By Hiu Chee Fatt, Trust Advisor, Labuan IBFC Inc. Sdn Bhd

Investment is a game of risk and reward. The first rule of investing is actually taught in kindergarten, at the tender age of 4 or 5, toddlers are told not to put all their eggs in one basket. Years, and maybe even decades later, adults are told time and again, not to put all their funds into one type of investment vehicle.

Diversification is key to minimize investment risk; - you don’t want to put all your eggs into one basket. A good asset allocation strategy will help your investment to perform better too.  Many savvy investors have real estate as one of the asset classes in their investment portfolio.

There is no doubt real estate provides good hedge against inflation, may provide a regular income stream in the form of rental and allows for long term capital growth, however it also requires a large initial investment, has a potentially high holding cost and depending on the market’s condition, the secondary market may be sluggish at the time you wish to dispose-off the investment, hence exiting the investment may be an issue.

Institutional investors such as big corporations, multinationals, pension funds, real estate investment trusts and so on, tend to be long term investors and may not be too concerned over the lack of shorter term liquidity, which hinders an investor’s exit opportunity.

However, for retail investors this risk needs to be carefully understood, appreciated and accounted for in their investment and exit strategies. Individuals or a grouping of individuals may often have a shorter term investment horizon as compared to institutional investors and without careful planning they may find that the once perceived lucrative real estate investment proposition is now no longer so!

Offshore vehicles such as an investment holding companies and funds are very useful tools used as conduits to real estate investment. Besides the obvious lower tax; for example there is no tax levied on investment holding vehicles in Labuan; these structures may also be used to pool investment capital and facilitate an investor’s smooth exit.

Structures mentioned below are particularly useful for small to medium sized companies, retail investors or a group of retail investors, all of whom generally have a limited capital base and a shorter investment timeframe.

So let’s see how these entities can be potentially used in real estate investment:

• Offshore companies and entities such as Labuan Funds, Labuan Companies or Labuan Limited Partnerships and Labuan Limited Liability Partnerships can be used to gather a larger pool of investment capital from shareholders.  Please refer to the chart to see how each vehicle is interposed in a real estate purchase and how each company or entity provides benefit either with the initial investment or with the subsequent disposal of the property.
• These entities may even ease the process of soliciting the initial investment capital from a suite of potential shareholders as companies and entities provide better protection to investors, compared to a gentleman’s agreement or a standard legal agreement.  In Labuan Limited Partnership and Labuan Limited Liability Partnership an ordinary shareholder’s liability is always limited to the capital invested into the company or the entity as opposed to all shareholders are equally liable for the total liability of an ordinary company. 
• The shares or interest in these companies or entities can be disposed-off without having to dissolve the company, hence, shareholders are able to partially or fully exit their investment via the disposal of their shares or interest in companies or entities, instead of disposing the actual property to realise their investment.

Similarly, a mutual fund can be set-up in Labuan and this allows a collective pool of monies with same investment objective to be created.  Funds are easily established, for example, a private fund can be registered in Labuan by simply lodging the fund’s information memorandum with the Labuan Financial Services Authority.

The fund can then offer regular redemption periods as a built in exit strategy for investors.  However, the fund manager has to be prudent in the provision of regular redemption periods, failing which, the fund may face a liquidity shortfall, should a large block of investors chose to exercise their redemption rights at the same time.

In addition, there is also no requirement for minimum level of working capital and the management of the fund can be conducted from any country in the world as there is no specific domicile requirement imposed.

In fact, a real estate developer, himself, may consider structuring a property fund investing into his own development projects. The property fund structure can solicit investment from a larger pool of institutional and qualified retail investors, who then jointly fund the development project as an investment.

Clearly, for all parties concerned, this is simpler way to participate and benefit from the real estate development project. This is especially true when one considers that the cost of registering a fund in Labuan is relatively cheaper than the mainstream jurisdiction and as an example, regulatory cost of registering a fund in Labuan is merely MYR$2000.00 In addition, private funds are not required to be licensed as a fund manager in Labuan.

These instruments become relevant when investing long term into foreign real estate especially in jurisdictions which have property gain tax and inheritance tax. A Labuan company can be used to protect real estate investors from these taxes, as, instead of selling the property directly to a buyer, the shares of the company or Labuan entity are sold instead.

Hence, the title of the property does not change and the investor will not be subjected to any property gain tax and/or inheritance tax.

In the nutshell, when real estate developers and investors start thinking outside the box and look beyond the conventional real estate investing framework, a whole new world of investment vehicles open up to them, promising tax efficient returns and allowing for painless investment entry and exit paths.