Source: FTSE EPRA/NAREIT Global REITs Index; Date: March 2006
Source: BVI Bundesverband Investment und Asset Management e. V.; Date: April 2006

Above all, institutional investors prefer an internationally standardized investment vehicle that offers real estaterelated services, but does not offer portfolio-related services at the same time. After all, institutional investors cannot and do not want to offer their investors this portfolio-related service. However, open real estate funds are not in the position to invest thematically in one area, for example, only in retail or office real estate. Thus, when investors then shift around their portfolio, e.g. take on more hotel real estate, this inevitably leads to liquidity changes in the fund.

REITs, on the other hand, primarily offer real estate-related services. They are focused on one area – the broader and more mature the market is, the more differentiated are the topics. Thus, an institutional investor who chooses a REIT based on his goals for his own portfolio management can invest thematically differentiated in real estate. Since there is no investment vehicle in Germany that offers purely real estate-related services, we need REITs. Since, on the flipside, many other European countries have no vehicles offering real estate-related services in their markets, they are considering introducing open funds there.

REITs as a solution to the problem of open funds
Open real estate funds and REITs can also complement each other in other ways. The open real estate funds can invest – according to a BVI recommendation – in REITs themselves in order to have access to more fungible real estate investments. This way, they can alleviate the term transformation problem. In fact, in the USA, institutional investors hold the majority of REITs.

A common misconception about REITs is that they invest in higher-risk real estate than do open real estate funds. This is simply not true: open real estate funds do not invest primarily in low-risk real estate, but rather in low-management real estate – in other words, office real estate. REITs, on the other hand, do not invest primarily in high-risk real estate, but in highmanagement real estate, such as retail, residential properties or hotels.

Creating good REITs
Critical to the success of German REITs is their design. The goal must be to maximize REIT market volume, and – related to that – to design a REIT that can hold its own in a European context. The requirement for this is both the freedom to choose between being a public or non-public REIT, as well as being limited to holding properties without offering project development services for third parties with limited real estate dealings.

It is a well-known fact that bankers and real estate specialists have different ways of thinking. When banks run a real estate business, this usually causes problems. Just think back to the WestLB crisis or the Bankgesellschaft Berlin. Nonetheless, the IFD’s recommendations on the development and design of German REITs are written by and for bankers. REITs in Germany – the country with the lowest stock exchange culture – are required to be public.

Furthermore, the German REIT is supposed to be as active as an opportunity fund, and lastly, only those companies who change into a REIT, and then – with friendly support of the investment banks – turn into a public company, will be allowed to enjoy the privilege of an exit tax. A solution for corporate real estate’s ”silent reserves” tax problem should be developed entirely independent from the introduction of REITs.

Non-public REITs
The USA, Australia and Japan are examples for how important non-public REITs are to the overall market. The fact that France and probably Great Britain both will do without non-public REITs has to do with the interests of the existing public real estate companies in both countries: The stock exchange requirement creates a market access barrier for newcomers.

Non-public REITs serve as incubators. Thus, a placeable portfolio can be put together, a track record noted, and the necessary critical size reached. Non-public REITs also promote discipline in the capital market, since companies can threaten to ”go private” (turning a public company into a non-public company) in the case of mismanagement. Non-public REITs are also suitable for mid-sized investors, and offer an interesting opportunity for communal owners of housing societies to partially privatize their company shares. Last but not least, non-public REITs increase competition among investment banks for companies wanting to go public, and are much more attractive to insurance companies and open real estate funds; at least in the beginning phase (immature markets are too volatile).

Do not dilute REITs!
Generally, for institutional investors (such as insurance providers), REITs are only an alternative to directly investing in real estate if they reflect the performance of the real estate themselves, and do not water it down with real estate-related services in an attempt to maximize returns.

Investors can manage their portfolio themselves, and, if they want, can add commercial real estate-related activities – such as management, building, and selling – to the mix by buying the respective values (e. g. Hochtief, Douglas, Metro, Techem, Jones Lang LaSalle) and in the preferred scope. A direct mixture through the management of the REIT merely leads to an excessive mix of activities, all of which must be financed differently. This obscures the ability of the REIT to reflect the performance of the property alone as a finance vehicle.

Conclusion
German REITs do not yet exist. Open real estate funds are fighting with considerable capital outflows in their bottom line, and opportunity funds are buying German real estate. We can only hope that we will soon have good German REITs, and that open real estate funds will overcome their crisis with the help of the investment opportunities offered by REITs. Moreover, hope remains that a professional division of labour will be established between REITs as a real estate-related service provider and open real estate funds as a portfolio-related service provider. We can also hope that opportunity funds will disinvest through REITs.

Then, after we have reorganized the financing side of the real estate market, we can – and should – focus more on real estate itself, actively find answers to questions surrounding the privatization of urban planning, and start dealing head-on with the requirements of the aging society and the increasingly differentiated residential markets.

By Prof. Dr. Ramon Sotelo
Professor Dr. Ramon Sotelo is a Junior Professor for Real Estate Economics at the Bauhaus-University of Weimar.