Don't give up on the G-REIT: we will see IPOs in due course, says Thomas Koerfgen
Not long ago, the media was reporting on the opportunities and risks associated with German REITs almost every day. Expectations were high. However, since they were introduced in March 2007, the hype has subsided. Now occasional voices can be heard pronouncing German REITs dead before they were even born. Why do we only have two listed real estate corporations to date in Germany with REIT status, Alstria Office REIT-AG and the Fair Value REIT-AG? Have all the arguments in favour of introducing G-REITs become obsolete? Warren Buffett once said that "half of the world's wealth is in real estate". This statement by the legendary investor highlights the crucial significance of real estate, not just for the global economy and individual continents and countries, but for everyone. Harry Markowitz, Nobel Prize laureate in Economics and co-founder of modern portfolio theory, also knows the importance of real estate. "A good portfolio is more than a long list of good stocks and bonds. It is a balanced whole, providing the investor with protections and opportunities with respect to a wide range of contingencies". To achieve this, different asset classes need to be combined. This is precisely the problem. Most investors still do not see real estate shares and REITs for what they really are. They are not perceived as a liquid form of the real estate asset class, but as one of many different equities sectors. Most investors do not understand the underlying assets, ie, the real estate held in the portfolio and under development.
The present lack of market acceptance of German REITs is not due to the German REIT legislation - despite the ongoing and thoroughly justified criticism (e.g. the exclusion of residential real estate). Rather, this caution is due solely to the current financial market situation and the resulting investor uncertainty.
Regardless of whether you invest in real estate directly - i.e. by purchasing a property, acquiring units in an open-ended or closed-end real estate investment fund, or investing in listed real estate shares or REITs - the foundations for investment success are the underlying real estate and its current and future value. At present, we are seeing considerable turmoil on the capital markets - not only in Germany, but throughout Europe. The majority of listed real estate corporations and REITs have been very much undervalued for months. Their market capitalisation is in no way representative of their net asset value, ie, the value of the companies' real estate portfolios. Share price discounts of 30% and more on the actual value of real estate holdings are the norm rather than the exception.The chart, which compares the FTSE EPRA/NAREIT UK Index with the Index members' published net asset values (NAVs) shows the extent to which the capital markets have decoupled from companies' net asset values in historical terms, too.The FTSE EPRA/NAREIT UK Index comprises a substantial proportion of the real estate corporations and REITs in the UK and represents a total market capitalisation well in excess of €30bn. The net asset value (NAV), which represents the market value of a company's real estate less its liabilities, is the prime consideration in analysing and valuing the real estate portfolios in question. The chart clearly shows the current discrepancy between the companies' intrinsic value, ie, the NAV, and their external value, as illustrated by their market capitalisation. Although the average NAV discount on the British real estate equity and REIT market has been significantly less than 20% in the period from 1989 to the present day, the figure at the end of May was 35%. We are seeing similar ratios both with other European real estate corporations and REITs and with the small number of listed German companies.
There is a simple explanation for the absence of further IPOs: since the markets currently do not appropriately and fairly measure the actual value of real estate portfolios held by those corporations and REITs that are already listed, why should the situation be any different for companies and REITs that are planning on going public? Why should a company go public in the current market phase if its real estate portfolios would trade at a significant discount? In addition, the small number of investors specialising in real estate and real estate equities have struggled in recent months with outflows of funds, which have forced them to divest portions of their portfolios. A REIT wanting to go public naturally has an interest in reporting the value of its real estate portfolio as accurately as possible - something that is both understandable and justified. However, investors would need to sell shareholdings to generate the cash needed to make new investments. To do this, undervalued companies would have to be sold to invest in fairly priced shares issued by a new REIT. This makes no sense in market phases such as these, in which companies are being traded at discounts of more than 30% of their NAV in some cases. Historically there have always been times when companies' NAVs across all industry sectors have been out of step with their share prices, be it positively or negatively. All these misvaluations have corrected themselves again over time. Such a correction is also expected for real estate corporations and REITs in the medium to long term, after which we will see the IPOs of German REITs we have been looking for. The German real estate market, which until now has been dominated by closely held real estate investments, will in the long term achieve the international significance expected from it as the world's third-largest real estate market. The markets will learn and, over time, will see REITs for what they are: the liquid form of the real estate asset class.
Thomas Koerfgen, managing director and head of real estate equities at SEB Asset Management, Frankfurt
