer, buy or sell REIT participation units as securities than it is to transfer, buy or sell properties; and (iv) In most countries, REIT enjoy tax-relief status (moreover, under certain conditions, individual investors who receive income from REIT investments may also enjoy tax-exempt treatments).

 

DIRE Structure in Indonesia

Image: Common DIRE Structure

 

In 2017, Indonesia’s Financial Services Authority (Otoritas Jasa Keuangan - “OJK”) issued Regulation No. 64/POJK.04/2017 which addressed DIRE in the form of Collective Investment Contracts (“Regulation 64/2017”). This regulation revoked the old DIRE regime which was originally put in place by both the OJK and the Capital Market and Financial Institutions Supervisory Agency (Badan Pengawas Pasar Modal dan Lembaga Keuangan/Bapepam - LK). Even though Indonesia does not specifically recognize the concept of trust, a DIRE can be established based on a collective investment contract (“CIC”) which is made by and between the relevant investment manager and custodian bank, and through which the investment manager is granted the authority to manage the collective investment portfolio while the custodian bank is granted the authority to manage the relevant collective deposits.[3]

A DIRE is used as a vehicle in order to raise funds from investors which will subsequently be invested in real-estate assets. As with stock under any equity investment, the investor will hold the participation unit of the CIC as ownership in the DIRE. The DIRE may invest in real-estate assets with or without utilizing any special purpose company (“SPC”) — a type of limited liability company which is owned by the DIRE with at least 99.9% of its paid-up capital and which is represented by an investment manager solely for the benefit of the holders of the participation units.

 

Protection for DIRE Investors

The DIRE regulation sets out several provisions which specifically address the protection of investors, as follows:

  • Asset separation - Since a DIRE is a contract that cannot directly hold DIRE assets or shares in a DIRE SPC, the investment manager will be responsible for holding the DIRE assets on behalf of the unitholders. Regulation 64/2017 requires DIRE assets which are held by an investment manager to be accounted for separately from the assets of the investment manager.[4] Hence, if the investment manager goes bankrupt, then the relevant DIRE assets will be separated from any assets which are associated with the bankruptcy.
  • Fund-raising limitation - Regulation 64/2017 limits the borrowing of funds and the issuance of debt securities by DIRE in relation to the purchase of income-producing real-estate assets to a maximum of 45% of the value of any such assets.[5] This provision is aimed at ensuring the certainty of the income source in terms of debt repayments; however, it may also have the potential to lead to the inability of DIRE to fund capital expenditure requirements for any underlying assets or for future acquisitions aimed at expanding the asset portfolio in order to cover cash flow shortages, which the DIRE might otherwise be able to resolve through the borrowing of funds.
  • Portfolio Composition - In order to ensure the investment integrity of any investment manager, Regulation 64/2017 also specifies a certain portfolio composition. Specifically, at least 80% of any net asset value must be invested in real-estate assets (either directly or indirectly through the acquisition of control in real-estate companies). Such real-estate assets must have been income-producing assets prior to their acquisition or, if the relevant lands and buildings are still in their construction stage, then the portfolio must generate income by no later than six months after the acquisition and must fulfill other conditions as required under the regulation. Meanwhile, the remaining value may be invested in (i) Other assets, such as securities in companies whose main business activities are in the field of real estate, money-market instruments, Indonesian securities portfolios and/or other financial instruments determined by the OJK and/or (ii) Cash and cash equivalents. In order to invest in any of the abovementioned assets, an investment manager must ensure that at least 51% of the relevant DIRE’s revenue will come from investments in real-estate assets and must ensure the validity of the legal ownership of such lands.[6]
  • Profit Distribution - The investment manager must distribute profits to the unitholders on an annual basis in amounts of at least 90% of net profit after tax, excluding calculations of any profits which have not yet been realized.[7]
  • Asset Transfer Restriction - The investment manager may not transfer assets if the value of the assets is lower than 90% of the assets’ market value based on the valuation of an independent appraiser which is undertaken within six months of the date upon which the relevant real-estate assets are to be transferred.[8]

In spite of any perceived preliminary benefits relating to the regulation, a number of risks are also associated with the DIRE structure which are not specifically addressed under Regulation 64/2017 and these risks include the following:

