German REITs

Table of Contents

1  Executive Summary  4

2  Introduction  6

2.1  Fundamentals  6

2.2  Definition and Characteristics of REITs  7

2.3  Proposal of the Initiative Finanzstandort Deutschland  8

2.3.1  Initiation  8

2.3.2  Proposed Legal Framework  9

2.4  Status of the German REIT Discussion  10

3  Overview of existing REIT-Regimes  12

3.1  Abstract  12

3.2  Methodology  13

3.3  Country Overview  14

3.3.1  United States  14

3.3.2  Japan  17

3.3.3  Netherlands  19

3.3.4  Belgium  21

3.3.5  France  23

3.4  Analysis of International Comparison  26

3.5  Best-Practice: A Recommendation for Germany  27

4  The German Real Estate Market  29

4.1  General Market Structure and Trends  29

4.1.1  Fundamentals  29

4.1.2  Office Real Estate Sector  31

4.1.3  Retail Real Estate Sector  31

4.1.4  Industrial real estate sector  31

4.1.5  Trends  31

4.1.6  Outlook  32

4.2  The most important German Real Estate Investment Vehicles  32

4.2.1  Open-end Property Funds  32

4.2.2  Closed-end Property Funds  34

4.2.3  Real Estate Companies  35

1

5  Market Potential for German REITs  37

5.1  Supply Analysis  37

5.2  Demand Analysis  39

5.3  Issues  39

6  Case for Action: Why to introduce REITs in Germany  42

Appendix 46  NA  

  Glossary  53

  Bibliography  54

2

Table of Exhibits

  Exhibit A: Overview of existing REIT Structures  7

  Exhibit B: Total Market Cap Distribution  12

  Exhibit C: The German Property Stock  29

  Exhibit :D The German Real Estate Market  30

  Exhibit E: Performance of European REITs  42

  Exhibit F: REIT Profiles Worldwide  43

  Exhibit G: REIT vs Non-REIT Trading Performance  44

  Exhibit H: Cluster Analysis of European REITs  52

  Exhibit I: European Office Markets Trends  52

Table Directory  NA  

Table I:  US-REIT Performance  16

Table II:  J-REIT Performance  18

Table III:  BI Performance  21

Table IV:  SICAFI Performance  23

Table V:  SIIC Performance  25

Table VI:  Worldwide REIT Structures  46

Table VII:  Corporate Real Estate  50

Table VIII:  Recent Residential Real Estate Transactions  50

Table IX:  Overview of Real Estate Investment Alternatives  51

Table X:  Overview of Existing REITs  51

3

1 Executive Summary

A Real Estate Investment Trust (REIT) is a property stock that is taxed, not at the corporate but at the investor level, which can lead to tax advantages. 1

The concept of REITs originated in the United States in 1960, allowing smaller investors access to large income-producing real estate, which facilitated the creation of a liquid asset class that has become a core part of institutional portfolio management.

REITs have proven attractive to investors because:

Their returns have beaten most major equity benchmarks over three decades, with

lower volatility

They have predictable cash flows and high dividend yields

They have a low correlation with other asset classes, aiding portfolio diversification

As US-REITs proved successful, other countries have introduced similar property investment vehicles. The Netherlands started in 1969, followed by Australia (1985), Canada (1994), Belgium (1995), Japan (2000) Singapore (2002), Hong Kong (2003) and most recently France (2003).

In Germany real estate has been the most popular investment theme of the past three years, despite its significant underperformance compared to European peers during the past 10 years, with open-end funds receiving almost all money inflows. The listed sector, however, is insignificant, both in terms of size and liquidity, and is in desperate need of a catalyst. The introduction of a G-REIT structure could potentially be the long-awaited saviour that could transfer the importance of German real estate into the listed sector.

Given the significance of real estate in their respective markets, the German and UK governments are currently considering the introduction of REITs. Depending on the progress of the consultative and parliamentary process, REITs are expected to be enacted by legislation during 2006 in both countries.

1 Brueggeman, W. / Fisher, J. (2001), p. 565

The REIT discussion in Germany has reached a serious stage, with all the most- involved parties seemingly agreed about the usefulness of a REIT structure.

The purpose of this paper is to highlight the case for REITs in Germany, to analyse the progress of REITs in countries that have installed these structures, to consider the on-going debate in Germany and what these developments may eventually mean for the German real estate market.

2 Introduction

2.1 Fundamentals

REITs invest directly in property and pass almost all earnings to shareholders as dividends. By distributing most of their profits, REITs get special tax treatment and avoid corporate income tax. 2 However, income from dividends is taxable by the recipient, depending on nationality and status.

REITs can have a diversified portfolio strategy, or invest in one real estate sector or a specific geographic region. They are often highly liquid stocks traded on major exchanges and allow institutions and private investors to participate in large property ventures that would otherwise be beyond them. As such, a REIT share is similar to any other dividend-paying share that represents ownership in an operating business. Given that nearly all income is distributed, yields are high and stable, thereby ensuring transparency and lower volatility.

Since the introduction of REITs in 1960 in the US, REIT-regimes have been internationally expanding and are today well established and widely spread investment vehicles. Their basic features through out the world have been influenced by their American role model, but slightly adjusted and translated into country specific legislature.

