Comparison of Reits in US-UK-Germany

Electronic copy available at: http://ssrn.com/abstract=1647484

This is the last in a series of four articles, in whichthe authors compare specific aspects of the realestate investment trust (REIT) regimes in theUnited States, the United Kingdom andGermany. Previous articles dealt separately withthe REIT regimes in each of these countries.

1. Introduction

The United Kingdom1 and Germany2 have recentlyenacted legislative regimes setting up entities known asreal estate investment trusts (REITs), with the intentionof encouraging indirect investment in real estate in thosecountries. The United States3 has had a REIT regimesince the 1960s and was, in many respects, a model forthe UK and German regimes. However, both of the newregimes diverged from the US example and, indeed, fromeach other, in a number of ways. It is often difficult toguess at the reasons why national legislators choose oneparticular option over another, but this article considersthe differences in national circumstances that mighthave led to the three countries enacting (or, in the case ofthe United States, continuing to use) different REITmodels. The article also evaluates the advantages anddisadvantages of certain features of each regime, andspeculates about the future of REITs.Many jurisdictions have regimes that they call “REITregimes”, but this uniform designation perhaps obscuresthe many differences between national regimes. “REIT” isnot a legal term of art in the same way that, for example,“company” is. Company law differs from country tocountry, but the essential elements of companies are thesame across jurisdictions. Companies all have legal per-sonality separate from their shareholders and actthrough their directors. Their permitted activities arelimited by their articles of association and relevantstatutes. No such general statements can be made aboutREITs: REITs take many legal forms and, in spite of theirname, are not necessarily trusts. To be considered a REIT,a vehicle must invest primarily in real estate and begranted tax advantages for doing so, but, broadly speak-ing, all other characteristics of REIT regimes are up tothe discretion of the country concerned. Most nationallegislatures try to design REITs so that they mirror thetax effects of investing in real estate directly, but themechanisms used to achieve this aim vary considerably.

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2. Comparison of Features of US, UK andGerman REITs

2.1. The stock listing requirementThere are a number of requirements that feature inmany, but by no means all, REIT regimes. The require-ment that REITs be listed is an example: when the UnitedKingdom and Germany enacted REIT regimes in 2007,the legislators in both countries decided that REITsshould be listed on a stock exchange. This approach con-trasts to the approach taken in the United States, wherethere is no such requirement, and the decision conse-quently faced considerable criticism from within the twocountries. In the United States, unlisted REITs are anestablished part of the real estate investment market. TheNational Association of Real Estate Investment Trusts(NAREIT) estimates that one third of US-REITs are pri-vate.4 Similarly in Australia, with the world’s second-largest REIT market, as well as Japan, with its still youngbut very successful REIT structure, both public and pri-vate REITs are permitted and operate successfully.Beyond the fact that a listing requirement is in itselfcomparatively restrictive, the specific characteristics ofthe listing requirements adopted by the United Kingdomand Germany appear to be unusually strict. UK-REITsmust be listed on a “recognized stock exchange” – a def-inition that excludes the United Kingdom’s AlternativeInvestment Market (AIM). The AIM is a sub-market of

* Dipl. jur., University of Augsburg, LLM Victoria University ofWellington, and Rechtsanwältin (attorney at law). The author can be con-tacted at [email protected].** BA, LLB (Hons) Auckland, BCL Oxon, JSD Cornell, Inner Temple,Barrister, Professor and former Dean of Law, Victoria University ofWellington, and Senior Fellow, Taxation Law and Policy Research Insti-tute, Monash University, Melbourne. The author can be contacted [email protected].*** BA (Hons), LLB (Hons) Victoria University of Wellington, LLMColumbia, and Analyst, New Zealand Treasury. The author can be con-tacted at [email protected].

1. Nicola Fritsch, John Prebble and Rebecca Prebble, “Real Estate Invest-ment Trusts in the United Kingdom”, Bulletin for International Taxation 5(2010), pp. 259-270.2. Nicola Fritsch, John Prebble and Rebecca Prebble, “Real Estate Invest-ment Trusts in Germany”, Bulletin for International Taxation 6 (2010), pp. 320-329.3. Nicola Fritsch, John Prebble and Rebecca Prebble, “Real Estate Invest-ment Trust Regimes Viewed Through the Lens of the US Paradigm”, Bulletinfor International Taxation 4 (2010), pp. 211-223.4. NAREIT, available at www.reit.com. The authors follow the industryconvention of distinguishing national REITs in different countries by the ini-tials of the country they are in. Accordingly, a REIT from Germany is a G-REIT, one from the United Kingdom, a UK-REIT, and one from the UnitedStates, a US-REIT.

A Comparison of Selected Features of RealEstate Investment Trust Regimes in the UnitedStates, the United Kingdom and Germany

Nicola Fritsch*, John Prebble**and Rebecca Prebble***International, United States, United Kingdom, Germany

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Electronic copy available at: http://ssrn.com/abstract=1647484

the London Stock Exchange and was designed with theobjective of giving smaller companies the opportunity tofloat their shares under a less restrictive regulatory sys-tem than the main market. For example, unlikecompanies listing on the main London Stock Exchange,they do not have to provide a financial track record ortrading history.5 The UK property industry had beenlobbying for an amendment that would allow REITs tobe listed on the AIM, as a compromise position insteadof private REITs. The ability to list on the AIM wouldfacilitate entities’ conversion to REITs and, therefore, alsohopefully encourage residential REITs6 because the poolof potential companies that can convert to REIT status iscurrently very small and would most likely becomelarger with a more generous rule regarding stock listing.7

