NAREIT - Special Issue

The European REIT market is gaining momentum. With Germany and the U.K. having introduced REIT legislation in 2007, opportunities to establish REITs in the European sphere have definitely accelerated. The question now is how quickly and to what extent the European REIT market will develop. Will REITs become a Europe-wide phenomenon? Will the market expand to be as big the United States REIT market?

The potential is certainly there. “The United States currently sees approximately 10 percent of its underlying commercial real estate owned by REITs. If you apply this ratio to the European market, then it could grow by more than $300 billion, or by 75 percent from its current figure,” says Fraser Hughes, research director with the European Public Real Estate Association.

Hughes adds that the largest growth opportunities appear to be in the German and Italian markets. “If the German market hits an 11 percent listed average then the market will hit the $139 billion mark, a five-fold increase. On this basis, the Italian market would be set for a seven-fold rise. The U.K. and France are already on the 10 percent mark.”

However, those hoping to see a massive proliferation of REITs in the near future may be disappointed. Some believe that the fragmented nature of the European market means structural barriers continue to be an impediment to U.S.-style growth.

Joaquim Ribeiro, chairman of the European Union REIT committee of the European Property Federation (EPF), a Brussels-based policy group striving for single, Europe-wide REIT legislation, says he fears the European REIT market as a whole could start to lose momentum if it continues to be difficult to create new REIT structures. “For investors looking to invest in Finland, Poland, Portugal and Romania, these countries are years away from having a REIT structure in place,” Ribeiro says.

Looking East

In the search for greater yields, institutional real estate investors are migrating to Eastern Europe. Currently, the best development returns in Europe are coming from Russia and the Ukraine. The highest level of development activity over the next three to five years will be in these countries because the markets have just opened up, whereas countries in Western and Central Europe have been heavily developed.

Factors that are driving Eastern European growth include retail and industrial development. There has been an increase in wealth in Eastern Europe, which has pushed retail spending. Industrial sector growth is driven by the opening of new ports, airports and rail lines.

REITs are not new to Europe. They have been available in the Netherlands since 1970, in Belgium since 1995, inFrance since 2003 and in Bulgaria since 2005, in addition to the latest legislation in Germany, Italy and the U.K.

Ribeiro says that even though REITs have been adopted in several EUmember states, the lack of a pan-European property investment vehicle is handicapping the market in several ways. Not only is it stunting the capacity of the property industry to develop on a Europe-wide scale, it also creates competitive distortions in the European capital markets as capital flows into countries that have REITs, Ribeiro says.

Therefore, EPF would like to see a European legislative instrument established that would create a framework for an EU REIT. The implementation of EU-wide initiatives tends to be very slow and highly bureaucratic, and the sticking point would likely be tax. “Tax is probably the most sensitive issue within the EU, and this could mean some tax leakage in the short term, which some governments may not accept,” Ribeiro says. He says that with lots of cross-border investment flows occurring within the EU, the establishment of national REITs, which transfers the tax liability from the structure to the investor, can lead to tax losses for national treasuries.

To get around the reluctance on the part of some countries, Ribeiro says an EU REIT could be introduced on the basis that national administrations could choose to adopt the framework or not. This would allow smaller countries, which may not have the regulatory expertise to introduce their own REIT legislation, to adopt an off-the-shelf package. As such, they would at least then have the option of establishing REIT legislation.

Even without an EU REIT, development in the European market is pushing ahead. In the first few months after the establishment of REIT legislation in the U.K., more than 10 property companies had converted to REIT status and several others were working on converting.

Iain Reid, chief executive of London-based Protego Real Estate Investors, says there is a key difference between the U.K. and the U.S. market at the moment, even though the REIT legislative structures are broadly the same.

“In the United States, companies have been set up as REITs and are full of income-producing property designed to deliver a high yield. In the U.K., companies were not originally structured to be REITs. They are traditional property companies, heavily into development and with high expenses, which depresses the dividend yield,” Reid says.

Ultimately, the European market still massively trails the United States in size and scope. Although an EU REIT would undoubtedly be a boon for European investors and companies that would like to convert to REIT status–especially those in Scandinavia and Eastern Europe–the priority for development probably lies within the markets that already have REIT legislation.