In light of the current trend of European REITs, the existing FBI structure has become outdated, with the Netherlands losing investment funds to Luxembourg. In addition, French and Belgian REITs, as well as the proposed structures in the U.K. and Germany, are less restrictive than the current FBI. Quite simply, changes are required for the FBI to regain its competitiveness.

Global Market Capitalization Breakdown June 30, 2005

Ronald Wijs, tax partner at Loyens & Loeff Amsterdam, and chief editor of the EPRA Global REIT Survey, says, "I think the ‘luxury version’ is going to take-off for Dutch REITs. As the new regime is likely to be fully exempt, with distributions not subject to withholding tax, including property in the regime would mean that rental income could flow directly to foreign shareholders free of taxation by the Dutch government. It also is likely that the Dutch government will try to strip out existing bottlenecks, firstly the very restrictive interpretation of permitted activities (currently including no project development—even in the organization’s own portfolio) and secondly the very complicated ownership/shareholders requirements."

United Kingdom

A U.K. REIT has been debated for many years. However, following the introduction of the SIIC, or French REIT, the U.K. has moved forward, albeit more slowly than expected.

Alongside the March 2005 budget statement, HM Treasury and the Inland Revenue published a paper entitled "U.K. Real Estate Investment Trusts: a discussion paper." The document confirmed that, "The government is committed in principle to reforming the taxation of property investment. The consultation has enabled the government to better define the key features of a potential U.K.-REIT model that allows for market flexibility. The paper also raised some challenging issues in designing the tax treatment for a model that meets both the needs of the U.K. property investment market and the government’s objectives for a U.K-REIT. The government will therefore engage in further dialogue with industry representatives. Subject to finding a workable solution that meets the stated objectives, including reform at no overall cost to the Exchequer, the government aims to legislate for a U.K.-REIT in Finance Bill 2006."

Projected Pan-Europe Market Capitalization — 2011

Source: FTSE EPRA/NAREIT Global Real Estate Index and UBS estimates.

Tax experts say there are three key areas where the government wishes to conduct further consultation before the drafting of legislation can commence.

• How can the government ensure gearing is not used to manipulate returns and avoid tax? There appears to be a concern that REITs may be exploited by certain sophisticated investors, who may gear up the vehicle and channel interest payments to lenders with tax capacity while allowing capital growth to flow to equity holders.

• How can the government introduce a REIT regime that works within both the U.K’s EU commitments and double tax treaty obligations without a loss of U.K. tax revenue? The issue of the taxation of distributions from the REIT in the hands of non-resident investors is likely to be the greatest hurdle for the introduction of a U.K. REIT. It is difficult to see how the U.K. can achieve its aim of introducing an entirely tax-exempt structure without losing tax revenue from off-shore investors—who have the ability to utilize double tax agreements, or EU law.

Projected Global Market Capitalization—2011

• How can group structures be accommodated within the proposed regime? The government will need to clarify how any conversion charge will apply on transfers from group companies to a REIT.

Richard White, tax partner at Ernst & Young in London and chairman of the TTC, says, "whilst there is almost unanimous agreement that a tax transparent vehicle for real estate investment is required to enable the U.K. to compete with other developed economies, the practical difficulties in satisfying the U.K. Revenue’s insistence on tax neutrality are likely to result, at best, in a delay in the introduction of U.K. REITs or, at worst, the introduction of a model which is not sufficiently attractive to investors to be workable."

Meanwhile, as the REIT discussion continues in the U.K., off-shore growth in private vehicles has rocketed. Since 1998 the size of the offshore market has grown from next to nothing to more than $40 billion. HM Treasury is fully aware of this development. However, if REIT legislation in a workable and attractive format is enacted in 2006, a positive impact on the market is likely. UBS, for example, estimates that market capitalization in the U.K. listed real estate market could nearly double, from about $50 billion currently to almost $90 billion by 2011.

Germany

Germany is the largest country in Europe in terms of GDP, but has one of the smallest listed real estate markets in the region. Only three German real estate companies are constituents of the FTSE EPRA/NAREIT Global Real Estate Index. Germany has by far the largest real estate stock in Europe, however, only a small fraction is held by institutional real estate investors (approximately $470 billion). Therefore, the opportunity to securitize a larger share of German commercial property is significant.