Currently, property companies that wish to convert toREITs and are already listed on the AIM must seek stocklisting with a “recognized” stock exchange. The compli-ance obligations involved with seeking a second listingmight well discourage otherwise eligible companiesfrom becoming REITs.The lack of a requirement that US-REITs be listed is par-tially credited with the success of the US REIT industryin the 1990s. No listing requirement meant that special-ized REIT structures such as UpREITs could be created,8

and trusts, partnerships and private property companiescould transition easily into the publicly listed REIT sec-tor.9 This development contributed to the US REIT mar-ket starting to boom in the early 1990s.10 An AIM listingcould be an option for investors holding few propertyassets to transfer property to a REIT, as well as for smallREIT start-ups to obtain a full listing at a later stage, oncethey are established.11

Whilst the German REIT regime also requires thatREITs be listed, it is perhaps more flexible than the UKregime, in that an entity wishing to become a G-REITcan gain “Pre-REIT” status and enjoy tax privileges inrelation to the transfer of properties to the entity prior tostock listing.12 Considering the effort typically involvedin obtaining stock listing, this allowance seems reason-able. In contrast, UK law provides that the entity has tosatisfy the listing requirement already at the time ofnotice to join the UK regime.13 This requirement wouldbe difficult for newly established companies to complywith. Accordingly, it seems reasonable to interpret therule in a way that the entity is required only to affirm thatit reasonably believes that it will meet the conditionwhen actually joining the regime.14

One of the justifications for a mandatory listing require-ment is the greater initial as well as ongoing disclosurerequirements and market scrutiny that public companiesface under capital markets law.15 Increased disclosureand reporting requirements, in turn, provide a higherlevel of investor protection.16 Investor protection was aparticular priority for the UK and German governmentsdue to recent scandals in real estate investment markets.Considering the crisis in global financial markets thatdirectly followed the introduction of both regimes,investor protection is likely to increase in importance.

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Investor protection is also likely to be an ongoing con-cern for Germany, in particular, because, under the G-REIT regime as it currently stands, G-REITs are notsupervised by the German financial supervisory author-ity (Bundesanstalt für Finanzdienstleistungsaufsicht). Thestock exchange effectively takes the place of a govern-ment regulator as far as G-REITs are concerned. In theUnited States, institutional investors appear to favourpublic REITs due to the higher level of transparency,17 sothere is perhaps some justification for reliance on listingas a governance tool. Listed vehicles also tend to providea higher level of liquidity than unlisted structures. Fur-thermore, at least in the case of Germany, the legislatorsreasoned that the German market did not need a newunlisted vehicle held only by a small number of (institu-tional) investors, since the open real estate fund fulfilledthis function.18 The UK legislators, who wished to intro-duce a vehicle distinct from already existing forms ofindirect real estate investment (in particular, unlistedopen-ended investment companies), took similar con-cerns into consideration.19

Another possible benefit of listing on a stock exchange isthat it can help to ensure that small investors – one of themajor target groups of the new vehicle – get the widestaccess possible.20 However, it is questionable whether alisted vehicle necessarily attracts more interest on thepart of small investors than an unlisted structure. In theUnited Kingdom, listed vehicles offering investments inasset portfolios by pooling money (in particular,approved investment trust companies) have tended toattract less interest from retail investors than theirunlisted counterparts, such as open-ended investmentcompanies, although investment trust companies havebeen present in the market for some time.21 The phe-nomenon suggests that the objective of making REITs

5. Id6. Freshfields Bruckhaus Deringer, “UK-REITs: an Updated Guide to theNew Regime” (December 2006, available at www.freshfields.com), p. 1.7. Savills L & P Limited, “REITs and Residential Investment”, available atwww.reita.org.8. An earlier article of the authors described the various REIT structuresthat began to appear in the US market in the late 1980s and early 1990s. SeeFritsch, Prebble and Prebble, supra note 3, 4.10.-4.12.9. Jack H. McCall, “A Primer on Real Estate Trusts: The Legal Basis ofREITs”, 2 Transactions: The Tennessee Journal of Business Law (2001/02), 1, p. 8.10. Savills L & P Limited, supra note 7.11. Id.12. Sec. 2 G-REIT Act.13. Secs. 106(1) and 109(1) Finance Act 2006.14. Freshfields Bruckhaus Deringer, supra note 6, p. 5.15. HM Treasury and Inland Revenue, “Promoting More Flexible Invest-ment in Property: A Consultation” (March 2003, available at www.hm-treasury.gov.uk), Para. 2.1.0. See also Andrew Petersen, “The Major Issues Fac-ing the Successful Introduction of the UK REIT”, Briefings in Real EstateFinance, Vol. 4, No. 1 (2004), pp. 8-9.16. German Bundestag Commentary on the G-REIT Bill BT Drs 16/4026,p. 15.17. Petersen, supra note 15, p. 9. Although this preference for public REITscould be due to other factors, such as greater fungibility of units.18. German Bundestag Commentary on the G-REIT Bill BT Drs 16/4026 8,p. 15. A previous article by the authors describes the vehicles that were avail-able for real estate investment in Germany prior to the introduction of theREIT. See Fritsch, Prebble and Prebble, supra note 2, 3.19. HM Treasury and Inland Revenue, supra note 15, Para. 2.9.20. Id., Para. 2.8.21. Id., Para. 2.10.


available to small investors could also have beenachieved through an unlisted structure, similar to theexisting authorized unit trusts and open-ended invest-ment companies, which are well established and, more-over, a product that small investors are already familiarwith.22 The listing requirement also means that existinglimited partnerships or unit trusts are hindered fromconverting to REITs directly. Collective offshore vehiclesare, in particular, unlikely to consider converting to aREIT to be an attractive option.23

Although unlisted vehicles are not subject to the samelevel of publication and disclosure requirements as listedvehicles, unit prices are regularly published and investorsare provided with a reasonable level of liquidity throughthe obligation to redeem units.24 In order to achieve suf-ficient protection for investors, one possible approachmight be to implement a number of restrictions into theregime governing unlisted REITs, for example, to ensurethat only “sophisticated” investors have access to thisinvestment option.25

