I OVERVIEW OF THE MARKET
To date, Indonesia’s market for investment-grade real estate assets is rather illiquid, showing very limited M&A and private equity activity. Many foreign investors consider Indonesia to be a risky place to do business. Indeed, although improving, Indonesia’s credit ratings are still below investment grade. Furthermore, the legal framework is generally deemed to be unsupportive of cross-border transactions. Indonesia’s investment law and land law impose restrictions on foreign investment. Banking and capital market legislation creates only limited room for creative financial structures. Creditors can establish security rights on land, shares and other assets, but in practice it may not always be easy to enforce these rights.
Being the world’s fourth most populous country, with a fast-growing middle class, Indonesia has the potential to develop into a major market for real estate M&A and private equity. An increasing number of foreign investors, particularly from Japan, Korea and China, who already have some experience in doing business in Indonesia, recognise this potential and invest in the country’s real estate market. Generally, the ASEAN market has an increased interest among foreign investors. Indonesia, perhaps together with Vietnam, Myanmar and Malaysia, is one of the countries that receives particular attention. Recent pro-foreign investment measures of the Jokowi administration, consisting of, inter alia, deregulation measures, a loosening of foreign investment restrictions, and tax and other incentives, contribute to this development.
Some measures that should specifically boost the Indonesian real estate sector are the relaxing by the Indonesian Central Bank (Bank Indonesia) of the macro-prudential policy by raising the loan-to value ratio, or financing-to-value ratio, for property loans. The policy should not only benefit individual home owners, but also developers, who can now provide a lower guarantee when taking out a loan from the bank. The Jokowi administration has also relaxed foreign ownership in residential property, albeit with limited short-term benefits expected. Finally, the Minister of Finance and the Indonesian Financial Services Authority (OJK) have taken several measures to make the use of real estate investment funds in the form of a collective investment contract (DIRE) – the Indonesian equivalent of real estate investment trusts (REITs) – more attractive.
There are generally four types of foreign investors active in Indonesia’s real estate market:
- a public real estate companies;
- b DIREs or REITs;
- c sovereign wealth funds; and
- d private equity.
Foreign investors will need to invest through an Indonesian limited liability company with foreign investment status or with a public listing. There are currently around 60 public real estate companies listed at the Indonesian Stock Exchange (IDX). Many of these companies have foreign participation. Well-known names with a strong presence are Agung Podomoro, Ciputra, Summarecon, Lippo and BSD. Most of the public real estate companies in Indonesia are traditionally developers, but some are trying to diversify their income streams, for instance, by investing in REITs, as discussed in further detail in Section III, infra.
Foreign investors generally invest in four categories of real estate in Indonesia:
- a commercial buildings for offices, hotels or retail;
- b residential buildings;
- c hospitals and healthcare;
- d land for development.
Most of the investments are for the long term, but particularly the investments in commercial buildings and residential buildings are sometimes only made to support development, after which individual units or parts of the property are sold.
In addition, some foreign conglomerates whose core business is not necessarily real estate are becoming active on Indonesia’s real estate market. This also applies to certain financial institutions and insurance companies. These companies are often investing in commercial real estate for their own domestic occupation, for instance, for foreign employees that need to be housed in Indonesia.
In terms of transaction structure, the investments are generally still rather conventional. Most acquisitions consist of plain vanilla sale and purchase of direct property, and sometimes involve the sale and purchase of shares in local real estate companies, either directly or through the IDX. Again, the legal framework puts limitations on the creation of more sophisticated structures. Often, foreign investors create a joint venture with local partners, which indeed may be a requirement under Indonesian investment legislation.
In terms of deal value, the investments may sometimes be significant, but generally not as large as in countries with a more developed real estate market.