  • The regulation does not clearly stipulate the procedure which has to be followed when changing an investment manager. Given the significant role of the investment manager, a clear procedure should be set out which specifically addresses their appointment and dismissal. For example, in terms of any equity investment in a public company, a change of personnel within any Board of Commissioners or Board of Directors must be approved through a general meeting of shareholders.
  • The regulation does not specifically stipulate any mechanism for the offering of additional units within a DIRE, including the “pre-emptive rights” of unitholders, as stipulated under equity investments. Therefore, an investor’s ownership percentage may easily be diluted in the event of the issuance of additional units.
  • No specific provisions are set out under the regulation which address changes that are made to the control of units or to mandatory tender offers and which would protect minority unitholders. In addition, no clear definition is provided of controlling shareholders, although the relevant CIC may provide a specific definition.
  • In general, the regulation stipulates that DIRE asset transactions that involve purchases made from any parties which are affiliated to the investment manager or from any parties involved in the management and/or formation of DIRE shall be deemed arm’s length transactions and should be disclosed in the relevant prospectus.[9] However, the regulation does not specifically set any requirements for such affiliated-party transactions, such as the submission of fairness opinions (pendapat kewajaran) to the OJK and the approval of unitholders in terms of any conflict-of-interest transactions or affiliated-party transactions other than asset transfers/acquisitions.
  • Even though the current legal framework delineates several procedures for certain material transactions within DIRE (such as the requirement to obtain unitholder approvals for the transfer of any DIRE assets which have revenues of more than 20% of the total DIRE assets), there remain several material transactions which are not specifically addressed under the regulation. For instance, there are no requirements that have to be met in terms of obtaining approvals from unitholders when a DIRE encumbers its real-estate assets for its own benefit, including the provision of any other type of guarantee.

Nevertheless, the absence of these provisions in the regulation opens up the opportunity for parties to specify and monitor the relevant requirements themselves under the relevant CIC, particularly in terms of any covenants or requirements which are deemed beneficial and which will make the DIRE more attractive to investors. Therefore, given the lack of precedent or in-depth regulation in Indonesia, it is essential that both the protection of investors and good corporate governance in terms of the operation of DIRE are clearly addressed under any under CIC. In drafting CIC, there are several approaches that should be considered, including benchmarking with REITs within developed markets, as well as the making of comparisons with the legal framework that governs equity investments.

Disclaimer: The opinions expressed in this article are those of the author and do not reflect the official stance of any organization.

 

[1] The writer is a managing associate at Melli Darsa & Co. (the Indonesian member law firm of the PwC global network)

[2] In Indonesia in particular, these tax incentives, among others, pertain to the distribution of profit received or obtained by the holders of a participation units under a Collective Investment Contract and are not subject to income tax. Dividends received from a DIRE SPC may be excluded from any calculation of taxable income if they qualify under the relevant tax regulations.

[3] Sri Sunarni Sunarto, Mengenal Lembaga Hukum Trust Inggris dan Perbandingannya di Indonesia, (Bandung: Pusat Penerbitan Universitas LPPM Universitas Islam Bandung, 1994), 13-14. “Although the concept of trust which establishes a clear separation of ownership between the legal owner and the beneficiary owner of the object is not purely recognized in the Indonesian legal system, Prof. Subekti sees several similarities between trust and prevailing legal institutions in Indonesia. This is possible based on Article 1317 of the Indonesian Civil Code, which in principle, states that an agreement applies only to the parties who enter into the agreement, except there is a promise made for a third party under said agreement (beding ten behoeve van derden).”

[4] Art. 7 (1), Regulation 64/2017.

[5] Art. 15 (1-2), Regulation 64/2017.

[6] Art. 13, Regulation 64/2017.

[7] Art. 22, Regulation 64/2017.

[8] Art. 18 (1), Regulation 64/2017.

[9] Art. 16, Regulation 64/2017.

Annisa Suci Ramadhani[1]

 

The Dana Investasi Real Estat (DIRE) or Real Estate Investment Trust (REIT) remains unpopular in Indonesia, while in terms of growth, it still lags behind other ASEAN countries such as Singapore and Malaysia. Even though a number of policies aimed at supporting the issuance of DIRE are set out in the government’s 11th Economic Policy Package, while several tax regulations have been issued in order to offer a number of tax incentives to DIRE,[2] to date, only three DIRE have been issued in Indonesia. The largest and most recent DIRE to be issued was Simas Plaza Indonesia (PT Sinarmas Asset Management) in 2019, while Jakarta Landmarks Plaza Indonesia, FX Mall and the Grand Hyatt have been defined as the underlying assets of this DIRE.