Chronologically the introduction of REITs in the US was followed by the implementation of “Fiscale Beleggingsinstelling” (BI) in the Netherlands in 1969. Dutch BIs are today among the largest institutional real estate investors in Europe. Australia became the third country comprising of a REIT-regime when it introduced “Listed Property Trusts” (LPT) in 1985. Because of the impressive performance REITs were showing in the US in the 1990s, the pace of newly introduced REIT- structures throughout the globe has increased during the course of the past ten years. In 1990 Belgium introduced “Sociétés d’investissement à capitale fixe immobiliers” (SICAFI), which aimed at being a competitive investment alternative to the Dutch BIs. The Canadian government then in 1994 launched the “Mutual Fund Trust” (MFT). In 2000 Japan followed with the introduction of the J-REIT, Singapore 2 Erickson, John (2002), p. 58

in 2002 with the S-REIT and Hong Kong in 2003 with HK-REITs. In Europe, the last

country establishing a REIT-regime has been France with “Sociétés d’investissement

immobiliers cotées” (SIICs) in 2003. Currently, besides Germany, Great Britain and

Finland among others are considering the introduction of a listed tax transparent real

estate investment vehicle.

Exhibit A: Overview of existing REIT Structures

Source: Kempen Research

(1) Datastream, as of August 8, 2005

At present, there is an ongoing debate in Germany about the introduction of REITs.

While one can say it is very likely that REIT legislation will be introduced, it is unclear

when this will happen, how it will be designed and what kind of advantages and

disadvantages will result for real estate investors, real estate companies and the

government. 3

2.2 Definition and Characteristics of REITs

The term “REIT” as abbreviation for “Real Estate Investment Trust” derives originally

from US tax-law. Generally REITs are defined as closed, publicly listed vehicles,

which allow tax transparent structures and which pay out nearly all of their net 3 Handelsblatt (2005), Nr. 134

income to their shareholders. 4 Regardless of national jurisdiction, tax efficient real estate vehicles generally have a series of common features, the most prevalent of which include:

Tax: Some form of corporate level tax transparency that, among

others, allows investors to accurately assess the liquidation value of the vehicle’s underlying assets; furthermore, income streams are only taxable on the investor level

Distribution: Minimum income distribution requirements in a range of 80% -

100% of their net income

LTV: Gearing limitations, whether regulatory or market driven, that

limit the amount of third party debt to, in general, not more than 50% of total underlying vehicle asset value

Liquidity: Liquid secondary market due to stock exchange listing

Apart from these core criteria, REITs worldwide are structured in numerous forms depending on national legislation.

2.3 Proposal of the ‘Initiative Finanzstandort Deutschland’

2.3.1 Initiation

“Initiative Finanzstandort Deutschland” (IFD) is an organisation founded in 2003 by politicians and members of the German finance sector. Within IFD, a special committee consisting of 12 people is considering and pushing the introduction of a REIT in Germany. The current proposal aims to create a competitive framework for the development of a German REIT, establishing a liquid and transparent asset class for property. 5 As such it includes the main features of the proven US model, while seeking to address the concerns of the tax authorities.

One major goal of the proposed introduction is to mobilise the real estate assets of German companies. These assets are currently held not for operating purposes but 4 Block, Ralph L. (1998), p. 14 5 Ackermann, Josef / Koch-Weser, Ciao K. (2004)

rather for tax purposes. 6 Due to high taxation on capital gains in Germany,

companies tend to shy away from selling properties with book gains because of the

high taxes that would have to be paid as a result.

2.3.2 Proposed Legal Framework 7

The IFD committee proposed the following criteria for the introduction of a German

REIT:

Transparency on company level similar to open-end funds. G-REITs should be

exempt from business and corporate taxes

The REIT’s main activity should be the operation of properties

A corporate structure (AG)

Mandatory listing on a stock exchange

At least 75% of company’s assets to be directly/indirectly linked to property

investments

Minimum dividend payout of 90% of net income

International Financial Reporting Standards (IFRS) in line with other quoted

companies, including fair market value reporting

Conversion tax is set at approximately 20%, payable over four years

In exchange, taxation at the company level would be abolished or strongly reduced.

Moreover, the committee would like to see changes to several existing acts to

facilitate lower transaction and taxation costs of property sales, to enable open-end

funds to invest in G-REITs and account for them as real estate investments, and to

enable insurance companies to treat G-REITs as real estate assets and not equity

investments for accounting purposes. IFD estimates that the adoption of its

recommendations would lead to a G-REIT market size of €37bn - €86bn by 2010, 6 Freyend, Eckart John von (2005)

7 IFD (2005) I

equalling 6x - 14x the current market cap of publicly listed real estate companies in Germany.

In principal there are two ways in which G-REIT legislation could be introduced: By creating a separate German REIT law completely outside the existing regulations, or by extending the German Investment Act. Under the first scenario, a G-REIT would be subject to the same regulatory requirements as a normal corporation. The IFD along with the German finance industry, which is pushing for the introduction of REITs in Germany, favours this approach because it expects an unregulated G-REIT structure in a separate law.

2.4 Status of the German REIT Discussion

The G-REIT model was published by the IFD in January 2005 and was generally supported by the Federal Ministry of Finance (BMF) under the condition that REITs will also be favourable for the government. 8 In other words, the BMF has made clear that REITs would not be introduced if tax shortfalls were the result. The Bund-Länder REITs Commission identified potential tax losses in particular for the German States and therefore questioned the feasibility of REITs. Subsequently, the IFD has proposed a number of remedies.

The BMF stated that it recognizes the need to introduce additional liquidity into the German real estate market, in particular to help privatize government and corporate owned property stock. In addition, the fear is apparent to fall behind with regard to the development of financial markets throughout Europe.

In the meantime, lobbyists have been invited to participate in official discussions with regard to the relevant details in finalizing the legislation. It appears that the two major areas of on-going debate are the regulatory framework and taxation. The open- ended fund industry prefers a full integration of REITs into the strictly regulated framework of the Investment Companies Act. Lobbyists of the banking industry, however, prefer a rather de-regulated approach to ensure a broad and liquid REIT market. 9 8 Die Welt (2005), Nr. 179 9 Frankfurter Allgemeine Zeitung (2004), Nr. 237