The start of the year heralded the adoption of the new U.K. real estate investment trust (REIT) legislation. And with Germany slated to follow suit later in the year, the pace is set toward a better functioning and more global European REIT market.
Holland, Belgium and France have already adopted appropriate legislation to facilitate the growth of the REIT sector. "Now with the U.K. and Germany both joining in, it's a big plus - in property terms you have three of the largest European real estate markets that will be REITs," said Jean-Pierre Husband, a Fitch Ratings analyst.
The potential market for U.K. REITs is huge. The estimated value of U.K. commercial property assets is at GBP650 billion ($1.256 billion), while the residential market is several times larger, said Chris Gibson-Smith, chairman of the London Stock Exchange plc. Based on the volume of assets available, the European Public Real Estate Association (EPRA) projected that the U.K. REIT market would be worth GBP74 billion in 2011, up from GBP42 billion in late 2006.
On the official January launch date of the U.K. REIT market, nine companies became U.K. REITs, including some of the largest and most well-known property companies such as British Land, Hammerson and Land Securities. Several other companies have announced their intention to become U.K. REITs over the next few months.
On the same day as the launch, the new U.K. REITs Index was announced as well. This new benchmark - which was designed to support the development of index-linked products aimed at the broad equity investment market - will allow the performance assessment of U.K. REITs.
But the process of converting into a REIT still differs in every country, and having the three largest players is just the first step towards creating a more unified European REIT market, Fitch's Husband said. He added that, at the moment, the property laws in Europe are still very much fragmented on a country-by-country basis. "It will take time for the harmonization of these markets that will give issuers and investors the ultimate environment for these structures," he added. Harmonization, Husband said, would make tax inefficiencies completely disappear, and taking away this tax burden means creating a more level playing field that would ultimately lead to more liquidity.
REITs and U.K. pubs
As for what impact the new market will have on the securitization market, players said the two products would enhance one another.
Michael Cox, a structured finance analyst at the Royal Bank of Scotland, said that it's been widely speculated that U.K. pubs will take advantage of the legislation this year. Pubs would likely have to separate their exiting business into an operating company structure and any debt outstanding would have to be either redeemed or transferred to the property company structure with the bondholder's consent.
"In practice, we believe that most debt would have to be redeemed given the limited capacity a REIT would have to fund amortization, due to the requirement to distribute 90% of profits as dividends," Cox said. "Hence, while speculation about the potential for pub companies to covert to REITs continues, we see spreads for pub paper remaining tight as investors hang on to paper in anticipation of windfall gains. We expect this to be a continuing theme throughout the year, and move to overweight feeling that the pub sector will continue to outperform."
And CDOs too
The European CRE CDO market is likely to benefit from the inclusion of REITs in the asset pool. RBS analysts said that in the early days of the U.S. CRE CDO market transactions mostly comprised REIT debt and cash CDOs. Merrill Lynch launched its 600 million ($776 million) CRE CDO transaction dubbed Taberna I, which consisted mainly of European REITs and real estate operating companies (REOCs) in December last year.
According to Fitch analysts, for European REITs that have difficulty accessing the capital markets because of minimum size requirements for newly issued securities, the CDO structure might be a more cost-efficient alternative than equity issuance. There is also the greater yield associated with smaller, unrated REITs that appeals to CDO investors.
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