European governments embraced REITs only recently, so Europe’s markets trail those of the US and Asia. But a ready supply of product and stable growth will help Europe catch up
The European real estate invetment trust (REIT) market is set to expand. According to investment bank JP Morgan’s latest estimates, €4.7bn of new REIT equity will come to the capital markets every year over the next 30 years. This figure is based on the amount of listed commercial property rising from 5% to 10%, in line with global levels. Expansion of this market will be helped by solid economic growth and rising investor allocations to real estate.
However, conditions in some countries are not all suitable for REITs. REIT legislation is set up in Germany, France, Italy and the UK, but, in Germany, for example, residential property is excluded from the REIT regime. On top of this, volatility in the financial markets may curtail short-term demand for real estate equity.
The current turmoil in the credit markets makes it difficult to time an equity-raising venture. Fallout from the US subprime mortgage market has increased the cost of borrowing, which will hinder the acquisition of property by existing REITs. Demand from investors may have peaked already, owing to a combination of high deal volume, capital market volatility and a change in sentiment towards European property. JP Morgan expects activity to slow in the second half of this year.
But competition among REIT country markets will only improve the existing REIT structures. The tax framework of the European REITs is largely based on the US structure. According to Dutch law firm Loyens Loeff, the European models are developing as a result of competition between countries, as opposed to government intervention.
France is widely seen as the leader of European REITs. SIICs, as the French structures are known, were introduced in 2003, and offer a relatively simple and transparent vehicle for investment. This is one reason why the French regime is attractive to foreign investors.
“Australia is the most mature listed property market globally, with the highest proportion of listed commercial property at 44%,” JP Morgan analyst Harm Meijer says. “If Europe’s listed market developed to this extent, the implied market cap for REITs would rise to €1.2 trillion. However, this is unlikely, given the financial market capacity, available management teams and the sheer volume of assets involved.”
The launch of REITs in France was replicated in the UK and Germany in 2007. The late introduction of tax-efficient vehicles in these countries could explain why Europe as a whole is under-represented in the REIT markets (see charts below) and global listed property markets. The Continent accounts for only 23% of the world’s listed property, despite possessing more than 40% of the world’s €12 trillion commercial property market.
JP Morgan says that the UK has the largest market cap, but fewer REITs, at just 28% of the sector, compared with 100% in Belgium and the Netherlands, offering scope for future conversions. REITs have not performed as well as expected in the UK because the government took too long to introduce the vehicles. “The UK government stalled because they were worried about losing revenue through tax leakage,” says a senior equity analyst. “But by the time they arrived, it was the market peak in terms of yield compression and rental growth.”
The structure itself may be more complex than its French counterpart but there is nothing intrinsically wrong with the UK model. It is more a case of poor timing. “By delaying the REIT’s introduction, it will take an extra three years for the UK market to get to the same size as elsewhere in Europe,” adds the equity analyst.
JP Morgan believes that there is ample product to fuel the growth of European REITs. This product comes from existing listed companies and unlisted funds, including German open-ended funds. More companies are expected to convert to REIT status or spin off portfolios into sub-managed REITs.
European economic growth and monetary policy will help the property market. JP Morgan expects eurozone GDP growth to be 2.7% this year and 2.1% in 2008. The UK’s GDP will lead with 3% in 2007 and 2.6% the following year. Inflation is stable at around 2%, which means interest rates should be steady. The Bank of England will likely keep rates at 5.75%, while the ECB will hike rates to 4.75% by June 2008.