II RECENT MARKET ACTIVITY
i M&A transactions
M&A activity on Indonesia’s real estate market is limited. A noteworthy transaction was the agreement between GIC Pte, Singapore’s sovereign wealth fund, and PT Rajawali Group, a large, privately owned investment company, to jointly invest up to $500 million in property projects in Indonesia in November 2014. The investment focuses on property projects in Jakarta’s Central Business District. However, the joint venture will also explore other real estate opportunities, including in office, retail, residential and mix-use projects.2
ii Private equity transactions
Private equity activity on Indonesia’s real estate market is even more limited. A noteworthy transaction is the creation of a joint venture between subsidiaries of Warburg Pincus LLC and the Indonesian public real estate company PT Nirvana Development Tbk in 2015. PT Nirvana Development specialises in the development of hypermarket anchored retail centres in emerging cities across the country. Since 2009, the company has developed five mixed-use projects in second and third-tier cities across Java and Kalimantan. The company’s aim is to development more projects in other cities in Indonesia, including Sumatera, Sulawesi and Nusa Tenggara. As part of the investment, the private equity firm committed $125 million, with the option to invest up to an additional $75 million.3
III REAL ESTATE COMPANIES AND FIRMS
i Publicly traded REITs and REOCs – structure and role in the market
As briefly touched upon above, there is currently no legal basis in Indonesia for the establishment of REITs. Instead investors who wish to invest in income-producing real estate in Indonesia can do so through DIREs. Contrary to REITs, DIREs are not legal entities, but are based on contract. DIREs are regulated by the OJK. In April 2016, the OJK issued a new regulation with guidelines for investment managers and custodian banks that manage DIREs. It is currently also preparing a regulation of DIREs based on shariah principles.4
A DIRE scheme involves a custodian bank and an investment manager who makes a collective investment in, inter alia, real estate and assets that are related to real estate – i.e., securities of real estate companies that are listed on the IDX or issued by real estate companies (or both).
It is not possible for a DIRE to invest in vacant land and real estate that is under development. However, it would be possible for a DIRE to invest in a special purpose company (in the form of an Indonesian limited liability company), established solely to invest in real estate assets. If a special purpose company is used, the DIRE must own at least 99.9 per cent of the issued shares of the special purpose company.
Unresolved matters include how a DIRE can directly invest in real estate or own shares in a special purpose company, considering that a DIRE is not a legal entity, while under the Indonesian Agrarian Law, only Indonesian individuals and certain legal entities can have title to land in Indonesia, and under the Indonesian Company Law, shares in an Indonesian limited liability company can only be held by legal entities or individuals.
It is prohibited for DIREs to borrow funds by way of issuing debt securities. The 2016 OJK regulation is more lenient regarding the maximum percentage of borrowed funds other than by way of debt securities, which increased from 20 per cent under the old regulation to 45 per cent of the total value of the real estate to be purchased under the new regulation.
There appears to be just one DIRE that is currently active in Indonesia: DIRE Ciptadana Properti Ritel Indonesia, which has been listed on the IDX since 2013. It owns a shopping centre in Solo, Java.
A likely reason for the limited popularity of DIREs is the lack of corporate and financial transparency that these funds and Indonesian companies generally often show. It is unlikely that recent measures aimed at making the use DIREs more attractive will change the general negative sentiment among foreign investors regarding these funds.