An analysis prepared by Germany’s Centre for European Economic Research (ZEW) and the European Business School (EBS) estimates that $140 billion of corporate and $130 billion of unleveraged residential real estate could be spun off into REITs. The Initiative Finanzplatz Deutschland (IFD, a key lobby group for the creation of German REITs) similarly estimates that $150 billion of real estate could be floated in the next five years.

Lobbying for German REITs
Sources	Property Portfolio ($ billion)
Contributions from: Tax Paying companies Former tax-free residential companies	$70 35
Conversions: Closed-end funds	25
Open-ended publikum funds Open-ended special funds	12 8
Total	$150
Source: IFD, June 2005

For REITs to be effective in the German market, the Zew-EBS report concludes that REITs need to be introduced soon to help lift the German real estate market out of crisis. The report also notes that a German REIT market will not develop overnight and that the potential may only be realized over the medium term. However, the report stresses that market volumes and marginal tax revenue for the government cannot be precisely estimated because the success of REITs will strongly depend on the cyclical development of the real estate sector as well as on the details of any financial incentives.

Michael Meiser, vice chairman of the Christian Democratic Union/Christian Social Union faction in the German Parliament, has stated that he believes the introduction of a German REIT would provide a platform to create employment in the financial and real estate sectors, without significant costs. Meiser stressed that German REITs should be launched quickly and certainly before U.K.-REITs.

Existing European REIT Structures Overview
Country	Established	Payout	Property	Gearing	Foreign Ownership
Netherlands	1969	100% taxable profit	None	<60%	Max 25% by single non-national
Italy	1994	No obligation	Limited	<60%	No restrictions
Belgium	1995	80% of net profit	Limited	<50%	No restrictions
France	2003	85% of profit from leasing	Limited	Unlimited	No restrictions
Source: EPRA Global REIT Survey, 2004

Max Berkelder, research director at Kempen & Co in the Netherlands, summarized the current situation. "The process of the German REIT introduction seems to be on the right track, although some tax leakage issues still have to be solved. A German REIT introduction combined with the announced abolition in June 2005 of penalty tax for German investors that hold foreign property stocks will lead to a revolution in the German property sector in the coming five to 10 years. The size of the German listed property sector plus the appetite from German investors for REIT stocks will structurally improve."

2011—What Will the Pan-European REIT Landscape Look Like?

The European market is progressing, albeit slowly, but it is safe to say that the European landscape of the future will offer a far broader set of opportunities to investors. The impact of German REITs on the European sector could be significant, with Germany potentially leaping from its current weighting of 3 percent in the FTSE EPRA/NAREIT Europe Index to approximately 30 percent. Likewise, Europe could increase to approximately 30 percent of the Global Index by 2011.

Expanding REIT markets in new countries also may reduce the weighting of more mature REIT markets, such as those of the U.S. and Australia. And with expanding REIT markets worldwide, the coverage of REITs could reach 90 percent of the total global listed market particularly if the U.K. and Germany adopt REITs.

Summary

So will we see an all encompassing pan-European REIT structure? Perhaps, but only after European countries individually establish viable REIT structures of their own. Europe has a long way to go to catch up to established REIT markets in North America and Asia. However, there are a number of encouraging signs, and if REIT legislation is passed in the U.K. and Germany within the next 24 months, we can expect to see increased levels of activity and growth in the European market.

Given the potential of the European market, estimates envisage an additional $100 billion entering the listed market in the next five years from Germany and the U.K. alone. These developments will offer investors a broader universe in a proven asset class. In market capitalization terms, the size of the European market could easily move in excess of $200 billion, driven by new issues alone, or approximately 30 percent of the global market. Given the expanding Asia/Pacific market, potential growth in Europe, and the increase in investor appetite in this increasingly global asset class, it would not be surprising to see the market capitalization of the FTSE EPRA/NAREIT Global Real Estate Index climb over the $1 trillion mark in the next five years.