Erstellt am: 18.03.2006 Autor: Edward Roby Status: Bisher nicht definiert
New asset class for cosmopolitan high rollers
Maybe it’s time to leave toto lotto, racetrack betting, even the glamorous gaming tables of Baden-Baden to the low rollers. Serious international money is queuing for a different jackpot, one projected to haul in triple-digit billions in Germany alone. The new spotlight is on the trading of property assets, perhaps even the one you call home.
Barring some improbable political hitch, a grand financial casino called the Real Estate Investment Trusts (REITs) is preparing for its gala opening in Germany next year. Reits are exchange-traded property companies with preferred tax treatment. Initiative Finanzstandort Deutschland (IFD), the banking lobby that has successfully promoted this imported concept, envisages a market potential of €127 billion for this new German asset class by 2010.
Along with that, U.S. and British investment banks and funds are engaged in a feeding frenzy in the seemingly moribund residential property market of Germany. In the past 18 months Fortress, Blackstone, Terra Firma, Morgan Stanley and a consortium of Cerberus and Goldman Sachs have acquired more than 300,000 German dwelling units from public and private owners, including Thyssen-Krupp, Eon and WCM.
The German real-estate branch projects that around 1.5 million publicly owned apartments will be sold by states and municipalities in the next few years. Lone Star fund had entered the sector from a different trajectory the end of 2004 when it bought €3.6 billion worth of non-performing mortgage loans from Munich’s Hypo Real Estate.
Collectively, the foreign investors have already plunked down two-digit billions to acquire real-estate holdings from German corporations and municipalities such as the city of Dresden, where an impending acquisition by the U.S. Fortress pension fund of 48,000 public apartments for €982 million is making renters nervous. At least some of the rental property already scooped up by other foreign investors such as Terra Firma is being turned into resident-owned condominiums on which the homeowner loan payments might be combined for the purpose of floating mortgage-backed securities.
Since it is unlikely that cosmopolitan investment banks will wish to remain local landlords in a glutted market, the rest of the acquired rental apartments might be included as property assets in a newly chartered Reit. And, most recently a Scandinavian bank has chartered Germany’s first umbrella fund for investment in domestic and foreign property stocks, for instance, the traded Reit companies that are already operating in such countries as France and the United States. More such funds are expected soon. The European Public Real Estate Association has reported on a budding boom in mutual funds investing in property, saying this boom is being propelled by Reits.
A boom in a busted sector?
Something exciting is obviously stirring in the German real-estate sector, although it does not seem to be the price of the underlying property assets, which has been generally static or declining in recent years. Rents demanded for apartments and especially for office buildings in some of the prime business centers have been sliding, even in Frankfurt, usually Germany’s hottest real-estate scene. Yawning vacancy rates in office buildings are a chronic problem.
Ignoring the oncoming Reits euphoria, this situation alone makes the sudden interest of huge foreign investors in German property somewhat hard to fathom. On the other hand, since the bursting of the global stock-market bubble in 2000-03, a real-estate price balloon has quietly taken its place in many a foreign market. That clearly reflects the real leading interests rates that central banks had slashed to zero or below in order to weather the equity crisis. The residential property boom has especially swept through Britain and the United States, home markets of Germany’s incoming foreign capital for property investment. But leading interest rates of the Federal Reserve and European Central Bank are now rising again, putting mortgage loans out of reach for some prospective house buyers. And market saturation is feared or has been observed in some places that have experienced the biggest real-estate price explosions. Yet, nothing of the sort has occurred in Germany.
Some of the foreign investors eying German property are said to be cyclical strategists who have wisely cashed out of their home markets at the price peak. They may believe that they are now entering the flat German market in a price trough of a normal cycle. Evidently, this view is not shared by the German owners who have been quick to sell out. Thomas Kretschmar, chairman of Hypoport AG, a large Berlin mortgage platform, offered a reason for that. The foreign investors have sometimes offered twice as much as the selling price German residential property owners had come to expect over the decades – namely, 10 or 11 times annual basic rent. That’s a big signal to cash in.