Apart from DIREs, some offshore REITs are active on the Indonesian real estate market. Two noteworthy examples are Lippo Malls Indonesian Retail Trust (LMIR Trust) and First REIT, both REITs listed on the Singapore Exchange Securities Trading Limited (SGX), sponsored by the Indonesian public real estate company PT Lippo Karawaci Tbk. LMIR Trust has a diversified portfolio of 17 shopping centres and seven retail spaces across Indonesia.5 LMIR Trust is currently discussing the acquisition of an additional shopping centre in Kuta, Bali.6 First REIT has a portfolio of 12 hospitals, two hotels and one shopping centre in various cities in Indonesia, in addition to several assets in Singapore and South Korea.7 LMIR Trust and First REIT are currently discussing the joint acquisition of an integrated development of hospital and shopping centre assets in Yogyakarta, Java.8
ii Real estate PE firms – footprint and structure
As discussed above, private equity activity on Indonesia’s real estate market is very limited. In the case of the aforementioned investment by Warburg Pincus LLC, a joint venture was created through an acquisition by Adventure Holdings BV, an affiliate of Warburg Pincus LLC, of 35 per cent of the shares in PT Nirvana Wastu Pratama, a subsidiary of PT Nirvana Development Tbk.9
i Legal frameworks and deal structures
As discussed above, investments in Indonesia’s real estate sector are generally still rather conventional, consisting of plain vanilla sale and purchase of shares in local real estate companies, either directly or indirectly (i.e. through the IDX).
A direct sale and purchase of shares in a local real estate company may be subject to foreign investment restrictions, for example, by imposing a cap on foreign ownership in Indonesian companies. Indonesia’s 2007 Investment Law creates authority for the president to compile a list of business lines that are closed and conditionally open to foreign investment. A revised version of this ‘Negative List’ became effective in May 2016.
A common business line for a real estate company in Indonesia would be '68110 – Real estate that is privately owned or rented'. This business line includes buying, selling, renting and operating of self-owned or leased real estate, such as apartment buildings, dwellings and non-residential buildings. As this business line is not included in the 2016 Negative List, a local real estate company with activities covered by this business line should in principle be 100 per cent open to foreign investment.
If the real estate company is not only active in buying, selling, renting and operating of self-owned or leased real estate, but also other activities (e.g., the construction or operation of real estate), different business lines are relevant, which may be included in the Negative List and can therefore be closed or conditionally open to foreign investment.10 In any event, from experience, although not explicitly listed as a business field that is closed or a business field that is conditionally open in the Negative List, certain business fields may in reality not be open to foreign investment. Furthermore, an Indonesian limited liability company (PT) should have at least two shareholders, so even if no foreign restrictions apply, it is common to have a local shareholder to hold part of the shares. There may also be commercial reasons to have local participation in the company.
A foreign investor wishing to purchase shares in a local real estate company requires a licence from the Indonesian investment coordinating board (BKPM). If the local real estate company is a ‘normal’ limited liability company with Indonesian shareholders, ‘a principal licence for investment’ must be obtained. This licence will result in the conversion of the company into a foreign investment (PMA) company, allowing the foreign investor to become a shareholder. As part of the application process for a principal licence for investment, the investor should submit an investment plan, by which the investor confirms willingness to invest more than 10 billion rupiah per business line, at least 2.5 billion rupiah of which should come in the form of equity. Before the shares in the local real estate company are transferred, it will generally be required to amend the articles of association of the company, for instance, in order to increase the issued and paid-up capital to at least 2.5 billion rupiah (in the case the company has one business line). After the BKPM has issued a principal licence for investment, the company will have to submit quarterly activity reports, which are used by the BKPM to monitor the implementation of the investment plan. As soon as the investment plan has been realised and the company is ready for operation, a business licence can be obtained.
If the real estate company already has the status of a PMA company, it will still be required to obtain a licence from the BKPM. This licence is a ‘principal licence for amendment’ or, if the investment plan has already been realised and the company is already operating, a ‘business licence for amendment’.
It usually takes around a month to obtain a principal licence for investment and around two weeks to obtain a principal licence for amendment from the BKPM.
No foreign investment restrictions apply to a sale and purchase of shares in a local real estate company through the Indonesian Stock Exchange. The 2016 Negative List stipulates that foreign investments in business fields that are conditionally open but made indirectly or as portfolio investment through the IDX will be deemed to be business fields that are open to foreign investment.