The German Association of Independent Real Estateand Housing Companies (Bundesverband freier Immo-bilien- und Wohnungsunternehmen e.V., BFW) presenteda number of strong arguments in favour of unlistedREITs in a discussion document on the “Importance ofnon-stock exchange-traded REITs for the success ofREITs in Germany” (“Bedeutung von nicht-börsengehan-delten REITs für den Erfolg von REITs in Deutschland”).26

According to the BFW, there is room in the German mar-ket for a private REIT vehicle for indirect real estateinvestment alongside the existing ones and complemen-tary to the listed REIT; both in terms of market volumeand the potential competitive market position that sucha structure might have on the national as well as Euro-pean stage. The existing market in property building anddeveloping is partly dominated by small and medium-sized companies.27 In this respect, the option of a privateREIT might open up new opportunities. Especially forsmaller companies, it can be particularly difficult to gainaccess to stock markets, not least due to the high costsinvolved and considering that initial public offering nor-mally costs around EUR 300 million.28 Private REITs,with their regional and property-type-related specializa-tions, would be an asset class different from open realestate funds.29 Closed real estate funds, which are cur-rently the most important investment vehicles for realestate investment on the German market, could be trans-ferred into private REITs. This would be an importantstep towards more transparency and professional man-agement and fungibility for this sector; a step that doesnot seem possible with only public REITs on the market.If entities are given the free choice whether and when togo public, they can more thoroughly prepare their realestate portfolios, position themselves on the market,avoid unfavourable price cycles on capital markets andthen go public once they feel ready for the capital mar-ket.30

Private REITs are certainly an option worth consideringfor the UK and German markets, thereby combining the

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advantages of a tax-transparent clear-cut investmentvehicle with the simplicity of an unlisted vehicle. Ofcourse, unlisted REITs would need to be subject to thesame regulatory, disclosure, and publication require-ments as public REITs if they hope to attract the samecalibre of investors. Alongside the public REIT, the pri-vate REIT could provide certain investors with a choiceand perhaps a more flexible alternative investment vehi-cle with advantages over the public REIT.31 Private REITscould moreover serve as important vehicles for entitiesin the stage prior to going public as well as pose an alter-native to popular offshore structures. On the interna-tional stage, giving investors the free choice between aprivate and public REIT has been an important factor formarket efficiency and performance.32

2.2. REITs and investments in residential propertyThe US REIT regime contains no restrictions on REITsinvesting in residential property and consequentlyinvestments in residential properties are an establishedpart of the US REIT market. In 2007, the residential sec-tor was among the top-three sectors within the NorthAmerican region, amounting to about 17%.33 In theUnited States, REIT institutional investors have beenentering the residential market in increasing numbers.This development is generally considered to be positive,as allowing for better maintenance and renewal of prop-erties as well as for more efficient property manage-ment.34

In spite of the success of US-REITs in residential prop-erty markets, the German legislators decided not to allowG-REITs to invest in residential property built before2007 (2007 being when the German REIT regime wasenacted). Germany has a relatively large percentage ofpeople living in private and communal rental housingcompared to elsewhere in Europe.35 Around 15% – 3.1million apartments – of the total rented housing is heldby public and communal housing companies.36 Becauseof these statistics, some feared that the introduction ofREITs might have unwelcome effects for tenants andinterfere with public-sector social and sustainable hous-

22. Id., Paras. 2.12 and 2.13.23. Savills L & P Limited, supra note 7.24. HM Treasury and Inland Revenue, supra note 15, Para. 2.12.25. Petersen, supra note 15, pp. 9-10.26. Ramon Sotelo et al., “Bedeutung von nicht-börsengehandelten REITs fürden Erfolg von REITs in Deutschland”, BfW, available at www.reits-in-deutschland.de.27. Id., p. 2.28. Id., p. 6.29. Id., p. 3.30. Id., p. 6.31. Petersen, supra note 15, pp. 9-10.32. Sotelo et al., supra note 26, p. 7.33. Ernst & Young,“Global REIT Report 2007” (October 2007, available atwww.reita.org), p. 71.34. HM Treasury and Inland Revenue, supra note 15, Para. 1.1.3.35. Bundesamt für Bauwesen und Raumordnung, “Comparison ofApproaches to Housing Policy in EU Countries”(November 2005, available atwww.bbr.bund.de).36. German Bundestag Commentary on the G-REIT Bill BT Drs. 16/4026,p. 18.


ing policies and urban development.37 One particularworry was that rents might rise, based on the assumptionthat REITs’ main concern would be to maximizeprofits.38 However, these concerns do not appear to befully justified, since German residential tenancy laws aresufficiently strong that residential G-REITs are unlikelyto be able to raise rents much, even if they wanted to.Germany’s attitude towards the possibility of REITsinvesting in residential property contrasts with theUnited Kingdom’s, which does not restrict REITs frominvesting in residential property. The United Kingdomsaw REITs as having potential to help “address the prob-lem of the provision of affordable housing including forkey workers in areas of high house prices”,39 whereas theGerman government feared that REITs might cause asteady increase in rents and a decline in affordable hous-ing.Both the UK and the German residential housing sectorsdiffer from the North American one. In the United King-dom, investments in the private rented and residentialproperty sector have increased in recent years, leading toa significant expansion in the “buy-to-let” market.40 Evenso, over 70% of privately rented housing remains in thehands of landlords who manage only a small number ofproperties.41 Consequently, there initially might be fewpotential properties suitable for institutional REITinvestments on the market in the short term. In thelonger term, however, specialized residential REITs areexpected to develop newly purpose-built rental flats inlocations of high demand. Different REIT structures arealso expected to emerge due to this, with institutionalinvestors entering the market, smaller companies mer-ging or, in the best possible scenario, even facilitatingaccess for small companies to the REIT market.42 Unlikethe German experience, the UK government at an earlystage saw REIT investments as a means to increaseinvestments by institutional investors in the residentialsector, 30% of which comprises the private rented andsocial housing sectors.43

