REITs Are Heating Up
In European Markets

The good times may be peaking for U.S. real-estate investment trusts but in Europe the party may be just about to begin.

REITs have been in favor for years with U.S. investors searching for high and steady dividend yields. But with interest rates apparently on the rise in the U.S., REITs' earnings prospects could be hampered. In Europe, in contrast, interest rates aren't expected to rise so quickly -- and more countries plan to introduce REITs before long.

European REIT structures -- publicly listed organizations that own properties like shopping malls, hotels or office buildings -- exist only in the Netherlands, Belgium and France. But Germany and the U.K. are pushing their own REIT legislation that would provide the typical tax advantages for REITs, a move that could significantly widen investors' choice.

Two weeks ago, the German Ministry of Finance said it aims to have REITs introduced by January. The U.K. government might have a framework for its own property-investment vehicles set up later next year. Finland, Sweden, Italy and Spain may follow.

Compared with the 146 U.S. REITs, which carry a total market value of approximately $250 billion, or about €194 billion, according to Morgan Stanley, the European market remains small. It consists of about a dozen listed REITs with a total market value of $70 billion. But they are increasingly popular.

"There seems to be a common perception among investors that the European market with REIT developments still in their infancy is becoming even more attractive than the American one," says Fraser Hughes, research director at the European Public Real Estate Association, or EPRA.

Last year, European REITs outperformed their U.S. counterparts. The European benchmark, the EPRA index, generated a total return of 41.73% in 2004, measured in euros, while the U.S. benchmark, the EPRA/National Association of Real Estate Investment Trusts index, returned 24.19%, also in euro terms. Like many others, research analysts at UBS AG contend that U.S. REITs are overvalued by as much as 10% and may slide in the coming months.

There are signs of that happening. In January, U.S. real-estate stocks fell 8.1% in dollar terms, according to the EPRA index, while European real-estate stocks rose 2.2% overall.

Also favoring European REITs is the notion that they are better value at their current price than U.S. REITs, when measured on the underlying net asset value of the properties they own. According to Martin Allen, analyst on property equities at Morgan Stanley, the U.S. REIT market has since 1990 traded at an average premium of 3.6% to its net asset value.

Many European REITs, on the contrary, have been trading at prices closer to their actual underlying net asset value or even at a discount. In the Netherlands -- the most established continental European REIT market, which often serves as a benchmark -- property-investment trusts have been priced at a long-term average of 4.3% below their NAV.

On average, the gross dividend yield for European REITs is expected to rise to 4.7% in 2006 from 4.5% this year, according to UBS. The average gross dividend yield for U.S. REITs, in contrast, is expected to fall to 4.0% in 2006 from 4.7% this year.

So far, interest in European REITs has come mostly from banks and institutional investors, but they may whet the appetites of more individual investors. "As a consequence of our aging society, people focus more on real estate. And against that background, REITs have a big advantage: They provide a sufficient level of liquidity for the smaller investors," says Scott Crowe, head of global real-estate strategy at UBS.

"As the demographic shift in Europe moves heavily towards the retirees, they demand an asset class that delivers a healthy stable income, and price appreciation without taking a roller-coaster ride," says Mr. Hughes of EPRA.

Selecting the right REIT is, of course key, as they can be more volatile and carry a higher risk than, say, bonds related to real estate. Checking out the underlying real estate of the portfolio is a must, analysts caution. Markets for retail property are on the upswing both in the U.S. and in Europe, but markets for office property differ widely.

The entry of Germany and the U.K. could boost the market further, says Boudewijn van Loen, a real-estate portfolio manager at F&C Asset Management PLC. "It will make it easier for a lot of existing real-estate companies to become a REIT and allow the market to grow."

Although in the U.K. a lot of the real estate is publicly listed, in Germany it isn't. According to Oliver Puhl, head of real estate investment banking at Morgan Stanley in Frankfurt, as much as €60 billion of German corporate property could be structured in REITs.

A German task force of financial experts called Initiative Finanzplatz Deutschland, set up by the Finance Ministry in 2003 to make Germany more competitive as a financial center, called for REIT legislation in a report to the government last week.

The report argued that REITs could benefit investors, Germany's capital markets, and the broader economy. If Berlin doesn't act, experts warned, "Paris or London, and not Frankfurt, might become the central trading spot for European REITs."

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