In the first of a weekly series this month on REITs we look at their introduction in Germany.
Legislation for German Real Estate Investment Trusts was only passed by the Bundestag on 23rd March this year, though it was with retrospective effect back to 1st January 2007. It seems too soon to draw accurate conclusions about the success of the change although there is an enormous potential upside for German property.
To evaluate developments over the next 12 months or so it’s important to register that both the German property sector in general and the legislation of Angela Merkel’s coalition government to establish REITs have special features that make the situation different from, for instance, the UK, one of the other newcomers on the block.
Taking the general distinguishing characteristics of the German property first of all, the most obvious of these is the size of the real estate sector. Estimates vary in the range of roughly 6.5 to 7.2 trillion Euros, making Germany by some way the European Union’s largest property market. However, up until now the term ‘market’ may have been slightly misleading as Germany has not only had a large proportion of rented housing (57% of the total) but (more significantly for investors) a very high level (73%) of commercial property owned by the companies utilising or occupying premises. The equivalent proportion in the United States is 25%.
As far the G-REIT legislation is concerned the most obvious distinguishing feature is that residential property is effectively ‘ but not entirely’ excluded from the new regime. Given the size of the rented sector in Germany, the protection from REIT involvement has been a disappointment for real estate investors but the possibility of German tenants being fleeced by international private equity groups was clearly a scenario to be avoided. In fact the restriction on residential property holdings is only that they may not form more than 49% of a portfolio. Why this should have stopped REITs going into this sector is not entirely clear but the commentators all seem to agree that this is the case.
Patrick Sumner, Head of Property Equities, Henderson Global Investors predicts that the German authorities will, in time, ease up on the restrictions applying to G-REITs in the residential sector.
Other distinguishing features relating to technical tax matters tend to be more abstruse. The basic situation is that G-REITs avoid having to pay corporation tax and trade taxes but are liable to property taxes and the German equivalent of stamp duty. G-REITs have to distribute 90% of annual profits to shareholders and there is no tax relief on these dividends. The complicated part starts from here-on (and Overseas Property Mall would love to hear your comments if you can shed more light!). For the period until 1st January 2010 holders of undervalued real estate assets which are moved into REITs will escape 50% of the capital gains tax.
Clearly this is a measure designed to encourage the switch to holding property through REITs. Lease-back to the original owners is permitted. Another factor for non-German investors to consider is that the country’s withholding tax level is 25% or 15% in the case of the majority of countries with which Germany has entered into double taxation treaties. Exceptionally, for investors in the Republic of Ireland, the level can be as low as 10%.
The German government has specifically blocked the tax advantages of holding companies when repatriating dividends by restricting direct shareholdings to 10% or less of a G-REIT’s shares. At the outset a G-REIT must have free float (the proportion of shareholders owning stakes of under 3% of the shares) of 25% and at no time may the free float fall below 15%. A further frustration for private equity is the 60% ceiling placed on gearing for G-REITs.
Given the size of the country’s total property bank the forecasts for the development of G-REITs seem relatively modest. Before the limitations on residential property investment became apparent there were predictions of 200 billion Euros worth of property being spun of into REITs (by the Centre for European Economic Research/European Business School), approximately half of them residential assets.
The Initiative Finanzplatz Deutschland forecast approximately 115 billion Euros worth of property being translated into REIT assets (read pdf report here). Chris Reich of ING Investment Management has predicted 80 to 100 G-REITs coming to market in the next three years. Roland Berger Strategy Consultants forecasts a more sober 57 billion Euros total capitalisation of G-REITs by 2010.
Coverage of G-REITs news in the English language media is definitely patchy so we’d appreciate local commentary and expertise. German real estate looks like being a story that’s definitely worth following.