REITs – Chances for the German real estate and financial markets

• Market potential for real estate investment trusts (REITs) in Germany: up to EUR 57 billion in 2010
• Liquidity for further growth through capitalization of real estate assets
• Tax advantages and interesting returns/risk structures
• Success levers for REITs

From 2007, German lawmakers are planning to introduce real estate investment trusts, which promise to become an attractive investment opportunity. In the study entitled "REITs – Chances for the German real estate and financial markets," Roland Berger Strategy Consultants estimates that the market volume of German real estate investment trusts (G-REITs) will reach up to EUR 57 billion by 2010. Companies' real estate assets are a source of considerable potential. Through REITs, companies can leverage these assets to finance growth and realize their expansion plans. According to a 2006 analysis based on desk research, market comparisons and interviews with market players, links between REITs and other asset classes lead to a superior combination of risks and returns.

A REIT is a publicly listed real estate company that aims to manage real estate. REITs were introduced in the US in 1960, in 1969 in the Netherlands, in 1985 in Australia, in 1994 in Canada and in 2000 in Japan. The UK and Germany are planning to introduce them in 2007.

"Germany's real estate market is the biggest in Europe, but companies could make a much bigger part of their real estate assets accessible to capital markets," explains Thomas Eichelmann, member of the Executive Committee and Head of the Financial Services Competence Center at Roland Berger Strategy Consultants. REITs provide an attractive opportunity to do so.

The bill proposed by the German Ministry of Finance plans strict regulations for REITs. They must be listed in the stock market, pay out 90% of their profits and have 75% of their capital invested in real estate. What's more, 75% of their revenue must be generated through real estate, and REIT shareholders cannot hold more than 10% of shares.

Popular investments

"REITs are popular because they enable companies to leverage their real estate assets and generate cash reserves," explains Dr. Markus Strietzel, Partner at Roland Berger Strategy Consultants' Financial Services Competence Center. Companies can use the unleashed capital to reinvest in their core business. REITs are especially attractive for municipalities and public institutions, as they allow them to acquire new liquidity.

There are currently about 200 REITs worldwide with a cumulative market capitalization of approximately EUR 330 billion. In Europe, Germany has the biggest real estate market (total volume of approximately EUR 7.1 trillion). However, until now, only about EUR 820 billion (11.5 percent) of real estate has been accessible on the capital market. According to the analysis, 13 DAX corporations had EUR 80 billion tied up in real estate at the end of 2005. Metro, for example, has 31.1 percent (EUR 8.9 billion) of its total assets invested in real estate, followed by Bayer (EUR 3.2 billion) and Deutsche Telekom (EUR 11 billion) with 8.6 percent each. Captive real estate makes up 5 to 15 percent of the second biggest cost pool and ties up approximately 10 percent of capital.

Tax advantages

Investors find REITs attractive primarily because of tax advantages. REIT income is not taxed, but is attributed to the investors, who pay taxes based on their personal tax class. Private investors also like REITs because they broaden their investment portfolio and are available at relatively low rates.

Interesting risk-return combination

A comparison of investment portfolios made between 1972 and 2003 shows that given the same level of risk, portfolios containing REITs generated better average returns than others. The average return for REIT portfolios was three percentage points higher (12 vs. 15 percent). Until 2005, the US REIT index showed stronger development than Standard & Poor's 500 stock index (S&P 500) and fix-interest securities. Over three years, it exceeds the S&P 500 by 11.6 percentage points, 18.3 percentage points over five years, and 5.5 percentage points over ten years. Compared with US bonds, the US REIT index shows development between 8.1 and 24.7 percentage points better.

Similar development has been forecast for Germany. G-REIT returns should correspond to their American role model. Compared with stocks, G-REIT therefore has an attractive risk-return profile.

The four levers of successful REITs

In order to ensure the financial success of REITs as well as optimal returns, four levers are critical: First, the portfolio should be optimized continuously, and the portfolio strategy must be in line with real estate market cycles. Second, investment processes should be monitored on a regular basis to ensure that interfaces and decision-making responsibilities, for instance for new investments, are clearly defined. Third, sound liquidity management contributes to generating high returns and creating resources for new investments. Fourth, operations must be continuously monitored to minimize stockouts. This can be supported by performance-based compensation for managers.

Outlook: Consolidation and integration

Once G-REITs have been introduced, consolidation and integration in the real estate sector can be expected. REITs must be publicly-listed companies. Going public generates discretionary equity that can be used toward acquisitions. The critical size for market capitalization is considered to be approximately EUR 1.5 billion. Bigger REIT companies will expand their service offer to increase their profit base. This vertical integration includes object management, which comprises maintenance, administration and budgeting.