Considering that no other county seems to haveimposed restrictions on investments in residential prop-erty, it is questionable whether the concerns of Germanlegislators are justified. During the development of theUK REIT regime, some even suggested introducing anobligatory requirement that REITs hold a certain per-centage of their assets as residential property.44 Accord-ing to the discussion document produced by the BFW,there is no evidence of a conflict between a REIT’s policyobjectives and Germany’s socio-economic objectives.45

Large stocks of apartments held by communal bodieshave been suffering from a lack of maintenance and littleeffective management. These apartments could be soldto REITs; thereby not only providing länder and commu-nities with extra funds, but also avoiding furtherexpenses caused, for example, through cost-intensivedemolitions of inefficient and rundown buildings.46

Contrary to the concerns of interest groups and the Ger-man legislators, experiences with private equity invest-ments in residential property and residential REITs in

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other countries have tended to show positive effects fortenants through professional management, and moreefficient cost structures and maintenance.47

Similarly, fears of rising rents due to luxury renovationsor profit-maximizing business strategies do not seem tobe justified. In practice, institutional investors tend to beat least as cooperative and understanding as amateurlandlords, with a willingness to draft contracts to excluderent increases, lease terminations and the resale of theproperty or luxury renovations for a certain period oftime.48 But even without these kinds of safeguardingcontractual agreements, tenants are well protected underGerman landlord and tenant law, which is one of theworld’s most comprehensive and favourable as far as ten-ants’ rights are concerned.49 Sec. 559 of the German CivilCode (Bürgerliches Gesetzbuch, BGB) limits rentincreases in cases of modernization to 11% annually.Moreover, only costs of modernizations increasing the“utility value of the leased property” – a term thatexcludes the costs of luxury modernizations – can bepassed on to tenants. A landlord may increase the rent upto the level of the reference rent that is customary in thelocality concerned,50 but only if there have been no priorrent increases within the last 15 months and the rentincrease does not exceed 20% within the last three years.These aspects of the comprehensive tenancy law frame-work under the BGB suggest that tenants are not likely tobecome deprived of any rights if their property is takenover by a REIT. The BGB provides sufficient protectionfor tenants and there seem to be no rational reasons forexcluding residential property as an investment target.Compared to the sale of residential properties to privateequity funds, which is already common practice,51 thesale of property to a REIT might even be the moresocially advantageous alternative, considering thatREITs’ investments tend to be longer term than those ofprivate equity funds. Perhaps incongruously, there are norestrictions under German law preventing foreign REITsfrom investing in German residential property. Barringonly German REITs from residential property invest-

37. Id.38. Id. and Deutscher Mieterbund, “Wohnungspolitk muss MieterinteressenBerücksichtigen” (November 2006, available at www.mieterbund.de).39. HM Treasury and Inland Revenue, supra note 15, Para. 1.13.40. Id., Para. 1.11.41. Id., Paras. 1.11 and 2.43.42. Savills L & P Limited, supra note 7.43. Kate Baker, “Review of Housing Supply: Securing our Future HousingNeeds (Interim Report to the United Kingdom Government)” (2003, availableat www.hm-treasury.gov.uk).44. HM Treasury and Inland Revenue, supra note 15, Para. 2.44.45. Sotelo et al., supra note 26, p. 2.46. Guido Eusani, “Regierungsentwurf zum Real Estate Investment Trust-Gesetz (REIT-Gesetz) – nur eine kleine Lösung”, Neue Zeitschrift für Miet- undWohnungsgrecht (2007), p. 72.47. Id., p. 73.48. Id., p. 72.49. Michael Voigtländer, “Mietwohnungsmarkt und Wohneigentum: ZweiSeiten einer Medaille” (November 2006, available at www.hypverband.de).50. Sec. 558 BGB.51. Oliver Puhl, “Deutsche Wohnungen im Focus internationaler Investoren– Dritte Welle von Investoren drängt auf den Markt”, Special Edition G-REITs(Wolfratshausen: Going Public Media AG, 2006), p. 88.


ments seems inconsistent with the aim of ensuring com-prehensive protection of the residential tenancy marketif foreign REITs can invest in communal and socialhousing freely.The German government might, therefore, consider thathalf of German property holdings are in residential realestate, leaving a considerable amount of dead capital thatcould be better used.52 If Germany continues to restrictREITs’ access to the residential property market, it mightfind that German companies begin to establish REIT-like structures that formally do not have REIT status,53

via holding structures on foreign markets,54 to circum-vent German restrictions. Instead, Germany shouldensure that the G-REIT is internationally competitive toprevent more German real estate landing in the hands offoreign REITs, a process that has already started – forexample, in 2006, 40,000 apartments were taken over bya French REIT, listed on the Paris stock exchange.55

Unless German REITs are permitted to participate in theresidential property market, it is hard to see how theywill become competitive with international REITs.It is worth remembering, however, that simply permit-ting REITs to invest in residential property does notensure that they will do so. The United Kingdom hopedthat UK-REITs would invest in residential property, butto date there are no residential REITs in the United King-dom.56 Opinions on why there is institutional reluctanceto invest in residential property differ, with some blam-ing the fact that yields from residential property in theUnited Kingdom have historically been low and suchinvestments require considerable administrative effort.57

Others, however, blame defects in the UK-REIT regimeitself, in particular, the application of stamp duty landtax.58 Whatever the underlying reasons, the failure ofUK-REITs to move into residential property investmentis regarded by many as an indication of overall poordesign of the United Kingdom’s REIT regime.

