What is a FII?
Real Estate Investment Funds are collective investment instruments. These funds are formed by raising funds via the system for distributing securities, under the terms of Brazilian Federal Laws 8.668/93 and 9.779/99, together with CVM Instruction 205/94 and subsequent rules. The money raised by a FII (REIF in English) can be invested in the development of real estate projects, the construction of buildings or the acquisition of existing properties. Such monies can also invest in projects that make possible access to housing and services, for later sale, rental or leasing.
A FII is a closed fund, where shares cannot be redeemed. The return on invested capital comes through the distribution of earnings, the sale of shares or – depending on the case – the winding-up of the fund through the sale of its assets and the proportional distribution of proceeds amongst shareholders.
Investor Profile
The investor in a Real Estate Fund is one who wishes to diversify his investment portfolio. The Real Estate Fund seeks investors with a long-term vision. Compared to investing directly in property, the shareholder in a Real Estate Fund enjoys greater liquidity.
FII in Brazil
These were made possible by Federal Law 8.668 in June of 1993 and then regulated by the CVM in January of the following year under Instructions 205 and 206. Brazilian Real Estate Investment Funds currently total around R$2 billion invested in some 60 funds, focusing on commercial buildings, shopping centers, schools, housing estates and so on.
FII around the world
American Real Estate Investment Funds are known as Real Estate Investment Trusts (REIT). They were created in the 1960s and today represent investments of around US$300 billion in more than 300 REITs traded on the stock market – 149 on the New York Stock Exchange (NYSE), 27 on the American Stock Exchange and 12 on NASDAQ. During 1998 they distributed more than US$11 billion in dividends to shareholders.
Advantages of a FII
- Fiscal Performance
- Pulverization / Low Risk
- Professional Management (real estate and financial)
- Economies of Scale
- Portfolio Diversification
- Excellent option for pension planning
Taxation
Real Estate Investment Funds are exempt from Brazilian tax, including income tax, which is liable only on financial revenues received from investment of the fund’s surplus cash flow (these can be compensated on distribution), and when earnings are distributed to shareholders, and on capital gains that the shareholder might obtain on selling his shares.
Brazilian Federal Law 9.779/99 determines that in order to enjoy this tax benefit, the fund must meet the following conditions:
- The fund must distribute 95% of its earnings to shareholders on at least a six-monthly basis;
- The fund shall not invest in real estate developments where the developer, builder or any partner is a fund shareholder who holds more than 25% of fund shares, either individually or together with any person connected to him;
- The foreign shareholder who cashes in his investment in less than one year shall be liable to IOF (a tax on financial transactions)
What is the Secondary Market?
The secondary market is used for the purchase and sale of shares after the primary issue has been completed. In the case of a Real Estate Fund, the trade is conducted within SOMA, a regulated over-the-counter market where brokers negotiate shares acting for shareholders who are seeking to buy or sell.
The value of a share is defined by its attractiveness, which is determined by the characteristics of the fund. Deals depend on the existence of buyers and sellers who are willing to trade.
Effects of the Federal Government’s Economic Policy
The Fund will conduct its activities within the Brazilian market, and is thus subject to the effects of economic policy as practiced by the Federal Government.
The Brazilian government occasionally intervenes in the economy making drastic and sudden policy changes. Government measures to curb inflation and implement economic and monetary policies have in the recent past involved interest rates changes, currency devaluation, exchange controls, tariffs, and controls on electricity consumption, among other measures. These policies and other macroeconomic conditions have significantly impacted the economy and domestic capital markets. In addition to this history of instability in Brazil, there is no way of telling what economic and monetary policy directives will be adopted in the coming months by the new government elected in October of 2002, and what will be their impact on the Fund. The business climate, the financial situation, the operational results of the Fund and the resulting distribution of income to Fund shareholders could all be impacted by the adoption of measures that could lead to currency fluctuations, indexation of the economy, unstable prices and rising interest rates, or could influence current fiscal policy.
Innovation
Real Estate Investment Funds are a form of investment that was introduced into the financial market only recently, and their use is not yet widespread or widely disseminated. This could lead to greater difficulty for the acceptance of real estate funds when compared to other forms of investment available in the market or to other financial assets available for investment.
Reduced liquidity
Real Estate Funds exhibit reduced liquidity in the Brazilian market. Because of this characteristic and the fact that Real Estate Funds are always structured as closed condominiums – that is to say, without admitting the possibility of share redemption –shareholders in Real Estate Funds may experience difficulty in selling their shares in the secondary market.
Security value X property ownership
While the investment portfolio of a Real Estate Fund consists of real estate or real estate related rights, the ownership of shares in a Real Estate Fund does not make the holders of these shares the owners of the real estate that comprises the Fund asset, or of a proportional fraction of such real estate. The rights of shareholders are exercised over all the assets of the portfolio, and are not individualized.
Greater influence of a majority shareholder on Fund decisions
Fund Regulations do not set limits to ownership of shares issued by the Fund, except in the terms of Federal Law No. 9.779/99 with respect to acquisition by the entrepreneur responsible for the Fund, or his partner or any person connected with him, who may individually subscribe to or acquire in the market up to 25% (twenty five percent) of the Fund's assets. Each share gives its holder the right to one vote in decisions taken at the Shareholders' Meeting. Thus, depending on the number of shares purchased, there may be a shareholder who is able to exercise more influence on decisions of the Shareholders' Meeting than the majority of individual Fund shareholders.
Fund's Exposure to Credit Risk
Fund shareholders will be entitled to income that will be paid to them from the values received by the Fund as paid by future tenants relating to lease of the facade of the construction works of the Property for installation of advertising material, or from the rental of independent units within the Property. Thus, for all the time that the Property is leased, the Fund will be exposed to credit risks inherent in transactions of this type of business.
In the event of non-renewal of any lease of the Property or its termination for any reason, the Fund will be exposed to the risks inherent in the demand existing for rental of the Property. The managing institution shall not be responsible for any variations in Fund results arising from fluctuations in this demand. Additionally, when leasing the Property the Fund should bear the credit risks of future tenants.
External conditions
Real Estate such as the Property is subject to conditions over which the Fund Manager has no control and can neither prevent nor influence. The level of economic development and general economic conditions may affect the performance of the Property and, consequently, the future earnings of the Fund's investors. The value of the Property and the Fund’s ability to effect the distribution of earnings to its shareholders may be adversely affected due to changes in economic conditions, the offer of other commercial spaces with characteristics similar to the Property, and reduced interest on the part of potential occupants for spaces such as those provided by the Property.
Information contained in the Prospectus
The Prospectus contains information about the Fund, the Property and the real estate market as well as prospects for the Fund's performance and the development of the real estate market that involve risks and uncertainties. While the information contained in the Prospectus has been obtained from reputable and reliable sources, and prospects for the Fund are based on reasonable expectations and beliefs, there is no guarantee that future performance will be consistent with these forecasts. Future events could differ materially from the trends indicated.