Foreign investment restrictions also do not apply to a venture capital company (PMV); any equity participation by a PMV would be deemed to be domestic investment rather than foreign investment – even if one or more shareholders of the PMV are foreign. A PMV can be established in the form of a limited liability company, cooperative or limited partnership (CV). The minimum capital requirement to establish a PMV in the form of a limited liability company is 50 million rupiah. A PMV in the form of a PT can be 85 per cent owned by a foreign entity or institution. However, the maximum direct capital participation in a PMV by a foreign entity as a shareholder is limited to the maximum amount of such entity’s net equity. Business activities in which a PMV may be engaged are equity participation, quasi-equity participation or financing through purchase of securities issued by business partners. Business partners can be individuals or companies, including micro, small, medium businesses and corporations receiving equity participation based on a profit-sharing principle from the PMV, and financing of productive business. A PMV may participate in a real estate company provided that the value of participation in one business partner (in this case, the real estate company) is a maximum 25 per cent of the venture capital company’s equity. Furthermore, this participation may only last for 10 years (plus extension for another 10 years). After the lapse of this period, the PMV must divest its shares in the real estate company as the purpose of a PMV is to help start up companies. Parties wishing to establish a PMV must obtain a business licence from the OJK.
It would also be possible for a foreign investor to carry out an asset deal. However, asset deals are not very common in Indonesia, as the transfer of assets in general and land, buildings and fixtures in particular can be a rather complicated, time-consuming and costly process. If a foreign investor decides on an asset deal, it will be necessary to establish a PT first. This company should obtain its own licences to be active in the real estate sector, as licences can generally not be transferred under Indonesian law.
Irrespective of whether it has the status of a normal limited liability company or a foreign investment company, a PT cannot hold an ownership right on land; this right is strictly reserved for individuals with Indonesian nationality. However, a PT can hold three other types of land rights: right of cultivation, right to build and right of use. In practice, the right to build is the type of land right most commonly used by real estate companies. It is granted for a maximum initial period of 30 years and is extendable for another period of 20 years, with a possibility of renewal.
On top of an ownership right, right to build and right of use, a right of ownership to a multi-storey unit can be established. This right can be issued to owners of residential, commercial or retail units in multi-storey buildings such as condominiums, strata-title office buildings or trade centres. The validity period depends on the expiry date of the land right on which the right of ownership to a multi-storey unit has been established.
The ownership right, right to build, right of use, and of ownership to a multi-storey unit can be sold, exchanged, transferred, bequeathed or mortgaged.
ii Acquisition agreements terms
Given the illiquid character of the Indonesian real estate market, it is hard to provide a description of the typical terms of real estate M&A and PE transactions. However, it is common for parties to enter into a share purchase agreement for the acquisition of existing shares or a share subscription agreement for the subscription for new shares in a local real estate company.
Although in-kind contribution is also possible under the law, shares are normally acquired or subscribed for by payment of a cash consideration. The purchase price is often paid directly to the sellers or issuers of the shares (i.e., without the use of an escrow account). Price-adjustment mechanisms are sometimes used, normally in the form of closing accounts, rather than locked-box mechanisms.
Given that foreign investment is strictly regulated in Indonesia, parties in M&A and private equity transactions will normally need to agree on conditions precedent relating to regulatory approvals, in addition to corporate and third-party approvals that need to be obtained. As a result, it may take a relatively long time for a transaction to be closed. For this reason and also given the uncertainties in the market, material adverse change clauses are also commonly used and accepted by parties. Equally, it is common for parties to agree on a broad list of pre-closing covenants. The use of a long stop date for the fulfilment of the conditions precedent is also generally accepted. Break fees are sometimes used, but not very common.
Just like other companies, real estate companies in Indonesia often have compliance issues. For this reason, it is common and in any event advisable to conduct extensive legal, financial and tax due diligence on a target company. Warranties and specific indemnities are commonly agreed on to mitigate at least part of the potential liabilities. To the extent these liabilities cannot be sufficiently mitigated, it may be advisable to do an asset deal, despite the fact that – as discussed above – the transfer of assets can be a rather complicated, time-consuming and costly process.