“What has happened in all other countries is a ‘clean out’ of the real estate market. In Germany, this is only now beginning,” said Georges Ruchti, an executive of Easetec, a Frankfurt consultant for real-estate capital markets. “Prices are on the floor. Nowhere is it as cheap as in Germany. These investors know they can only go up. There is a complete selection and they can do good cherry picking at the bottom of the cycle.”
Allan Saunderson, editor of the Frankfurt-based market newsletter Property Finance Europe, sees transatlantic cultural differences in investment strategy. U.S. investors look at cycles, he said, while Germans believe an investment, like a Florida condominium, is only safe after it has been rising for years. “The Germans – like the Japanese – are pro-cyclical investors,” he said. “They always lose money.”
That might explain the mismatch between the hearty foreign appetite for German property and the unpalatable German property yields. When the investment vehicle of Reit finally arrives in Germany, enthusiastic foreigners could bid up these solid property stocks, even if the current stock-market boom is then fading for other segments.
Tax reform ‘a la carte’
Another Reit-market driver would be the allure of preferential tax treatment for the corporate sellers of property. Business advocates of tax reforms have long complained that normal tax rules stifle growth by deterring German companies from using capital gains on their property assets for investment in their core businesses. The accrued difference between property assets carried on the companies’ books and their current market value has to be taxed when these hidden assets are divested. Under the proposed Reit model, the capital-gains tax due when such assets are uncovered and change hands is only half of that which it would otherwise be. This special tax treatment – dubbed “exit tax” -- could save many a property-rich corporation a bundle of money.
Ralf Grönemeyer, Commerzbank’s Frankfurt equity strategist, said in his 2006 market forecast briefing that such property assets are three-quarters of the book value of German companies. And IFD estimates that German companies are sitting on real property assets of EUR 1.1 trillion, carried on their books as reserves. “The idea is to direct this into cashflow and operations only,” said Grönemeyer. “Reits offer a new exit channel for these assets. You pack property into Reits and sell it to Allianz and the like (institutional investors) for 6 percent a year.” And, he added, “The focus is turning in the direction of growth.”
This tax aspect of the Reits juggernaut has received short shrift in business press, despite its usual sensitivity to what lobbyists see as regrettable political inertia in the area of business tax reform. The reporting emphasis, instead, has been on the other interesting tax features of the listed Reit corporations. In a nutshell, these unusual companies are exempted from both corporate income and business trade taxes. In exchange for that privilege, they will be required to disburse at least 90 percent of their earnings to their shareholders.
It is the shareholders, who will then incur liability for the tax on these earnings in the form of their dividends. The political stumbling block here has been the profusion of bilateral double-taxation treaties by which foreign shareholders in domestic Reits might be able to avoid German taxation. The trick for the legislators is to plug that potential loophole. Germany has been considering the imposition of a flat pre-emptive tax of 10 percent or 15 percent on all Reits dividends to prevent foreigners from avoiding German tax liabilities. Britain, the big other Reit market entry, will undoubtedly take a parallel approach.
Insurers, prominent among the institutional investors that are expected to purchase the Reits shares, are wary of this. The up-front tax, which is permissible under double-taxation arrangements, might discourage life insurers from buying Reits shares because these insurers already have to pay out as gains to policy holders all but around 10 percent of their return on financial investment. And foreign insurers might be unable to recover a source tax withheld by Germany when it comes time to settle their income taxes.
Freeing funds’ capital
Germany has also been weighing the British idea of capping the size of individual Reits shareholdings. This appeals to Germany’s distressed open-ended property funds. They have demanded equal treatment with Reit for fear that their big investors might defect en masse to this attractive new asset class, draining liquidity from the funds. With the slogan “same business, same rules,” the investment-fund and asset-management lobby, BVI, has said that tax breaks for Reits cannot be justified if they would damage other asset classes.
