New Laws Are Looming
For European REITs

Legislation on real-estate investment trusts and large portfolio sales are likely to dominate the European real-estate landscape in 2005.

In particular, legislation aimed at introducing REITs in two of Europe's most important markets, Germany and the U.K., is being closely tracked because neither government has decided how to go about it.

Investors in both markets have lobbied hard for REITs because they will inject liquidity into the real-estate market, making it more tax efficient. REITs, which are likely to be publicly traded, also will open up commercial real-estate investment to smaller investors.

REITs own properties, such as hotels, apartments or office buildings, and pass on rental income to shareholders. REITs are already established in markets such as the U.S., France, Belgium and the Netherlands. The U.S. is home to the biggest REIT market, with a total market capitalization of about $290 billion (€222.17 billion). REITs have been popular with investors. The stocks of U.S. REITs, companies owning real estate or mortgages that must pay out at least 90% of their taxable income in the form of dividends, delivered total returns of 41% in 2004, up from nearly 37% in 2003. Total returns measure stock-price appreciation plus dividends.

The German Finance Ministry is expected to reach a decision later this month on whether it will give REITs the green light. It is widely expected that the government will approve REITs, although it is likely to impose a number of conditions, which could include foreign-ownership restrictions.

"REIT legislation will make the industry more flexible," says Fraser Hughes, research director at the European Public Real Estate Association, who notes that German REIT legislation will probably be passed more quickly than in the U.K. That could be good news for many open-ended real-estate funds in Germany, which have had some problems accurately valuing their properties recently, as REITs could provide a vehicle to solve some of their issues.

But, unlike the U.K. government, the German Finance Ministry hasn't provided draft legislation detailing the potential structure of its REITs, according to Dr. Florian Schultz, a partner at law firm Linklaters Oppenhoff & Radler in Frankfurt.

"I am optimistic that the government will agree to REITs, although the crucial and difficult point is the tax concept for a German REIT -- the market is demanding a REIT with several tax benefits, whereas the ministry has sent clear signals that it will not support legislation that will lead to a reduction in [its] tax payments," he says.

In the U.K., as the government stalls on the legislation, investors are moving their real-estate holdings offshore to reduce their tax payments. Last year had an increase in the number of listed U.K. property trusts domiciled in the Channel Islands.

"The bottom line is that the more vehicles that go offshore, the less tax the government will receive," says Mr. Hughes. "Ultimately, the government is encouraging an 'unregulated' offshore real-estate investment market."

The U.K. offshore real-estate market has grown to about £20 billion, or roughly €29 billion, from about £1 billion in 1998. Tax received in 1998 from the U.K.-listed property sector was about £350 million, which fell to about £200 million in 2003, largely because of privatizations and companies moving properties into offshore vehicles.

"If this continues, by around 2008, I imagine there won't be much of a listed market to tax in the U.K.," says Mr. Hughes.

Deutsche Bank AG's head of European real-estate research, Peter Hobbs, agrees. "Within the U.K., the government faces considerable tax leakage through the creation of many offshore private real-estate investment vehicles," he says. "The introduction of REITs will be a major factor enabling the government to slow or reverse this trend."

The German government doesn't face this problem as there is no offshore real-estate market.

The second big trend in 2005 is likely to be large residential divestitures in Germany and corporate asset sales throughout Europe.

According to Mr. Hobbs, the U.K. government alone is reported to be planning a £30 billion outsourcing of assets. In Germany, a number of federal and local governments plan to sell and lease back real-estate portfolios. The French government recently said it intends to dispose of €1.5 billion in real-estate assets over the next three to four years.

There were already a number of large residential transactions in Germany in 2004. In December, German steel giant ThyssenKrupp AG sold its residential real-estate group for €2.1 billion to a consortium comprising U.S. bank Morgan Stanley and Corpus-Immobiliengruppe, based in North-Rhine Westphalia. Earlier in the year, U.S. opportunity fund Fortress Immobilien AG acquired Gagfah, a health-ministry housing corporation, from German public pension fund BfA for €3.5 billion.

"There remain significant opportunities for government and corporate owners to monetize their assets because institutional investors remain interested in secure income yield," says Gordon Black, Heitman's managing director of international private equity in London. "We believe that there should be robust activity during 2005."

Both corporate and government real-estate portfolio sales -- and often lease-backs -- dominated the European real-estate scene in 2004.

"Last year was an interesting year for opportunity funds as there was very little investment in direct property transactions," says Chad Pike, Blackstone Group managing director and head of European real estate. "The weight of money from private individuals and institutions meant that private-equity players focused more on very large, complicated corporate situations."

There has also been a big increase in competition for large sale/lease-back deals in Europe over the past five years, which looks set to continue into 2005, according to Edward LaPuma, chief investment officer at New York-based investment firm W.P. Carey & Co. "I think we'll now start to see competition coming from more non-U.S. based investors as well."

Earlier this month, W.P. Carey acquired the corporate headquarters of the Pohjola Non-Life Insurance Co. in Helsinki for €83.6 million in a sale/lease-back transaction.

Nonperforming loan portfolios, especially in Germany, are also expected to be put on the market this year as consolidation sweeps through its banking sector. Subsequently, the selling of nonperforming loans, which include real-estate loans, is likely to account for a significant part of the market this year, according to Raffaele Lino, managing director of DTZ Investment Advisers GmbH in Frankfurt.

"Every German bank has a problem with nonperforming loans, and they need to sort the problem out," says Mr. Lino. "There's fierce competition for nonperforming loans. Most interest comes from U.S. opportunity funds, although smaller U.S. and U.K. players could also acquire nonsecured loans."

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