EPRA Works Toward Cross-Border Standards Founded just over a year ago in November, 1999, Amsterdam-based EPRA has so far attracted 78 members, established the first real time index of public real estate companies across Europe, and laid a foundation for promoting a pan-European public real estate industry.

By Michael Fickes

Real estate companies in Europe are becoming interested in investigating the advantages of the REIT structure for application to their own markets. But the systems for cross-border tax structures, presumably under European Union agreements, are still a long time off. But some companies are beginning to pursue the concept within national borders, and in two countries, the legislative structures are already in place.

Belgium and The Netherlands Take the Lead

In Brussels, a real estate company called Cofinimmo pays no corporate income taxes. A dozen other Belgian real estate companies offer the same benefits to their investors.

Likewise, a dozen or so real estate companies in The Netherlands pass most of their net incomes through to investors in the form of untaxed dividends.

These companies resemble, but are not identical to, U.S. real estate investment trusts. The Dutch vehicles have done business since the mid 1980s, while the Belgian companies only recently came to the public market, following legislation enacted in 1995.

Property companies in the rest of Europe operate as limited partnerships or conventional corporations.

While the REIT-like business in Europe may seem small, the entire real estate industry on the continent comprises a significant number of companies, both public and private. "There are only about 300 listed property companies across Europe," says Quinton Hill-Lines, deputy chief executive of the European Public Real Estate Association (EPRA). "It's a small sector."

Indeed, EPRA research estimates the size of the real estate sectors listed on European stock markets at) 80 billion, or about one percent of the total )7 trillion capitalization of these stock markets.

On the other hand, EPRA believes that interest in forming public real estate undertakings is growing. Since 1998, 17 new companies have gone public in Belgium, Denmark, Finland, Italy, Sweden, and the United Kingdom. In addition, real estate markets in France, Holland, and Spain have shown strong returns. Outside of Belgium and The Netherlands, public real estate companies have generally adopted conventional corporate structures and resemble public real estate operating companies (REOC's) in the U.S. Turkey, which is not yet in the E.U., has adopted a structure similar to U.S. REITs.

Formed in 1996, Cofinimmo operates on what may be the leading edge of the European real estate industry. The company is a SICAFI (Société d'investissement a capital fixe en immobilier)—a French acronym (pronounced See-Cafy) which translates to a "fixed capital real estate investment trust."

Like a U.S. REIT, a Belgian SICAFI is a real estate business structure that does not pay corporate income taxes. In exchange for this benefit, SICAFI's must invest in property in a diversified manner, maintain a debt ratio of 50 percent of the market value of their assets, and distribute at least 80 percent of their net income.

An FBI (Fiscale Beleggingsinstellingen) , the acronym given to Dutch real estate businesses with REIT-like qualities, receives similar tax treatment.

According to industry observers FBI's based in The Netherlands tend to be larger than Belgian SICAFI's because the FBI's have been around longer. In addition, The Netherlands has a highly developed pension fund industry, which invests large sums in FBI companies. "In proportion to its population, The Netherlands may have the largest pension fund industry in the world," says Bernard Cardon, CEO of Cofinimmo. "In Belgium, we are not entirely unfunded—I have no figure—but we are closer to the Latin countries of Europe, which generally use pay-as-you-go pension systems."

Despite its relative lack of pension fund investment support, Cofinimmo ranks as the largest real estate investor in Belgium, according to Cardon. "We have )1.6 billion in holdings, which translates to about $1.36 billion in U.S. dollars," he says.

The Cofinimmo portfolio contains more than 108 office properties, and spans more than 760,000 square meters (approximately 8.2 million square feet) of space.

The company specializes in office properties and has seen net rents increase 9.5 percent over the past year. The occupancy rate of Cofinimmo's office properties rose to 98.25 percent from 97.03 percent during the first six months of 2000.

Cofinimmo has grown rapidly since its founding in 1996 through investments in Belgian office properties. Growth beyond Belgium's borders poses problems, however. "Belgium is a small country," Cardon explains. "To grow more, we should invest in properties in other countries. The problem is that we receive tax advantages only as long as we invest in Belgium. If we buy a building in France or Germany, we will have to pay local taxes and not be able to receive refunds in Belgium."

Others May Follow—But Not Yet

From time to time, other European governments have considered creating REIT-like structures, but with little success. "There has been lobbying for the concept in the U.K.," Cardon says. "But the Treasury there did not see the advantages. The French government is divided about the idea. Finland tried to do something recently, but didn't succeed. There is a movement to create a Swedish instrument."

Despite legislative reluctance, the European business community's interest in the REIT concept has grown side-by-side with real estate as an industry in its own right.

Historically, European real estate has not functioned as an independent industry. Manufacturers, retailers, and other business enterprises simply owned and managed the real estate necessary to their own operations.

And pension funds and other institutional investors that own real estate tend not to manage property aggressively. "Many hold property as a bond-like asset, buying it and keeping it as an income machine," says Andy Schofield, director of global property research in the London offices of Henderson Global Investors.

As the current owners of real estate—companies and investment funds—divest their holdings, however, observers believe a more dynamic real estate industry may begin to emerge.

