By Theodore Murphy

The global property investment community received good news this January when a German official announced that there could be a REIT market in Europe's largest economy by the start of 2006.

"The Finance Ministry is in favor of introducing real estate investment trusts in principle," said Germany's Deputy Finance Minister Barbara Hendricks in a Jan. 19 statement. "We expect that the introduction of German REITs will strengthen Germany as a financial center and the German real estate industry in a lasting way and can make Germany the leader in real estate investment in Europe."

Indeed, Germany's real estate investment profile suggests that the introduction of a REIT structure could be a step in the right direction for this market valued by real estate advisory firm DTZ at €1.2 trillion ($1.6 trillion U.S.). The bulk of commercial real estate assets in Germany are in corporate hands. The remainder is mostly owned by German open-end real estate funds, which attract very little international institutional capital and are beset by structural liquidity issues.

The German property market has been in the doldrums for the last five years. In a stagnant economy, with minimal growth, rising inflation, and a fast aging population, Germany's fragmented markets have generally floundered across all sectors, with rents sliding and vacancy soaring. Indeed, the introduction of REIT legislation is just one of the pieces required to complete the German property market puzzle.

"It is a step in the right direction," says William Hauser, a New York-based portfolio manager for HVB Capital Management, Inc. "But the fundamentals are still not there."

Liberate the Capital

Moving company-owned real estate to listed REITs may allow German corporations to free up investment capital. "Some 70 percent to 75 percent of commercial property assets in Germany are held on corporate balance sheets compared with approximately 50 percent in the U.K. and 25 percent in the U.S.," says John Gellatly, London-based director of real estate investment banking at Credit Suisse First Boston.

At a time when unwieldy conglomerates have fallen out of business vogue and agile specialists with svelte balance sheets are held up as models, the option to spin real estate departments off into subsidiary REITs could be very appealing to Germany's corporate giants.

"We are watching the situation very carefully and may decide to make a move if the legislation is right," says Marion Ringling, spokesperson for Munich-based Siemens Real Estate, the real estate branch of Siemens AG which owns and manages some 68.9 million square feet around the world, with a book value of a2.8 billion ($3.7 billion U.S.).

Invite Some Friends

Germany's property management companies and open-end real estate funds may attract more foreign and institutional investors if the government introduces REITs. Currently, the German property market ranks last proportionately in Europe as a destination for international capital, with only 5 percent to 10 percent of the country's assets held by international investors, according to Martin Becker of the Real Estate Finance Department of the European Business School.

U.K. Update Last spring, in the wake of REIT-friendly pronouncements by Gordon Brown, Chancellor of the Exchequer (U.K. equivalent of U.S. Secretary of the Treasury), few observers would have expected that Germany would create a REIT structure before the U.K. However, with elections expected in May 2005, progress this year on REIT legislation shifted down the list of priorities. "I think the property industry in the U.S. got wildly excited last year, and then wildly disappointed," says John Gellatly, London-based head of real estate investment banking at Credit Suisse First Boston. Nonetheless, Gellatly, who represents the U.K. real estate industry in informal talks with the government, says that the government is commited to REITs and expects to see progress soon. "We expect to see a policy document [before the end of March]," he says. "I have been told it will have a combination of hard legislative proposals as well as some areas open for discussion. We're not quite yet at a statement of political intent. But if we get a positive policy document," he says, "we'll only be three months behind Germany. Suddenly, everyone will say, ‘Wow, that's great.'"

"There is no money going into Germany because international institutional investors prefer to invest indirectly through a vehicle. They don't like the current open-end funds, which many consider too diversified," says Becker, whose department has conducted REIT feasibility studies at the request of the Finance Ministry. German open-end funds typically hold assets in multiple property sectors, whereas REITs tend to specialize in just one. "The REIT vehicle could give them the focus they want," he adds.

The biggest beneficiary of a REIT structure could be Germany's embattled open-end real estate fund market. The essential mission of Germany's open-end funds is similar to that of U.S. REITs: to allow retail investors to invest in large-scale commercial real estate.

The term open-end derives from the fact that the fund continually creates new shares on demand. Investors buy the shares at net asset value (NAV) and can redeem them at any time at the prevailing NAV. The structure has been around since the 1950s and has played a vital role in mobilizing the resources of a population that did not have a tradition of equity investing. The sector benefited from large inflows in the wake of Germany's stock market slide in 2002, as investors took shelter in what they saw to be more tangible assets than those offered on the stock market. According to BVI, the German fund management association, at last year's close the open-end real estate fund market was valued at €87.2 billion ($113 billion U.S.).

At the time of Hendricks' announcement, worry over the health of the open-end fund market was at a peak. At the heart of the disquiet is a case brought by a Frankfurt public prosecutor last September against Deka and DB Real Estate, two of Germany's largest funds, accusing some executives of accepting bribes in exchange for acquiring properties at inflated prices.

Making matters worse, BVI released a statement that showed €653 million ($853.2 million U.S.) had flowed out of open-end real estate funds in the fourth quarter of 2004. If confidence is further eroded, more investors may want out.

Transition Dynamics

What form REIT legislation in Germany might take is yet unclear. Key issues concern whether development restrictions and mandatory listing will be in place, as in France.

"We are hoping for the most liberal structure possible," says Immo von Homeyer, spokesperson for IVG, the largest company in Germany's small listed real estate sector. IVG, like most of the other listed property companies and many of the larger corporate real estate departments in Germany, has a development branch.

The German government's public embrace of the REIT concept comes 18 months after the first French company adopted a REIT-like tax transparency structure. According to Alec Emmott, director of Société Foncière Lyonnais, the SIIC (Sociétés d'Investissements Immobiliers Cotées—French REIT equivalent) structure did wonders for the French listed property sector.

"The listed sector in France was down on its knees two years ago, because we were all listed at a discount to NAV and breakup value. One-by-one we were being picked off by opportunity funds, breakup artists," he says. "If something hadn't changed I think the sector was in danger of ceasing to exist."

Since the adoption of REIT legislation, the French listed property sector's market capitalization has nearly doubled, boosted not only by rising valuations of existing listed players but also by new entrants from home and abroad.