G-Reit market set for glacial progress
The conversion of Hamburg-based real estate company alstria into a Reit at the beginning of October and its inclusion in a new Deutsche Börse German Reit segment in November heralded a new dawn for the German property market. But despite the big long-term potential of Germany’s position as Europe’s largest property market, observers aren’t expecting a substantial increase in the near future in the number of German Reits – known as G-Reits.
Olivier Elamine, alstria: attractive benefits
The rationale for conversion to a G-Reit was straightforward, says Olivier Elamine, chief executive of alstria, which listed as a regular company in April 2007. "We knew that the equity story worked with G-Reit status – that’s why we listed in advance of conversion – but the benefits of the new regime are clearly attractive for us as a company and for investors. That said, this is only a change of tax status for alstria – we are not changing the way the company operates." Elamine believes that G-Reit status gives alstria greater operational flexibility. "We can now sell assets without worrying about capital gains tax, which will increase our portfolio liquidity," he says. Moreover, as a G-Reit, alstria is exempt from corporate income and trade tax. Also – and perhaps most important – vendors that sell real estate benefit from an exit tax, which offers 50% relief on income, corporate income tax and capital gains tax. "In short, alstria gained a significant competitive advantage in becoming a G-Reit," says Elamine.
Hurdles remain to G-Reit uptake
Despite alstria’s enthusiasm for the new regime, the prospects for G-Reits look uncertain for several reasons. First, the provisions of G-Reit legislation, signed into law on June 1, are far from ideal: it was a compromise given its lengthy gestation. Planned for 2006, G-Reits were delayed by a change in government and over arguments about whether residential property should be included within G-Reits, as is possible in most European regimes. There has also been a debate about how much leverage G-Reits could employ.
"Germany opted for the most conservative course," says Harm Meijerad, senior real estate analyst at JPMorgan in London. "It ruled residential property out of Reits and imposed rules that are more restrictive than elsewhere in relation to leverage." G-Reits cannot have a net debt/portfolio ratio of more than 55%, although as Elamine points out, G-Reits can breach the 55% limit for as long as three years without penalty. In contrast, France has no rules governing leverage; and in the UK, a different measure (the interest cover test) roughly equates to a 75% net debt/portfolio ratio.
Another bugbear of the G-Reit regime is the bar on paying quarterly dividends: the rules stipulate annual dividends, which make G-Reits less advantageous to equity investors. By choosing a cautious path in relation to leverage, Germany has diminished the attractiveness of G-Reits. "If a company is stable and traditionally run, then G-Reits make sense – after all, they do have significant tax advantages in common with Reits worldwide," explains Meijerad. "But for companies that are more dynamic and want to retain some flexibility, G-Reits in their current form look unsuitable."
Rules will change
The crucial caveat to G-Reit rules is that they will almost certainly change. "We expect the legislation to evolve over the next five years and become more relaxed," says Meijerad. "And at some point, European Reits will appear, which will change the whole landscape." German property companies might well hold back from converting in the expectation of a more favourable regime.
In addition, the broader characteristics of the German real estate market are a barrier to a rapid increase in G-Reit numbers. "There are not many listed real estate investment companies in Germany," says Meijerad. Of around 40 listed real estate corporations in Germany, fewer than half a dozen are of sufficient scale to warrant conversion.
Most property investments are made through open-ended funds, whose values are based on appraised net asset value. Open-ended real estate funds, established in the 1950s, are unique to Germany and must be conservatively managed in order to retain their status. But although they have enjoyed a big influx of capital since 2000, they have suffered from scandals relating to valuations.
One way to give G-Reits an immediate critical mass would have been to allow conversion of open-ended funds to G-Reits. Instead, the rules state that open-ended funds have to be liquidated and reconstituted in order to become G-Reits – a process that will proceed only at a glacial pace.
So, although institutional investors will increasingly favour G-Reits as a result of their tax advantages, there are likely to be few investment options in the short term. The limited number of companies that could realistically convert – and the present virtual closure of the IPO market to property companies – means that Germany’s property market is not about to undergo the revolution some hoped for.