2.3. Gearing restrictionsAlthough there are no gearing restrictions in the USREIT regime, both the UK and German legislators choseto impose borrowing limits on REITs when designingtheir own regimes. The G-REIT’s leverage is limited to55% of the value of its immovable property. The UKregime indirectly limits gearing by imposing a tax chargeif the finance cover ratio falls below 1.25. The UnitedKingdom’s reasoning was that REITs should not be bur-dened with high debt servicing costs that would reduceprofits and result in fewer potential distributions toinvestors,59 thereby transferring returns from incomeoriented to capital oriented.60 The intention was to createa structure different from that of an ordinary propertycompany,61 as well as to ensure that REITs maintainedsufficient financial power and stability. The gearingrestrictions set out under the UK and German regula-tions lie significantly below the level of less risk-averseprivate equity funds, which are typically 90% to 95%leveraged.62

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Although these concerns are reasonable in one sense,gearing is an important and necessary capital source forany kind of company on the market. For REITs, somelevel of borrowing seems essential to be able to acquirenew properties and to meet unforeseen liabilities with-out having to hold large cash reserves.63 Considering thatreal estate requires ongoing maintenance, servicing andrefurbishment, imposing gearing restrictions might hin-der the effective and dynamic management of REITs andtheir potential projects.64

Gearing restrictions should also be considered in thecontext of the distribution requirements REITs in allregimes must comply with. The rule that a REIT mustdistribute around 90% of its income to its shareholdersleaves the vehicle with few net proceeds and little finan-cial scope to manoeuvre. Consequently, if REITs arerestricted in their borrowing power, the capital marketsare their only viable source of finance, through increasesin share capital and private or public stock offerings.65

Raising money in this way can be costly and is not alwaysin the interests of existing shareholders.66 The issue iseven more acute in the context of the current economicdownturn, where REITs are finding themselves instraightened circumstances. The United Kingdom hasfaced criticism from the property industry for its failureto relax the gearing ratio or take other measures to helpREITs.67

In practice, the average debt ratio of REITs in the UnitedStates has generally been below 55% for much of the lastdecade and around 65% of REITs are rated investmentgrade, which is also due to their relatively moderateleverage levels.68 Accordingly, in spite of the fact that

52. Sibeth Partnerschaft, “Legislation – Optimistic Start for G-REITs?”, avail-able at www.sibeth.com.53. On synthetic REITs in general, see Volkert Volckens, “Der SynthetischeREIT – Mehr Als Nur Plan B?”, Beiten Burkhardt RechtsanwaltsgesellschaftmbH (November 2006, available at www.deutsche-boerse.de).54. Eusani, supra note 46, p. 71.55. “Franzosen kaufen 40 000 Wohnungen”, Die Welt (6 October 2006). Seealso Peter von Barkow, “Der G-REIT aus Kapitalmarktsicht – Die Strukturentscheidet über den Erfolg”, Special Edition G-REITs, supra note 51, p. 68.56. United Kingdom House of Lords Select Committee on EconomicAffairs, “The Finance Bill 2009” (Third report of session 2008-2009), 23 June2009, Para. 258.57. Id., Para. 263.58. Id., Para. 261.59. Guidance GREIT 02200.60. HM Treasury and Inland Revenue, supra note 15, Para. 2.3.1 and Euro-pean Public Real Estate Association (EPRA), “EPRA Global REIT Survey”(August 2007, available at www.epra.com).61. HM Treasury and Inland Revenue, supra note 15, Para. 2.3.1.62. German Bundestag Commentary on the G-REIT Bill BT Drs. 16/4026,p. 23.63. HM Treasury and Inland Revenue, supra note 15, Para. 2.3.2.64. Petersen, supra note 15, pp. 9-14.65. Id. McCall, supra note 9, p. 5; and HM Treasury and Inland Revenue,supra note 15, Paras. 2.3.2 and 2.3.3.66. Petersen, supra note 15, pp. 9-14.67. United Kingdom House of Lords Select Committee on EconomicAffairs, “The Finance Bill 2009” (Third report of session 2008-2009), 23 June2009, Para. 250.68. NAREIT, “The Investors Guide to Real Estate Investment Trusts (REITs)”(2009, available at www.reit.com), p. 3. The gearing ratios of a number ofREITs have increased significantly over the last 18 months, however, inresponse to market pressures. See Larry Light, “Cracks in the REIT Rally’sFoundation”, Wall Street Journal (5 September 2009, available atwww.wsj.com).


there is no restriction on gearing under the US regime,US-REITs tend to have made moderate rather thanexcessive use of debt financing. They are, nevertheless,free to have a high leverage if needed to finance propertyacquisitions or other necessary investments. As far asinvestors are concerned, they can choose whether theywish to invest in a more or less risk and cost-adverseREIT, as long as they are aware of the REIT’s leveragingpractices and debt servicing costs involved.Worldwide, permitted gearing levels for REIT structuresvary significantly. However, in many countries, there areno borrowing restrictions imposed on the vehicle, as isthe case with the successful and established Australianand Japanese REITs.69 Given these international exam-ples, it seems likely that the UK and German REIT mar-kets could benefit from a less restrictive position ongearing.