When foreign investors choose to create a joint venture with local partners for their real estate investment, parties often enter into an additional joint venture agreement or shareholder agreement. These agreements commonly create rights for certain shareholders to, inter alia:
- a nominate members of the board of directors and board of commissioners of the company;
- b list reserved matters at the level of the board of directors, board of commissioners or the general meeting of shareholders;
- c set out a deadlock mechanism for when shareholders or their nominated directors or commissioners cannot agree on the reserved matters; and
- d contain terms in business plans and reporting, financing of the company, the distribution of dividend, create restrictions on the transfer of shares.
Some of the provisions of the joint venture agreement or shareholders’ agreement may also be covered by the articles of association of the company.
iii Hostile transactions
There do not appear to have been any hostile transactions in Indonesia’s real estate sector.
iv Financing considerations
M&A and private equity transactions in Indonesia’s real estate sector are typically financed by a combination of equity and debt. As discussed above, when a foreign investor wishes to purchase shares in a local real estate company, the company will need to have the status of a foreign investment company. This also implies that more than 10 billion rupiah per business line should be invested; at least 2.5 billion rupiah of this amount should come in the form of equity. If the company has more than one business line, the investment requirement is multiplied by the number of business lines.
Certain reporting requirements apply to a recipient of a foreign loan in Indonesia. Furthermore, when certain monetary thresholds are met, the conversion of Indonesian rupiah to foreign currencies or the purchase of foreign currency against Indonesian rupiah conducted by a bank and its customers must be based on an underlying transaction.
Under Indonesian law, lending obligations can be secured by various types of security. Rights to land as well as buildings and fixtures can be mortgaged. Shares in a PT can be pledged. Security on moveable assets can be established in the form of a ‘fiduciary transfer’. Other than in the case of a pledge, the creditor-transferee holding a security in the form of fiduciary transfer will normally not have physical control of the assets.
In order to be able to create security such as the above, generally, consent from existing creditors is needed. In addition to creditor consent, shareholder approval is also required. The Indonesian Company Law and the articles of association of an Indonesian company normally stipulate certain requirements to obtain corporate approval from the organs of the company (i.e., the board of commissioners or the general meeting of shareholders). Lack of corporate approval would legally affect the validity of the loan and pledge agreements and cause the board of directors to be held liable for any loss in relation thereto.
v Tax considerations
The proceeds from a sale of shares in an Indonesian company may be subject to capital gains tax, which, where the shares are not listed, is 25 per cent when the seller is a company and 30 per cent when the seller is an individual. The sale of shares listed on the IDX is subject to a tax of 0.1 per cent of the transaction value.
Dividends received by a resident company from another Indonesian company are exempt from tax, provided the dividends come from retained earnings and the recipient company holds at least 25 per cent of the capital of the company distributing the dividend. If the recipient company holds less than 25 per cent of the shares, the received dividend is subject to 15 per cent withholding tax, which represents an advance payment of the company’s tax liability. Dividends distributed to a non-resident are subject to 20 per cent withholding tax, unless the rate is reduced under a tax treaty. Dividend distributions to individual shareholders are subject to 10 per cent withholding tax. Dividend income of individual shareholders is subject to another 10 per cent final income tax.
In order to limit tax exposure, it may be an option to transfer shares at the level of the offshore parent of an Indonesian real estate company, in which case the transfer of shares is not subject to any Indonesia withholding, provided that the parent company is not a tax resident of a tax-haven country.
In the case of an asset deal, the sale of assets is subject to 10 per cent VAT. Furthermore, any capital gain on the sale of assets (non-land or buildings) is subject to a 25 per cent income tax. The transfer of land will trigger the obligation for the seller to pay income tax, which is 5 per cent of the purchase price of the land (unless the seller is foreign and the rate is reduced under a tax treaty), and the purchaser to pay an administrative fee for the transfer of land rights, which is approximately 4.7 per cent of the purchase price of the land.
