If German real estate is an interesting investment story, how do we access it? German Special Funds, Luxemburg Special Funds, G-REITs - a structural comparison for the foreign investor is provided by Thomas Gütle

Taking the overall size of the German property market and the importance of the German economy as investment criteria, a weighting of around 20% for Germany among European portfolios of foreign investors could well be considered appropriate.

However, the actual share of direct and indirect German property investments is typically much smaller, most likely a very low, single-digit percentage. Nevertheless, foreign investors are showing a sustained, strong interest in property investments in Germany.

Although opportunistic investors have largely left the market by now as a result of the sub-prime crisis, demand for the core to value add property segments is set to remain solid. In addition to the currently rather low relative share of such investments, it is the availability of investment opportunities with attractive yield prospects that favour the German property market in a European context.

For institutional investors that have decided to invest in German properties indirectly, the question then arises as to which vehicle is best suited for such an investment. The G-REIT, German Special Funds and Luxemburg Special Funds represent three alternative investment vehicles.

To date, the G-REIT is only a theoretical option. REITs, which have been implemented in 31 countries (according to EPRA figures) so far, are a type of vehicle many foreign institutional investors are familiar with and which are popular for property investments.

One major advantage certainly is their liquidity which, however, requires that their shares are listed on the stock exchange (this does not apply to private REITs) with a sufficient free float. Under such circumstances, the investor is in a position to enter or exit the property market at a reasonable cost in terms of time and financial expenditure.

Theoretically, the G-REIT offers these advantages to foreign investors as well, since it is basically structured in accordance with the same international standards as established REITs in the US, France and the UK. In fact, it could well serve as an ideal vehicle for investments in the German property market.

However, despite the REIT Act, which came into force on 01 January 2007 amid great expectations, a proper German REIT market has not yet evolved. Two companies are currently listed on the stock exchange as G-REITs with a combined market capitalisation of around €647m. Furthermore, the market potential was limited by excluding residential portfolio properties from the REIT Act.

The pipeline that can be derived based on the current German property stock index (Deutscher Immobilien-Aktienindex (Dimax)) in the shape of listed companies that could opt for the REIT status is very thin since the market capitalisation without larger residential property companies such as Gagfah (index share: 21.1%), Patrizia (1.3%) or Deutsche Wohnen (3.2%), which under the current law cannot become REITs, is only €8.2bn.

By contrast, the British market represents a value of around €28bn, and in France, the market capitalisation of Société d'Investissements Immobilier Cotée (SIIC) is about €44.8bn. Moreover, approximately two thirds of the 75 companies included in the Dimax have a market value of less than €100m - and some of them considerably less. This hardly meets the expectations of foreign investors.

The amendment to the German Investment Act makes German Property Special Funds more competitive. The German Property Special Fund (Immobilien-Spezialfonds or ISF) was introduced in 1976 and is exclusively targeted at institutional investors.

Current net fund assets are around €22bn. However, to date, the level of acceptance of the ISF as an investment vehicle among foreign investors has been low, with only around 4% held by foreign investors.

In the past, the main reasons for this included the considerably more restrictive regulations compared with the Luxemburg equivalent, issues of valuation as well as a strong "German-ness" of the documentation. The amendment to the German Investment Act (Investmentänderungsgesetz), which came into force in late December 2007, resulted in a significant liberalisation.

Nevertheless, a direct comparison shows that some provisions have remained comparatively more restrictive in Germany, in particular concerning the use of debt capital and shareholder loans with possible negative effects on yields as well as the range of available investment options. Furthermore, the German regulator still only accepts documents in German, whereas the Luxembourg authority allows the submission of documents in English, French or German.

The German Special Fund is exempt from corporation tax (Körperschaftsteuer) and business/trade tax (Gewerbesteuer), and - contrary to Luxemburg's Fonds Commun de Placement (or "FCP") - is not subject to any further taxes.

Foreign investors are only subject to limited tax liability with respect to their domestic (property-related) income. The tax on capital yield withheld at source - currently 30%; from January 2009 25%, plus solidarity surcharge (a temporary tax to finance German reunification) in each case - can be deducted, resulting in a reduced tax burden to 15% plus solidarity surcharge.

Still, for tax-exempt foreign investors, this is not attractive. While this taxation can be avoided by investing in institutional mutual funds (institutioneller Publikumsfonds), the investor is then subject to the stricter rules governing German mutual funds.

Luxemburg's FCP corresponds to the German Special Fund. They can be launched as a SICAV (Société d'Investissement à Capital Variable) or as an FCP. Since the FCP as a special fund is directly comparable to the German Special Fund, one can simplify the following considerations by including the FCP in the discussion of the Luxemburg Special Fund.

The structure of FCPs and German Special Funds is very similar. Both are subject to regulation by the respective supervisory authorities, auditors and independent experts. In contrast to German Special Funds, a sales prospectus must be prepared for FCPs, which is then reviewed by Luxemburg's supervisory authority, the CSSF. From an investor's perspective, this can be quite positive.

In contrast to the G-REIT, the Luxemburg FCP and the German Special Funds are not listed on the stock exchange. While the German Investment Act (Investmentgesetz) stipulates a return option for Special Funds that can be exercised at any time, there is no such statutory provision for the FCP. However, there is the option of including such a provision in the FCP's statutes.

Like the German vehicle, the Luxemburg Special Fund is exempt from corporation tax and trade tax. However, the FCP in Luxemburg is subject to taxation at an annual rate of 0.01% of the net value of the inventory. Still, the negative impact of this tax on fund performance is generally low. Distributions by the FCP are not subject to withholding tax in Luxemburg.

Luxemburg Special Funds should again prove to be more popular with foreigners. In view of the insufficient market, the G-REIT, while potentially attractive, currently does not represent a real alternative for foreign investors wishing to invest in the German property market indirectly.

Despite the deregulation of German Special Funds, the rival product in Luxemburg continues to have advantages for potential foreign buyers and can therefore be expected to remain the preferred vehicle for this group of investors for the foreseeable future.


Thomas Gütle is Managing Director of Cordea Savills GmbH