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EURO REITS

More countries confer tax-free dividend status

BY DONNA MITCHELL

Unibail’s Le Forum des Halles, Paris. The firm’s new REIT status puts it on an even footing with non-French REITs.

There’s something of a REIT wave sweeping Europe’s largest economies. Until now, Belgium and the Netherlands have been among the very few European countries that had REITs. But it looks like this is about to change considerably.

French real estate companies are adjusting to a new REIT-equivalent tax structure that the government adopted in September. U.K. Chancellor of the Exchequer Gordon Brown is expected to propose that Parliament adopt a law allowing REITs in 2005. And word has it that German real estate funds are considering REIT status too. The German government is making a series of changes to the rules that govern their financial markets, one of which is to introduce REITs. Currently, German banks hold a lot of property; if the real estate funds do change over, the banks can sell them this property, freeing up capital to reinvest or pay out. Anyway, Germany doesn’t want to be the only major European economy without REITs, says Martin Allen, a Morgan Stanley real estate analyst based in London.

REIT status permits a U.S. corporation to deduct from its taxes the dividends it pays to shareholders, as long as those payments amount to at least 90 percent of taxable income. Congress created REITs in 1960 to give individual investors access to large-scale real estate investments.

Besides reducing a company’s tax bill, REIT status can make a stock attractive because it enables the company to offer higher dividends.

It’s high time more of Europe got on board, say real estate analysts overseas. Until real estate companies in, say, Britain become REITs, they will be at a significant tax disadvantage against real estate operators from such countries as Belgium and the Netherlands, which already have a REIT structure in place.

Once U.K. property companies start offering the richer dividends REITs offer, investors will begin ponying up for their stocks, analysts say. As things stand now, Allen says, the sector is undervalued. At the end of 2003, real estate companies in the United Kingdom were trading at a 25 percent discount to their net asset value, he says. By contrast, Dutch real estate companies traded at only a 5 percent discount (the Netherlands adopted the REIT structure in 1969), while U.S. real estate stocks changed hands at a roughly 17.5 percent premium.

Yet there are bright signs for U.K. real estate stocks, undervaluation notwithstanding. The overall sector was up 20 percent between August 2003 (when the REIT talk began to spread) and early February, and it outperformed the broader equities market by 11 percent.

There is still room for improvement, Allen says, but “it has given the U.K. listed property industry a renewed sense of purpose.”

Conveniently, the U.K. government gave the British real estate industry one more reason to push for REIT status five years ago, through a tax on sales transactions by limited partnerships. When these partnerships sell property or other assets, they must pay a registration tax of 4 percent of the transaction price. This makes them less desirable to investors — and REITs more so.

French companies are already reaping the benefits of that country’s new tax structure. Since September, 11 of France’s 13 real estate companies applied for status as Societes d’Investissements Immobiliers Cotees — or SIICs, the French equivalent of “REIT.” Also, French-based subsidiaries of Hammerson, Rodamco, and Wereldhaze, are considering the changeover, says Philippe Tannenbaum, senior finance analyst for Credit Lyonnais, Paris.

Before this, French property companies traded at a discount of about 30 percent, historically. That discount dropped to 11 percent in November 2003 and has since been erased, says Philippe Le Trung, a Paris-based European property analyst for Citigroup.

For Paris-based Unibail, a developer of shopping centers, convention centers and office properties, the conversion to SIIC status was a no-brainer; it was first in line to adopt, observers say.

“Tax-transparent status is important because of its attractiveness to investors,” said Léon Bressler, chairman and CEO of Unibail.

Like many property developers in Europe, Unibail attracts stock investors worldwide, and that means it competes with European retail real estate developers that have long enjoyed REIT status, such as Netherlands-based Rodamco Europe. These companies, freed of corporate tax obligations, are not only able to offer higher dividends, but they can also accept a lower cash-on-cash return when bidding on properties beyond their borders. Rodamco, for instance, could bid on a property and settle for a 6 percent minimum yield. By comparison, before the advent of SIICs, French property companies had to demand at least 8 percent because of their tax burden, says Tannenbaum.

Unibail’s shopping centers make up about 35 percent of total assets and 40 percent of rental income. The company’s approach to financing is conservative; rather than borrow, it sells older properties to free up cash for new development. (Le Forum des Halles, a retail and entertainment center in downtown Paris, is among Unibail’s properties in the French capital; it has several more throughout the country.)

Bressler says SIIC status is changing the way Unibail does business. The company is drawing more and more individual investors and recently started paying dividends on a quarterly basis.

“We are open to going to other European cities for retail and convention center development,” said Bressler. (Up to now the company has operated only in France.) But, he adds, “we will do that with extreme caution. There are a lot of things to be done in France still.”

French SIICs differ from U.S. REITs in a number of ways. For instance, U.S. REITs can be either publicly traded or else privately controlled by institutional or private investors or venture capitalists. In France real estate companies must be publicly traded and have a minimum market capitalization of €15 million ($18 million) to qualify as SIICs. Further, whereas a REIT can be managed internally, by a full-time executive team, or externally, by a third party, SIICs are only managed internally.

Nor are French corporations the only beneficiaries of SIIC status; the new tax regime could indirectly help the French government and taxpayers too, observers say. By giving workers a stable, high-yielding investment alternative, SIICs reduce future retirees’ reliance on the public pension system. That’s good news for France, which for the past three years has run a national deficit exceeding 3 percent of gross domestic product (that is, it exceeds the limit the European Union set for its member euro-currency countries). The French government is expected to sell off about 656.6 million square feet of property holdings to help pay down the deficit and then rent them back, but even that won’t take all the pressure off pension funds, says Credit Lyonnais’ Tannenbaum.

“The funds that the government uses to pay rents will likely drain pension and social security accounts,” said Tannenbaum, who consequently advises French citizens to put money elsewhere. “It is a great time [for individual investors] to make investments in public companies.”

France has about 10 years to build a privately funded pension option before the next wave of retirees needs the money, says Alec Emmott, a managing director at Paris-based Société Foncière Lyonnaise. The firm manages some €2.2 billion of commercial real estate in the Paris business district, including a significant retail presence on the major shopping arteries.

Financing pensions, though, is a big, bold venture. There are some who wonder about all the fuss over SIICs — whether they will be up to the task.

“Companies will be promoting listed real estate shares as the Holy Grail of asset allocation,” said Emmott. “Alongside bonds, equities and direct real estate, they can be presented as the mythical fourth asset class.”

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