In 2015, the Minister of Finance enacted a regulation on the tax treatment of taxpayers and taxable entrepreneurs that use certain collective investment schemes for the financial sector. The regulation brings an end to double taxation on DIREs. More particularly, the special purpose vehicle that manages the DIRE will be exempted from the obligation to pay income tax. Furthermore, the special purpose vehicle or the DIRE is considered as a low-risk tax entrepreneur and can therefore benefit from an expedited tax refund.
Land and building tax is payable each year on land, buildings and fixtures. The rate is determined by the regional governments and therefore depending on where the assets are located. However, the rate is typically no more than 0.3 per cent of the estimated value of the assets.
vi Cross-border complications and solutions
As discussed above, a direct sale and purchase of shares in a local real estate company may be subject to foreign investment restrictions. In order to circumvent foreign investment restrictions, foreign investors sometimes resort to an investment structure involving nominee arrangements, on the basis of which an Indonesian individual or entity holds the shares on behalf of the foreign shareholder. However, in Article 33 of the 2007 Investment Law, an express prohibition was introduced so that ‘the foreign investor and the domestic investor who invest in a limited liability company to enter into agreements and/or statements which assert that share ownership in such limited liability company is for and on behalf of another person’. Such agreements are invalid and unenforceable. Article 33 of the Investment Law also provides for these agreements to be null and void.
In practice there continues to be still much uncertainty as regards the correct interpretation of the nominee prohibition. However, any element of the contractual arrangements that goes beyond a true financing arrangement runs the risk of running foul of the law. This means that in very broad terms these arrangements should best avoid powers of attorney to exercise ownership rights and of assignment of dividends and voting rights. However, a true financing arrangement (which could be strengthened and secured by a right of pledge) should be allowed under the law. Under Indonesian company law, the voting rights on shares must remain with the pledgor.
V CORPORATE REAL ESTATE
There does not appear to be any trend in the Indonesian real estate market in separating corporate real estate from operating companies.
It is common in Indonesia to separate the ownership of real estate from building management. Building management activities could, for example, be covered by the following business lines: ‘81100 – Integrated services for the support of facilities, such as general interior cleaning, maintenance, waste disposal, guard and security, mail routing, reception, laundry and related services’; ‘81290 – Cleaning services for buildings’; and ‘81300 – Services for garden maintenance’.
Note that activities under business lines 81100 and 81300 may be, and 81290 are, closed to foreign investment.
The prospects of Indonesia’s real estate market are rather positive. Momentum is picking up. The effects of recent and ongoing pro-foreign investment measures of the Jokowi administration are already visible and will likely become stronger in the longer term. Having said that, Indonesia’s credit ratings as well as its legal framework will likely need to improve further before the country’s market for investment-grade real estate assets can gain full potential.
1 Emir Nurmansyah is a partner, and Oene Marseille and Gustaaf Reerink are foreign counsel at Ali Budiardjo, Nugroho, Reksodiputro. The authors would like to thank Craig Williams of Savills Indonesia for his valuable input on current developments in Indonesia’s real estate market.
2 See www.gic.com.sg/newsroom?id=482.
3 See www.warburgpincus.com/investments/nirvana-development/; www.warburgpincus.com/category/news-releases/.
4 See www.antaranews.com/berita/552845/ojk-berharap-perusahaan-properti-terbitkan-dire-syariah.
5 See www.lmir-trust.com/.
6 See www.lmir-trust.com/investor.html.
7 See www.first-reit.com/about-overview.html.
8 See www.lmir-trust.com/investor.html.
9 See www.reuters.com/article/indonesia-press-nirvana-dvlpmt-warburg-p-idUSL3N0WR0NL20150325.
10 See also Section V, infra, on foreign investment restrictions to companies active in providing integrated services for the support of facilities as well as cleaning services for buildings.