For all the fanfare, the legislative launch of UK and German REITs could hardly have been worse timed. Mark Faithfull asks what next for crashing NAVs, Teutonic indifference and acquisitive cash funds

When the great and good of UK property gathered to sound the opening bell at the London Stock Exchange in February 2007 they had good reason to believe they were ringing the changes. A month earlier UK real estate investment trusts (REITs) had been given the legislative go-ahead and the FTSE's first UK REIT index opened with nine members. Germany was also preparing to introduce its own retroactive G-REIT legislation, bringing Europe's two most important real estate markets into the REIT fold.
Fast forward 18 months or so and the picture is not so pretty. Traditionally global REITs have traded at a premium to net asset value (NAV) of over a third, reflecting their tax-efficient structure. But British REITs are currently valued at anywhere between 10-50% discounts to NAV, with the UK scoring the softest performance of all global REITs for the calendar year 2007.
And German property companies remain underwhelmed. Just two G-REITs have been established to date - Alstria Office and Fair Value - and continuation of this lukewarm response to the initiative was underlined recently by IVG Immobilien's decision to defer its own launch. It had previously announced a plan for a REIT through an initial public offering (IPO) this year, made up of German office properties worth around €3.5bn. The target launch date of April/May "if market conditions are favourable" came and went and in June chief executive Wolfhard Leichnitz admitted that IVG saw no chance of placing a REIT in the market this year.
It is not all bad news. Alstria Office's first-quarter net profit of €6.2m may have been down fractionally from €6.3m a year earlier but showed a marked improvement in operational performance. Alstria raised its full-year 2008 revenue forecast to €101m and CEO Olivier Elamine asserted: "The investment markets still show liquidity at a level comparable with 2006 and significantly higher than 2005."
The conversion to G-REITS has undoubtedly been hit by the highly political exclusion of residential property when Germany formalised its REIT legislation. That decision also derailed the best laid plans of a number of opportunistic international equity investors which had snapped up multi-tenant residential blocks eagerly expecting to package them up in REITs.
Thomas Demmel, partner with Field Fisher Waterhouse Deutschland, adds that there are also plenty of other investment opportunities. "REITs are not the only way forward," he reflects. "There is plenty of potential in rental growth and there is a lot of restructuring in former Eastern Germany, where standards are going up. But you have to be careful where you invest - in the East you need to look at the microclimate or land a great deal."
Herbert Quelle, head of economic affairs for the German Embassy in London, adds of the issues surrounding residential property investment: "The current rules are set in stone but we can be assured of continuous revision and if people can be persuaded then this may change. For REITs this is just the start; they may not meet the maximum demands and expectations now but in five years from now that may be different."
The second largest (after France) of the European REIT markets - the UK - has had a particularly tough time. Shares in British Land have fallen by over a half since it acquired REIT status in January 2007, while Hammerson's share price has fallen over 40%, as has that of Land Securities, Britain's largest property business, which is preparing for a three-way split of its business.
Yet increasing discounts have attracted interest from some of the Middle East's globally active investors, notably Dubai-based Nakheel, which has mooted its intention to buy a UK REIT as it expands into property asset management.
"UK REITs are trading at a 30-40% discount now and that's a huge opportunity," said chief financial officer Kar Tung Quek of Nakheel's proposed strategic move.
Indeed, persistent takeover rumours and stake building have fuelled talk that the UK's depressed listed real estate sector could be about to turn a corner. Peel Holdings has built up a 4% holding in Land Securities while stake builder Paul Kemsley and sportswear entrepreneur and Newcastle United chairman Mike Ashley have been amassing shares in Shaftesbury. Dubai sovereign wealth fund Limitless is also closing in on a €305m deal for London developer Minerva.
Meanwhile in Italy, after a year-long wait, the Italian government in December implemented much-anticipated REIT regulations. The guidelines of the Italian REIT legislation, known as Società per Investimenti Immobiliari Quotati (SIIQ), were decided as long ago as December 2006 but introduction of the new regulations has been in limbo. The SIIQs strongly resemble their French counterparts (SIICs) although the Italian regulations retain capital gain taxation upon the disposal of assets.
As in Germany, the take-up by Italian listed retail property companies has been slow. In April, Immobiliare Grande Distribuzione (IGD) announced that it had decided to convert to SIIQ status with retroactive effect to 1 January 2008.
IGD has a real estate portfolio with a market value of €1bn consisting of 10 malls, 14 hypermarkets and supermarkets and three development assets. The group also owns two shopping centres through its 50/50 joint venture with Beni Stabili.
But of its counterparts, IMMIT Immobili Italiani, the €1.3bn property unit of bank Intesa Sanpaolo, recently postponed plans to list as a SIIQ, while Aedes Immobiliare says it plans to launch a €1.2bn SIIQ but not until the back end of the year.
"The three new REIT markets have all struggled to distinguish themselves in a period of low yields and high debt costs," says James Cowen, portfolio manager for real estate securities at Invesco. "Clearly no-one is going to question tax efficiency and in all three markets REITs are perfectly commercially viable but at a time of significant discounts to NAV then there is not a great incentive for the equity markets to go down this route. There is simply not the appetite."