However, across the global marketplace, REIT continue to attract a positive outlook from investors as a result of various factors, including: (i) The risk arising from investing in one property decreases when investors invest in REIT, which can comprise diverse property portfolios; (ii) Through the ownership of REIT participation units, an individual investor who has relatively limited capital available can afford to invest in high-value properties such as hotels, malls and convention halls, in comparison with buying/investing directly in high-value assets which require large amounts of capital; (iii) It is easier to transfer, buy or sell REIT participation units as securities than it is to transfer, buy or sell properties; and (iv) In most countries, REIT enjoy tax-relief status (moreover, under certain conditions, individual investors who receive income from REIT investments may also enjoy tax-exempt treatments).

 

DIRE Structure in Indonesia

Image: Common DIRE Structure

 

In 2017, Indonesia’s Financial Services Authority (Otoritas Jasa Keuangan - “OJK”) issued Regulation No. 64/POJK.04/2017 which addressed DIRE in the form of Collective Investment Contracts (“Regulation 64/2017”). This regulation revoked the old DIRE regime which was originally put in place by both the OJK and the Capital Market and Financial Institutions Supervisory Agency (Badan Pengawas Pasar Modal dan Lembaga Keuangan/Bapepam - LK). Even though Indonesia does not specifically recognize the concept of trust, a DIRE can be established based on a collective investment contract (“CIC”) which is made by and between the relevant investment manager and custodian bank, and through which the investment manager is granted the authority to manage the collective investment portfolio while the custodian bank is granted the authority to manage the relevant collective deposits.[3]

A DIRE is used as a vehicle in order to raise funds from investors which will subsequently be invested in real-estate assets. As with stock under any equity investment, the investor will hold the participation unit of the CIC as ownership in the DIRE. The DIRE may invest in real-estate assets with or without utilizing any special purpose company (“SPC”) — a type of limited liability company which is owned by the DIRE with at least 99.9% of its paid-up capital and which is represented by an investment manager solely for the benefit of the holders of the participation units.

 

Protection for DIRE Investors

The DIRE regulation sets out several provisions which specifically address the protection of investors, as follows:

  • Asset separation - Since a DIRE is a contract that cannot directly hold DIRE assets or shares in a DIRE SPC, the investment manager will be responsible for holding the DIRE assets on behalf of the unitholders. Regulation 64/2017 requires DIRE assets which are held by an investment manager to be accounted for separately from the assets of the investment manager.[4] Hence, if the investment manager goes bankrupt, then the relevant DIRE assets will be separated from any assets which are associated with the bankruptcy.
  • Fund-raising limitation - Regulation 64/2017 limits the borrowing of funds and the issuance of debt securities by DIRE in relation to the purchase of income-producing real-estate assets to a maximum of 45% of the value of any such assets.[5] This provision is aimed at ensuring the certainty of the income source in terms of debt repayments; however, it may also have the potential to lead to the inability of DIRE to fund capital expenditure requirements for any underlying assets or for future acquisitions aimed at expanding the asset portfolio in order to cover cash flow shortages, which the DIRE might otherwise be able to resolve through the borrowing of funds.
  • Portfolio Composition - In order to ensure the investment integrity of any investment manager, Regulation 64/2017 also specifies a certain portfolio composition. Specifically, at least 80% of any net asset value must be invested in real-estate assets (either directly or indirectly through the acquisition of control in real-estate companies). Such real-estate assets must have been income-producing assets prior to their acquisition or, if the relevant lands and buildings are still in their construction stage, then the portfolio must generate income by no later than six months after the acquisition and must fulfill other conditions as required under the regulation. Meanwhile, the remaining value may be invested in (i) Other assets, such as securities in companies whose main business activities are in the field of real estate, money-market instruments, Indonesian securities portfolios and/or other financial instruments determined by the OJK and/or (ii) Cash and cash equivalents. In order to invest in any of the abovementioned assets, an investment manager must ensure that at least 51% of the relevant DIRE’s revenue will come from investments in real-estate assets and must ensure the validity of the legal ownership of such lands.[6]
  • Profit Distribution - The investment manager must distribute profits to the unitholders on an annual basis in amounts of at least 90% of net profit after tax, excluding calculations of any profits which have not yet been realized.[7]
  • Asset Transfer Restriction - The investment manager may not transfer assets if the value of the assets is lower than 90% of the assets’ market value based on the valuation of an independent appraiser which is undertaken within six months of the date upon which the relevant real-estate assets are to be transferred.[8]