2.4. Exit tax and entry chargesThe United States, the United Kingdom and Germanyhave each taken distinct legislative positions regardingthe tax consequences of transferring assets to REITs. Inthe United States, there is generally no tax-privilegedtreatment for the transfer of property to a REIT or theconversion into a REIT. “Built-in gains” are subject tocorporate income tax, as are other kinds of capital gain.70

An exemption may apply if the REIT concerned holdsthe assets in question for at least 10 years, i.e. if it doesnot sell them or enter into any other kind of taxabletransaction with those assets during that time.71

Both the United Kingdom and Germany have chosennot to follow the approach of the US model. They wereanxious to ensure that their respective REIT regimes didnot produce an overall loss in tax revenues for the state.72

Under the UK regulations, built-in gains realized on thetransfer of property are tax-free. However, there is a 2%flat tax conversion charge on the market value of theproperty rental business assets. In Germany, by contrast,the conversion into a REIT or sale of properties to aREIT always constitutes a taxable event. However, thereis a 50% tax reduction (exit tax) for the gain realized onthe transfer. This privilege was limited until 1 January2010 and is subject to further restrictions.73

The tax treatment of built-in gains set free on the trans-fer of property to a REIT or conversion of an entity intoa REIT is an important aspect of all REIT regimes. TheUS experience has shown that the taxes arising on con-version deterred companies from directly convertinginto REITs. Instead, practitioners developed advancedstructures that allowed for a tax-free or tax-deferredtransfer of property. The introduction of the UpREITstructure, which gave investors a way to avoid taxationon built-in gains, led to a significant revival of the REITmarket in the 1990s.74 No corresponding structures havebeen developed in Germany or the United Kingdom, butthis is perhaps not surprising given the relatively recentintroduction of these regimes and the global recessionthat immediately followed their introduction.

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The US experience might lead to questioning whetherthe German and UK exit tax and entry charge were set atsufficiently low levels so as not to discourage potentialinvestors from transferring property to REITs. Too oner-ous a charge discourages existing property vehicles fromconverting to REITs and investors from transferringproperty to a REIT,75 although the UK and German legis-lators are presumably well aware that too low a chargecreates a way for entities to dispose of built-in gainswithout giving rise to taxable events. With these con-cerns in mind, the UK entry charge seems to have beenset at a relatively low and reasonable level. France, forexample, set a 16.5% exit charge on latent capital gains onproperties transferred to REITs.76 The French charge is a50% tax reduction on the capital gains tax normallypayable on the transfer of assets.77 In the United King-dom, however, industry bodies called for a total taxexemption on capital gains released on conversion toREIT status. The motivation for suggesting such a gener-ous rule seems to have been a feeling that any tax charge,however minimal, might prevent offshore vehicles fromreturning.78

The German entry charge, on the other hand, could per-haps have been set lower. A 50% tax reduction for capitalgains realized on conversion is certainly within the rangeof reasonableness, but it is worth noting that during theconsultation period in the United Kingdom, practition-ers had considered a tax amounting to around 10% ofembedded capital gains reasonable.79 It remains to beseen how innovative practitioners will be in developingmore advanced REIT structures that reduce the tax bur-den for investors.Which out of the UK and German approaches is mosteffective, in practice, probably depends on the specificcircumstances of each market. The more built-in capitalgains potential REITs have, the more favourable theUnited Kingdom’s flat 2% entry charge on the propertyrental business assets seems. In any case, the three-yeartransition period granted by the German legislators inproviding for a reduced exit tax seems short, given thatthe REIT market will need several years to develop. Thisprojection seems particularly true in the light of recentevents in the global real estate market, which will delaythe full development of new REIT industries for sometime. Full taxation on conversion or transfer of property

69. HM Treasury and Inland Revenue, supra note 15, Table 2.1.70. Built-in gains are gains from the appreciation of property that must berecognized on conversion to a REIT.71. EPRA, “EPRA Global REIT Survey” (December 2008, available atwww.epra.com), p. 250.72. HM Treasury and Inland Revenue, supra note 15, Para. 4.5.73. Sec. 3 Income Tax Law (Einkommensteuergesetz).74. McCall, supra note 9, p. 8.75. Berwin Leighton Paisner & DTZ Group, “Promoting More FlexibleInvestment in Property (Joint Submission to HM Treasury & Inland Rev-enue)” (2004, available at www.blplaw.com), Para, 2.17 and Petersen, supranote 15, p. 11.76. EPRA, supra note 60, p. 27.77. HM Treasury and Inland Revenue, supra note 15, Para. 4.5.78. Id.79. Berwin Leighton Paisner & DTZ Group, supra note 75 and Von Barkow,supra note 55, p. 77.


to a REIT certainly deters potential investors if at leastsome postponement of the tax or relief is not grantedunder specific circumstances.80

2.5. Taxation at the corporate levelUnder Germany’s REIT regime, all income and capitalgains are exempt from corporate or trade income taxes,irrespective of whether the income stems from realestate-related sources or not. In contrast, UK-REITs arenot totally exempt from corporate and trade income taxsimply by virtue of being REITs; rather, only the profitsthat stem from their property rental business are tax-free.81 All other income, including income from a REIT’sinterests in other REITs, is fully taxable.82 This differencein tax treatment means that UK-REITs have more free-dom to engage in secondary activities related to realasset management than G-REITs. At the same time, how-ever, the income from those activities of a UK-REIT isfully taxable.83 The fact that non-property rental incomeis not tax privileged in any way might encourage UK-REITs to engage primarily in property rental business,which was after all the United Kingdom’s aim in intro-ducing a REIT regime.84

In the United States, dividends that are distributed toshareholders are deducted when calculating a REIT’sincome.85 All retained income and capital gains are sub-ject to corporate income tax. The downside of thisapproach is that it encourages the entity to distributemore of its income than is legally required to take advan-tage of the tax privilege. US-REITs are, therefore, disin-clined to hold cash reserves, which may become prob-lematic if unforeseen circumstances arise.The German REIT regime offers the most comprehen-sive tax exemption at the entity level, totally and person-ally exempting G-REITs from corporate and tradeincome tax. The German approach is, perhaps, preferableto the UK one, which makes the tax exemption depend-ent on the type of activity the income stems from.86 Dis-tinguishing between two types of REIT income unneces-sarily complicates the already complex tax regimes forUK-REITs and their managers. At the same time, how-ever, it is difficult to assess which method of entity taxa-tion is better overall as this question is closely tied withthe policy objectives of the particular national regime.87