Will the absence of pass-through tax vehicles offering special tax treatment for public real estate ventures hinder the development of a more aggressive industry?

Perhaps not.
In Germany, for example, special tax depreciation rules helped to finance property development for many years. "These tax treatments provided investors with a higher depreciation than the technical depreciation would generate," says Alan Cadmus, president and CEO of Polis Grundbesitz und Beteiligungs AG, a real estate holding company headquartered in Berlin. "In the past, for example, an investor could deduct 50 percent of the cost of a building from personal taxes. So if you invested $1 million in East Germany in construction work, you could deduct $500,000 from your personal tax bill. This provided a big subsidy for construction work for individuals on their own or investing through a limited partnership."

This tax structure led to the development of large tax-transparent limited partnerships in Germany, continues Cadmus.

But these tax treatments were eliminated in 1999, when a new government altered the tax laws.

"Even though tax driven real estate investments have been stopped, the real estate market itself will not stop," Cadmus says. "We can continue by applying the U.S. REIT concept. We do not have REIT structures, but there are attempts in Germany to establish corporate structures that operate like REITs."

Polis itself aspires to create such a structure. Two years ago, Cadmus visited the U.S. to study REITs and to compare them with German corporate structures. "Most real estate corportions in Germany have strategies for investing in large pieces of real estate or some other strategy for reducing risk," he says. "But these companies have not offered persuasive stories to the German capital markets."

Cadmus has set up Polis with the idea of creating a real estate company with a more REIT-like investment story. Cadmus began by forming a partnership between Polis and a small private bank, which invested in the company's first two office projects. Currently, Polis owns six office buildings with a net asset value of approximately DM 100 million or (US)$40 million.

The Polis strategy aims at developing, owning, and managing office buildings equipped with advance technology in major German urban centers. For the time being, Cadmus expects development to proceed in west Germany, believing that east German development has reached the top of the current cycle.

Pursuing its development goals, Polis doubled in size during 2000. Cadmus expects the company to double its holdings again next year. At the beginning of 2002, if all goes according to plan, Cadmus will take Polis public with an IPO, featuring a German corporation designed to mirror the real estate operations of a U.S. REIT.

Unconventional Thinking

By German standards, a public Polis will be an unconventional concept.

"We invest in real estate," Cadmus says. "For German tax reasons we do not do this directly. Instead, we establish small private corporations that own each piece of real estate. In every case, Polis owns 100 percent of the shares in these companies, which do nothing but hold the real estate."

After the IPO, Polis shareholders will have indirect interests in all of the real estate owned by those small private corporations.

Essentially, Polis aims to become a publicly traded holding company that owns a series of single asset corporations, without worrying about tax consequences.

"We are early with this idea," Cadmus says. "I'm optimistic that as one of the first of these kinds of structures, we will be an attractive concept for the capital markets. Our idea is to focus on real estate as a business, not as a tax shelter."

While some observers will doubtless point to the clumsiness of a holding company structure, Reinhard von Hennigs, an attorney with Nelson Mullins Riley & Scarborough, LLP of Atlanta and Munich, calls the concept innovative and potentially marketable.

But why not simply operate as a limited partnership? Even though the extra depreciation benefits have been eliminated in Germany, limited partnerships still pass income through to the partners before taxes. "In U.S. terminology, limited real estate partnerships in Germany work like closed end partnerships, and there is no market for trading shares," Hennigs says. "German investment law has tried to form a kind of market under a statute called Kapitalanlagegesellschaftengesetz or KAGG. This statute provides a way to designate a safety value for the shares of a real estate limited partnership. It also requires the partnership that issues the shares to be willing to buy back the shares for face value. Although this provides some liquidity for the limited partners, the face value of those shares is often discounted by a large percentage in a buy-back transaction."

The system provides liquidity, albeit discounted liquidity, for investors but also limits the partnership's investment capabilities. "Because these partnerships don't want to be forced to sell real estate to buy back shares, they tend to limit their net real estate investments. Sometimes net investment in real estate are as low as 50 percent," Hennigs says.

The Polis concept aims to create an alternative to the problems posed by the partnership structure. "This is an exciting development," Hennigs says. "Essentially, companies like Polis are saying forget about the tax problem. Create a corporation and drive investment with dividends."

The theory goes like this: the corporation can invest as much as it wants in real estate, without the need to maintain large amounts of cash to pay back investors, who can cash out by selling their shares on the public market. The increased corporate holdings combined with aggressive real estate management will overcome the problem of taxation at both the corporate level and shareholder level.

Despite the complexities of German corporate law, the Polis idea suggests what the future of the real estate business could look like in Europe. Given the reluctance of all but two countries to legislate REIT like structures to date, the alternative lies in creating a real estate business structure that offers business efficiencies great enough to overcome any drag on investment created by tax structures.

Clearly the market in Europe for REIT- or REOC-like companies in Europe is still evolving. The European Union will have some impact as the cross-border tax hurdles will likely be reduced in time. For now, investment in individual countries is possible through the structures currently in place under the national laws. But, a broader approach in the future could help to open real estate opportunities to more investors.

Michael Fickes is a freelance writer from Cockeysville, MD.