Will Germany Give REITs A Chance?
The real estate investment trust has long been an established feature of the property market in the U.S. REITs, which usually manage commercial and residential properties, are traded like any other stock. That's a nice idea -- but unfortunately not one many Europeans can benefit from.
REITs have been pretty scarce in Europe because of a lack of enabling legislation. German investors, for example, instead have $118 billion tied up in open real estate funds. Open funds are not traded like stocks. Investors who want out receive a fixed price based on the assessed value of the portfolio. That arrangement is fine if the fund is spinning profits. But if the underlying properties are struggling and investors are exiting en masse, then the fund managers may have to sell off assets at a loss to cover the fund's obligations. "There's always a discount on an emergency sale," says an executive at a major real estate company in Germany who asks not to be named.
The flaw in these open funds is becoming glaringly obvious as some real estate ventures feel the negative effects of Germany's dismal property market. And that's helping fuel efforts to launch REITs as soon as 2006. If the drive is successful, real estate holdings could be packaged as publicly traded companies that would pay dividends from rent proceeds and property sales. And the increased liquidity and transparency of being listed on a stock exchange would likely bring more investors -- and properties -- to the market.
What about the existing property funds? Confidence in them suffered badly in December. That's when Frankfurt-based DekaBank, which is owned by Germany's public banks, disclosed that outside auditors valued the holdings of one of its main funds at more than $900 million less than did the panel of experts used by the bank. As investors fled the fund, DekaBank was forced to sell buildings, including Lloyd's headquarters in London, and pump in $2.6 billion in cash. DekaBank also fired the fund's top managers. Deka, which says the valuation gap is not as grave as outside auditors maintain, has announced a plan to stabilize the fund, including a promise to buy out any investors who want to sell their stakes.
Deka's problems are casting a shadow on other real estate funds, which have been marketed as low-risk, steady-return investments. Last year net new investment in Germany's open funds plunged to $4 billion, from $18 billion in 2003, as investors reacted to negative headlines generated by DekaBank. So far, no other funds have disclosed problems on the same scale as Deka. But overall returns of German open funds are at a 25-year low of 3.3%. That compares to an average return of 4.65% in the last decade. And even healthy funds could face serious problems if investors panic and head for the doors. Critics say funds have been too slow to open their books and reassure investors everything is in order. "The only way to restore trust is with absolute openness," says Stefan Loipfinger, publisher of fondstelegramm, an investor newsletter.
That's why real estate specialists are looking for new ways to unshackle the property market with an investment vehicle that's more attractive to investors. REITs would be more liquid than open funds because they trade daily on stock exchanges. And the funds would also be subject to stock exchange rules, which would force them to disclose more information about their holdings to investors. "The stock exchange has the fundamental advantages of transparency, equal access to information, and fair pricing," says Philipp Härle, an attorney in the Berlin law firm Tilp who frequently represents people who believe they have been ripped off by banks.
What's more, REITs would allow German companies to spin off their often substantial real estate holdings without paying prohibitive capital-gains taxes. In fact, proponents of REITs argue that Germany would get a new investment product and create thousands of jobs in the financial-services industry. Given that Germany's property market is valued at an estimated $9.5 trillion, the potential market is huge. That would be a boon for Germany's financial center, Frankfurt. Fans of REITs are keen to launch them as soon as possible to make the city a trading center before London, its archrival in Europe, gets into the business. Britain does not yet have REITs, but market watchers expect the country's parliament to pass a law permitting them to be set up as early as next year.
REITs would give corporations another sales channel for offloading assets, freeing up capital for their core businesses. And that could be good for the whole German economy. Last month, Dusseldorf-based ThyssenKrupp sold some 48,000 apartments, left over from the days when the steelmaker provided housing for workers, to investors including Morgan Stanley (MWD ) for $2.8 billion. More companies would unload property if they had the option of using REITs, and investors would gladly snap up these assets. "It would be fantastic for the market to also have this instrument," says Norbert Müller, head of German capital markets at real estate consultant and services provider Jones Lang LaSalle (JLL ).
At the same time, there's no question those who favor REITs see them as a way to attract foreign investment and help stabilize Germany's fragile real estate market. A slow economy and massive overinvestment have led to office vacancy rates of 17% in cities such as Frankfurt. REITs wouldn't do much to conjure up tenants, but they would provide funds for a more liquid market to dispose of assets. "It will drive up prices," says Geza Toth-Feher, a lawyer at Paul, Hastings, Janofsky & Walker in London who follows the market. That's why REITs legislation has support from both banks and investors, who hope a new law will go into effect in 2006. "There are no major antagonists," says Klaus Droste, managing director of global corporate finance at Deutsche Bank (DB ), who leads industry lobbying efforts.
Still, the legislation isn't a done deal. Backers and government officials are still trying to figure out how REIT dividends should be taxed. The government won't want to lose tax revenue, but foreign investors aren't used to paying German tax on stock dividends. One solution may be a flat tax of 20% or so on REIT dividends paid to foreigners. And there is still a risk that Finance Ministry officials will block approval. Plus, as with any law, politics could affect the outcome. Sale of German property to foreigners is still a sensitive issue, especially when big blocks of apartments are involved.
Proponents are anxious to win passage fast, before the 2006 national election campaign gets going and the legislative process comes to a standstill. "We have to do it this year," says Siegmar Mosdorf, a former senior aide to Chancellor Gerhard Schröder who is working as a consultant to REIT advocates. Failure of the legislation would be a serious blow to Germany's real estate industry, which has not had a good run since the early 1990s. REITs are hardly the whole solution to the real estate slump. But if they could help avoid debacles like DekaBank's, that alone would be a major achievement.
By Jack Ewing in Berlin