In spite of any perceived preliminary benefits relating to the regulation, a number of risks are also associated with the DIRE structure which are not specifically addressed under Regulation 64/2017 and these risks include the following:

  • The regulation does not clearly stipulate the procedure which has to be followed when changing an investment manager. Given the significant role of the investment manager, a clear procedure should be set out which specifically addresses their appointment and dismissal. For example, in terms of any equity investment in a public company, a change of personnel within any Board of Commissioners or Board of Directors must be approved through a general meeting of shareholders.
  • The regulation does not specifically stipulate any mechanism for the offering of additional units within a DIRE, including the “pre-emptive rights” of unitholders, as stipulated under equity investments. Therefore, an investor’s ownership percentage may easily be diluted in the event of the issuance of additional units.
  • No specific provisions are set out under the regulation which address changes that are made to the control of units or to mandatory tender offers and which would protect minority unitholders. In addition, no clear definition is provided of controlling shareholders, although the relevant CIC may provide a specific definition.
  • In general, the regulation stipulates that DIRE asset transactions that involve purchases made from any parties which are affiliated to the investment manager or from any parties involved in the management and/or formation of DIRE shall be deemed arm’s length transactions and should be disclosed in the relevant prospectus.[9] However, the regulation does not specifically set any requirements for such affiliated-party transactions, such as the submission of fairness opinions (pendapat kewajaran) to the OJK and the approval of unitholders in terms of any conflict-of-interest transactions or affiliated-party transactions other than asset transfers/acquisitions.
  • Even though the current legal framework delineates several procedures for certain material transactions within DIRE (such as the requirement to obtain unitholder approvals for the transfer of any DIRE assets which have revenues of more than 20% of the total DIRE assets), there remain several material transactions which are not specifically addressed under the regulation. For instance, there are no requirements that have to be met in terms of obtaining approvals from unitholders when a DIRE encumbers its real-estate assets for its own benefit, including the provision of any other type of guarantee.

Nevertheless, the absence of these provisions in the regulation opens up the opportunity for parties to specify and monitor the relevant requirements themselves under the relevant CIC, particularly in terms of any covenants or requirements which are deemed beneficial and which will make the DIRE more attractive to investors. Therefore, given the lack of precedent or in-depth regulation in Indonesia, it is essential that both the protection of investors and good corporate governance in terms of the operation of DIRE are clearly addressed under any under CIC. In drafting CIC, there are several approaches that should be considered, including benchmarking with REITs within developed markets, as well as the making of comparisons with the legal framework that governs equity investments.

Disclaimer: The opinions expressed in this article are those of the author and do not reflect the official stance of any organization.

 

[1] The writer is a managing associate at Melli Darsa & Co. (the Indonesian member law firm of the PwC global network)

[2] In Indonesia in particular, these tax incentives, among others, pertain to the distribution of profit received or obtained by the holders of a participation units under a Collective Investment Contract and are not subject to income tax. Dividends received from a DIRE SPC may be excluded from any calculation of taxable income if they qualify under the relevant tax regulations.

[3] Sri Sunarni Sunarto, Mengenal Lembaga Hukum Trust Inggris dan Perbandingannya di Indonesia, (Bandung: Pusat Penerbitan Universitas LPPM Universitas Islam Bandung, 1994), 13-14. “Although the concept of trust which establishes a clear separation of ownership between the legal owner and the beneficiary owner of the object is not purely recognized in the Indonesian legal system, Prof. Subekti sees several similarities between trust and prevailing legal institutions in Indonesia. This is possible based on Article 1317 of the Indonesian Civil Code, which in principle, states that an agreement applies only to the parties who enter into the agreement, except there is a promise made for a third party under said agreement (beding ten behoeve van derden).”

[4] Art. 7 (1), Regulation 64/2017.

[5] Art. 15 (1-2), Regulation 64/2017.

[6] Art. 13, Regulation 64/2017.

[7] Art. 22, Regulation 64/2017.

[8] Art. 18 (1), Regulation 64/2017.

[9] Art. 16, Regulation 64/2017.

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