The fund operators want to be able to manage Reit assets and also be able to set up their own Reits. The funds, however, are closely regulated, while the comparatively transparent Reit companies would in theory be “regulated” mainly by the discipline of the equity market. Therefore, BVI has demand relaxation of regulatory limits on mutual-fund investments in Reit stock.
In a white paper by BVI executives Stefan Seip and Rüdiger Päsler, the funds lobby argues that the regulated funds should receive the same exit-tax break as Reits when issuing shares against property. As its exit-tax rule for packaging hidden property reserves into a Reit, IFD’s legislative concept envisages that the tax, which is half of the normal effective rate, would be due on these reserves over a period of four years.
As an asset class, regulated open-ended real-estate funds are theoretically quite different from traded property companies. Mutual fund investors participate in the property market only indirectly, while Reits shareholders shoulder the direct risk of owning equity. The question is whether these two products will compete for the same groups of investors. Reits, it appears, will cater heavily to large domestic and foreign institutional investors, such as insurers, pension funds and mutual funds.
The open-ended property funds initially set out to attract small retail investors. But the urge to grow caused them in recent years to pitch their product increasingly to large professional investors. Some of these institutional investors came to regard their property fund investments as a higher-yielding substitute for money-market funds. Such big investors actively manage their assets to maximize yield, meaning that they may move out of a fund unexpectedly, taking a large chunk of fund liquidity with them. That introduced an element of volatility to a normally stable, long-term investment vehicle. It was this behavior that is blamed for causing the strange recent crisis in the German sector of open-ended property funds.
Crisis? What crisis?
The crisis began in mid-December when Deutsche Bank suddenly announced a revaluation of the assets of one of its property funds. This supposedly triggered a selloff, which prompted the bank to freeze its redemptions of the shares in two of its funds, shares that are also exchange traded. That new uncertainty about fund redemptions caused the selling to spread to the rest of the property fund market, estimated at the time to have had managed assets near €90 billion. In January, two funds of an organization called Kanam also had to be suspended for liquidity problems, triggered by an unflattering rating comment. By the time the two-month selloff ran its course, an estimated €7 billion had drained out Germany’s 34 open-ended property funds. And the financial regulator and finance ministry had become alarmed.
In the end, when Deutsche Bank reopened trading in its fund’s shares on March 3, 2006, it appeared that its independent revaluation of fund property showed no drastic changes and that not even the price of the fund shares took a severe penalty. This prompted some observers to wonder whether there had actually been a crisis worthy of the name. One outcome seemed clear, however. The uproar in the funds scene provided what might have been the decisive boost for the political campaign to allow Reits into Germany.
The boost would come partly from the various proposals to reform the distressed property funds sector -- voluntarily or with legislation. One idea is to reduce volatility by requiring institutional investors to give 12 months notice that they plan to sell a block of fund shares exceeding €1 million. “You won’t see these investors putting their money into this vehicle, if they have to wait 12 months to get their money out,” Bernd Knobloch, the chairman of giant real-estate investment bank Eurohypo, told a Property Finance Europe interviewer. “You don’t tell them, ‘we don’t want you anymore.’ You just make their life more difficult.”
For the professional investors, of course, the alternative to the property funds is Reits. Small investors, typically wary of equity anyway, would stay with the funds. The traded Reit companies, meanwhile, would supposedly invigorate the declining German property market by attracting foreign and domestic shareholder capital. And they would certainly provide other corporations as well as public authorities with a neat vehicle to reap capital gains on their vast real-estate holdings. Reit would become the main vehicle for monetizing the slumbering property of Germany, making the office buildings, the hotels and especially the formerly municipal apartment buildings of Germany an internationally traded financial asset.
The locusts are coming! globalization critics may say. And tax collectors, insurers and open-ended mutual property funds may tacitly harbor their own misgivings about all this. But for many big German industrial companies, for the real-estate investment banks, for the big broker-banks that promoted Reits and for the stock exchanges that will list them, this is an unprecedented opportunity. For this smart money, those scavenging high-rollers sweeping in from abroad cannot come soon enough.