Cowen believes that while some UK property companies may become attractive buys for some investors, a buying spree is not on the cards. "The clarification on capital gains should help but what is interesting is how active companies such as British Land have been at disposal of assets. That's something that the REIT structure has definitely helped," says Cowen. "In Germany open ended funds have regained some of their former popularity and the limit on 10% shareholding and the exclusion of residential have not helped REITs. Italy also remains a tough market for foreign companies to invest in. This is about evolution, not revolution. I do believe that conversion to REITs has a future but not while the markets are in downturn."
However, despite the slow uptake of REITs in Germany and Italy and their poor performance in the UK, JPMorgan's European REIT development report forecasts that €140bn of new equity will be added to the European capital markets in the long term.
In Europe there remains plenty of room for growth, according to the European Public Real Estate Association (EPRA), which says that Europe accounts for just 22.6% of global REIT market capitalisation, estimated at €754bn, despite having 42.3% of the world's underlying assets in the direct commercial property market.
Ernst & Young also agrees with this healthier prognosis. "Essentially, we've seen a dramatic shift in REIT formation away from North America and toward Asia and Europe," says Michael Frankel, global director of REIT Services for Ernst & Young. "We've seen a tremendous outpouring of capital in Asia and Europe, where REIT regimes in the UK and Turkey have helped the rest of the world surpass the US for the first time in total number of REITs."
Nick Tyrrell, managing director, head of research and strategy, European Real Estate Group, JPMorgan Asset Management, adds: "The fact remains that investors still consider their portfolios under-represented in real estate compared with other assets. Once prices have adjusted - which could take a year or more - the supply/demand balance in the investor markets will turn positive once again."
And indications that not all markets are in decline have been backed by the performance of the only eastern European REIT market, Bulgaria. Despite the credit crunch, Bulgarian REITs have been bolstered by the booming domestic construction and property markets and in 2007 they led out global REIT performance. Lithuania is also considering its own REIT legislation.
However, the variety of national REITs now available in Europe is raising some concerns. Late last year the leaders of the European Landowners Organisation, the European Property Federation, the RICS, The European Group of Valuers' Associations and the Urban Land Institute Europe called on the European Commission to create an EU REIT to "overcome obstacles to cross-border property investment in the EU and enhance market security and stability."
Joaquim Ribeiro, finance director of Sonae Sierra, the influential Portuguese-based shopping centre developer, and chairman of the EU REIT Coalition, insists: "Creating an EU REIT would turn the current fragmented EU market for property companies into the largest and likely most efficient property market in the world. Investors, small and large, private and institutional, would greatly benefit from that."
And in May the French REIT industry backed EPRA's drive to establish a tax-efficient pan-European REIT. Jean-Paul Dumortier, the head of the country's real estate securities association La Fédération des Sociétés Immobilières et Foncières (FSIF), suggested that the French SIIC regime has the most attractive investment characteristics and could be the best model for an EU REIT.
Despite this clarion call, the complexities involved in aligning the tax rules of 27 EU countries to create a common regime for an EU REIT - and the need to bring transparency up to an acceptable common benchmark - make their introduction hugely problematic to say the least.
Instead Europe's newest trio of REITs look set to forge their own way as they establish themselves in the UK, Germany and Italy, regardless of the current climate.
"The new REIT markets have been hammered," reflects Jim Rehlaender, managing director and head of international for European Industries Inc, the investment manager of Schroders' Global Property Securities. "We went through a lot of similar issues in the States, these things take time," he says. "Ultimately the supply elements in Germany, Italy and even the UK are under control and that's the main thing. One issue at the moment is that a lot of sector analysts are being laid off and that means there are not enough experienced people touting the merits of REITs to institutional investors."
But Rehlaender believes that the markets will gradually mature. "The problem is we are in transaction deadlock and it is very difficult to get an accurate valuation of the current REITs when no-one is trading," he says. "I think the big issue for these new REITs is that they have to start thinking in a new way and attract interest by talking about dividend strategies rather than capital growth."

REITs: A European snapshot

Belgium, Bulgaria, France, Greece, the Netherlands and Turkey all allow REITs in some form. For example, in France they come under the SIIC designation. Germany and the UK enacted REIT legislation at the beginning of 2007, Italy finally signed off its own legislation at the end of the same year. Spain, Poland, Malta, Luxembourg and Austria all have tax-transparent regimes with some elements of REIT structures in place. Lithuania is considering the introduction of REIT legislation.
Germany introduced retrospective legislation in April last year dating back to January 2007. Two REITs have since been launched, with a third by IVG on ice.
Italy finally gave its version of REITs (SIIQs) assent and one company has confirmed its conversion plan.
In the UK REITs wer introduced in January 2007. Many major developers and property owners have switched to REIT status and there are 21 REITs in the UK now but performance has been hit dramatically by the global real estate downturn.