2.6. The distribution requirementOne of the core requirements of any REIT regime is thatREITs must distribute most of their profits to sharehold-ers. REIT regimes aim to allow small investors theopportunity to invest in real estate in a similar way tolarge investors who are able to invest directly. Accord-ingly, a key component of any regime must necessarily bea requirement that the indirect investment vehicle actu-ally pays out its profits to its shareholders regularly. Con-sequently, the US, UK and German REIT regulationsrequire REITs in each country to distribute the lion’sshare of their income to shareholders. In return for doingso, they receive a tax exemption (this quid pro quo is

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most literally true of US-REITs, which may deduct dis-tributions to shareholders from their taxable income).The three regimes share an underlying philosophy, butthe manner in which they put this philosophy into prac-tice differs. In particular, there are differences as to thescope and type of income that has to be distributed. Ger-man REITs, which are tax exempt regardless of thesource of their income, must distribute 90% of their totalnet income.88 In contrast, REITs in the United Kingdomare required to distribute 90% of only their tax-exemptincome from property rental business. They are notrequired to distribute any particular percentage of theirincome that does not enjoy tax privileges. The distinc-tion between tax-exempt and non-tax-exempt incomefor distribution purposes might have a positive effect onUK-REITs’ ability to hold cash reserves.89 The differencein the distribution requirements between G-REITs andUK-REITs are a necessary consequence of the differenttax regulations, considering that only UK-REIT incomethat stems from property rental business is tax exempt,whereas the G-REIT’s total income is subject to the taxprivilege. The distribution requirement, therefore, corre-sponds to the respective tax exemption granted underthe regimes.Similar to the German regime, the relevant US rulesrequire REITs to distribute 90% of their taxable income,but income in this respect excludes capital gains.90 Inpractice, US-REITs might feel tempted or even com-pelled to distribute a higher percentage, since only dis-tributed income is exempt from taxation.91 Conse-quently, some US-REITs have only small amounts of netproceeds readily available for investments or otherexpenditures.92 This result is a downside of the distribu-tion requirement: REITs have only a small amount ofretained earnings that can be invested in growing thebusinesses internally.93 Another consequence is thatREITs are highly dependent on rising funds from thecapital markets and through borrowing (although bor-rowing is also restricted in Germany and the UnitedKingdom).

2.7. Legal form and minimum share capitalIn the United States, a REIT can be of any kind of USentity (for example, a partnership, corporation, limited

80. Andreas Knebel, “Einbringung von Immobilien in REITs – Steuer-rechtliche Anreize zur Mobilisierung von Immobilienbeständen”, Special Edi-tion:G-REITs, supra note 51, p. 64.81. The authors have described the mechanics of this tax treatment in moredetail in Fritsch, Prebble and Prebble, supra note 1, 4.9.82. Secs. 105(3)(c) and 119(2) Finance Act 2006.83. Katrin Gänsler, “REITs in Deutschland und Großbritannien – ein Ver-gleich”, Internationales Steuerrecht (2007), p. 104.84. HM Treasury and Inland Revenue, supra note 15, Para. 3.8.85. Internal Revenue Code (IRC), Sec. 857.86. Uwe Stoschek and Helge Dammann, “Internationale Systeme derBesteuerung von REITs”, Internationales Steuerrecht (2006), p. 407.87. Berwin Leighton Paisner & DTZ Group, supra note 75, Para. 2.14.88. Sec. 13(1) G-REIT Act.89. Gänsler, supra note 83.90. IRC, Sec. 857.91. Id.92. Petersen, supra note 15, pp. 8-12.93. McCall, supra note 9, p. 5.


liability company or business trust), as long as it haselected to be treated as a domestic corporation for taxpurposes.94 The REIT regimes in the United Kingdomand Germany are more restrictive, requiring REITs to beestablished in a certain legal form. There is only one per-mitted legal form for G-REITs: that of the stock corpora-tion (Aktiengesellschaft, AG) under the German StockCorporation Act (Aktiengesetz, AktG).95 UK-REITs mustbe closed-ended companies that are tax resident in theUnited Kingdom, although their place of incorporationmay be elsewhere.96

In Germany, the stock-listed AG is an established vehiclefor indirect real estate investment in form of the “Immo-bilien-AG”, a vehicle investors are already familiar with,although the structure has not been particularly success-ful.97 Even on the international stage, the AG is a recog-nized corporate structure. This legal form was not theonly possible vehicle considered, however: during thedevelopment stage of the German REIT regime, onemodel that enjoyed a considerable measure of supportwas the trust model, which is similar in form to the struc-ture provided for under US law.98 German lawmakersultimately rejected the trust option, probably becausethere is no tradition of trust structures being active inthe German market, and legislators were concerned thatthe unfamiliar structure would make investors wary ofparticipating. Furthermore, there was no existing legalframework in Germany that would support the kind oftrust structure that a REIT would require. German lawcontains provisions for trusts, but they do not providefor a separation of the real assets from the actual stockcorporation, as a REIT regime relying on the structurewould require.99 Faced with these impediments, Ger-many’s decision to use the AG structure for its REITregime seems reasonable.In the United Kingdom, the main question regardinglegal form was whether to opt for an open-ended or aclosed-ended vehicle. The advantage of choosing anopen-ended structure would have been that there arealready well-established products on the market, such asauthorized unit trusts and open-ended investmentcompanies, which are familiar to investors. However, theUK legislators ultimately decided in favour of a closed-ended vehicle, with one of the determining factors beingthat there are a number of dangers inherent in investors’redemption rights in open-ended structures, which is arequirement to qualify for authorization as a collectiveinvestment scheme.100 Open-ended vehicles investing inilliquid assets such as real estate might encounter diffi-culties if they can be required to redeem units onrequest, since real assets might be difficult to liquidatequickly or only under unfavourable market conditions atthe time of the request.101 As a result, existing open-ended structures for real estate investment have beenunable to invest all of their assets in property,102 which isanother reason why they did not seem the ideal legalform for a REIT structure. Furthermore, considering thatthere are already open-ended structures on the market, aclosed-ended structure would mean more diversifica-tion and flexibility for investors.103

