PRINT THIS STORY:

CHANGE TEXT SIZE:

Britain, Germany put final touches to REIT regulations

By Steve Bergsman

To a greater or lesser degree, two more European countries are set to welcome the REIT structure next month: the U.K. and Germany. In Britain, where the likes of British Land Co., Hammerson and Land Securities Group are eager to become REITs, everything seems to be neatly in place.

In Germany, though, the scene is considerably less tidy. At press time Germany’s Federal Ministry of Finance said it remained committed to introducing stock-exchange-listed real estate companies on Jan. 1. But this may be optimistic, given that as late as last month, German REIT legislation was still in draft form as politicians continued to hammer out changes. “The best-case scenario for Germany appears to be that the REIT legislation will be voted upon sometime in early 2007 and then become retroactive to the first of January,” said Mark Abramson, a managing director in the Frankfurt office of Chicago-based Heitman, a real estate investment management firm.

Whereas Britain has a long history of publicly traded property companies, most of which will convert to the REIT format, there are few such companies in Germany. Not that German investors have been shy about investing in real estate; they have placed billions in German open-ended real estate funds. REIT issuance will originate from these funds, says Fraser Hughes, research director at the Amsterdam, Netherlands-based European Public Real Estate Association. And the operating inefficiencies and scandals that have plagued the funds probably translate into an investment community that is only too happy to see this conversion.

A major difference between such open-ended funds and REITs is that with the former, investors find cashing out difficult, especially when there is a run because the fund has to sell the real estate first. A REIT, on the other hand, is fully liquid, because investors own shares, which they can sell at any time.

A second pool for German REITs will comprise property owned by corporations or the government. In Germany many large corporations, including retailers, still have enormous value tied up in their real estate. The key point about Germany is its potential, Hughes says. “We expect to see significant growth in that market over the medium-to-long-term.”

France, the Netherlands and Belgium have REITs in place, as do Greece and Bulgaria. According to a Morgan Stanley report published last year, in the Netherlands there were seven REITs valued at a total $17.5 billion, 10 Belgian ones at a total $4.8 billion and 10 in France at a total $17.1 billion.

The next major European country to adopt REITs could be Italy, says James Rehlaender, managing director of European Investors, a New York City-based asset management firm. “The Italian government is partly motivated by the need to off-load some of its own real estate,” he said. The Italian government owns a lot of incongruous properties in the main shopping corridors of major cities, Rehlaender says. A prime example: a federal prison on the Via Veneto, Rome’s famous shopping street. “The government is really driving this, unlike in the United States, where the private sector pushed for REIT legislation,” said Rehlaender. “This will be a way for the Italian government to reduce its deficit and stimulate an industry.”

There are minor structural differences among the REITs introduced in each country, of course, but in Europe some of the differences will be striking. Elsewhere, REITs tend to own property exclusively in their own country. In Europe there are already some cross-border REITs, especially in the retail sector. “There is a feeling among the property-share investors in Europe that retail is a sector that is very suited to a pan-European investment approach,” said Martin Allen, a real estate equity analyst at Morgan Stanley. “We already have a number of pan-European retail vehicles.”

A second difference, at least at the start, is that there will be a large group of diversified REITs, thanks in part to the large number of mixed-use properties in European cities. The property portfolios of many investment funds that could convert to REIT status are diverse as well. Over time, this could change, though, with the market becoming more sector-specific, as in the U.S.

“Clearly, when investors become sophisticated as to property type, the market will become more sector-oriented,” said Chris Ludlam, head of fund development at London-based Invista Real Estate Investment Management Holdings, a spin-off of The Royal Bank of Scotland Group. “We are already starting to see that in the funds that invest in industrial or logistic properties.”

“There is currently a fair amount of specialization by property type in Britain, and we will expect to see more of that in Europe over time,” said John Kirz, managing director for real estate finance at New York City-based Moody’s. Most REIT activity in European real estate will focus on office, industrial and retail properties, he says. Apartments will get less attention, Kirz says, because in many European countries this sector is weighed down by governmental housing policies.

Some analysts narrow it down further, saying most REIT activity will involve retail and office space. “The difference between the U.S. and European markets from an institutional standpoint is that the listed property space in Europe is heavily concentrated in retail and office,” said Abramson. “About 70 percent of the market cap is in these two sectors.”

Ownership of the enormous amount of grocery-anchored retail across Europe is fragmented, says Mark Baillie, head of real estate for Europe and North America at Macquarie Real Estate’s London office. “It’s a situation where assets are owned by the operators of retail outlets,” said Baillie. “We will see over the next few years these retailers selling real estate off their balance sheets and recycling that capital into improving the format of their stores. They’ll sign long-term leases to maintain some control over the properties.”

This will be less apparent in Britain, though, where there has already been some consolidation of shopping center real estate. “U.K. retail was more popular in the last half of 2004 and first half 2005,” said Abramson. This indicates that investor sentiment has turned elsewhere, he says.

Invista’s Ludlam would agree. “Retail had been a very hot sector in the U.K., but that sector is overpriced at the moment,” Ludlam said. “We would expect to see a slowing of investment in retail, while other sectors, such as office, are more attractive at current pricing.”

But that won’t slow the rush to REITs in London when the gate goes up next month.