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Although there is no minimum share capital requirementunder the US REIT regime, both the German and the UKlegislators introduced a minimum share capital require-ment for their structures, i.e. EUR 15 million104 and GBP50,000,105 respectively. A REIT might, indeed, require ahigher minimum capitalization than a normal stock cor-poration, due to the increased costs arising from theobligatory stock listing and related publication require-ments. Nevertheless, the increase in the normal mini-mum share capital requirement for stock corporationsunder the German regulations from EUR 50,000 to EUR15 million is an enormous one, thereby further prevent-ing smaller companies from entering the REIT market.

2.8. The scope of REITs’ business activitiesThe UK REIT regime contains a rule requiring REITs tohold at least three separate assets.106 The existence of thisrule is perhaps surprising, since neither the German northe US rules provide for a corresponding requirement.The requirement to hold a minimum of three propertiesprevents highly specialized UK-REITs from investing injust a single property, such as a hotel. A shopping mall, onthe other hand, would be an eligible property for REITinvestments because the individual shops are consideredto be separate properties, being units that are designed,fitted and equipped for separate rental.107 Malls andhotels are clear cases on either side of the single-propertyline, but there are many potential borderline cases whereit is not clear how this requirement will be interpreted inthe long run. It is difficult to guess at the motivation forthe UK rule, but one possible reason for its inclusionmight have to been provide for a minimum diversifica-tion for investors, in view of the fact that one of the rea-sons for the regime’s enactment was to provide smallerinvestors with opportunities to invest in diverse propertyportfolios.108 This explanation is not fully satisfactory,because surely smaller investors would also benefit frombeing able to invest in single-property REITs, but in theabsence of any other rationale it is probably correct.

94. IRC, Sec. 846(a).95. Sec. 3 G-REIT Act.96. Sec. 134 Finance Act 2006.97. Eusani, supra note 46, p. 66 for an explanation of the many drawbacks ofImmobilien-AGs.98. For example, Initiative Deutsche Wohnimmobilien – REITs, “SchriftlicheStellungnahme zum Entwurf eines Gesetzes zur Schaffung Deutscher Immo-bilien-Aktiengesellschaften mit Börsennotierten Anteilen” (prepared for theGerman Bundestag (28 February 2007, available at www.bundestag.de).99. Hanspeter Gondring and Yvonne Weick, “Formen von REITs als indi-rekte Immobilienanlage”, Special Edition G-REITs, supra note 51, p. 27. 100. HM Treasury, Inland Revenue, supra note 15, Paras. 2.15-2.17.101. Id.102. Id.103. See Berwin Leighton Paisner & DTZ Group, supra note 75, Para. 2.6.104. Sec. 4 G-REIT Act.105. The minimum share capital requirement is a requirement of listing onthe London Stock Exchange, rather than a requirement of being a UK-REITper se. UK-REITs must be listed, but they do not necessarily need to be listedon the London Stock Exchange. Any recognized stock exchange suffices, so, intheory, it is possible for a UK-REIT to be subject to a different minimum sharecapital requirement, depending on the exchange it lists on.106. Sec. 107 Finance Act 2006.107. Guidance GREIT 02030.108. HM Treasury and Inland Revenue, supra note 15, Para. 1.22.


In order to justify their tax privileges, REITs’ core busi-ness is typically limited to passive real estate activities.National legislators typically do not intend their REITregimes to provide tax advantages to property develop-ers. The UK and German regimes are good examples inthis respect: both countries impose restrictions on theirREIT structures regarding property development activi-ties. Aside from the letting and leasing of property, theGesetz zur Schaffung deutscher Immobilien-Aktienge-sellschaften mit börsennotierten Anteilen (“the G-REITAct”) limits a G-REIT’s activities to real estate-relatedancillary activities regarding the entity’s own portfolio.This restriction includes property development. Activi-ties for third parties may only be rendered through tax-able REIT subsidiaries. However, the general scope ofactivities of such taxable REIT subsidiaries is limited toreal estate-related ancillary services. This limitationmeans that G-REITs may not generate “bad income”from non-real estate-related sources, such as pure oper-ating services provided to its tenants (for example,through hotel management, security services, etc.).The US regime is less strict. In the United States, 5% of aUS-REIT’s income may stem from non-qualifyingsources. The United Kingdom is even more liberal, per-mitting 25% of REIT income to be non-qualifying,although this income does not receive the same tax ben-efits as qualifying income.Like the G-REIT, the US-REIT may develop real estateonly for its own portfolio. Unlike the G-REIT, however,US-REITs may conduct real estate development for thirdparties via taxable REIT subsidiaries. The scope of activ-ities a US-REIT may undertake through taxable sub-sidiaries seems significantly broader than that of the G-REIT. Taxable REIT subsidiaries in the United Stateswere at one stage permitted to perform only “customary”real estate services to tenants, but even this mild restric-tion has now been lifted.109 Not restricting the servicestaxable REIT subsidiaries may engage in enables US-REITs to provide a wider range of competitive services totheir tenants (for example, Internet or cleaning services).The income from those services ultimately benefits theUS-REIT and its investors – an opportunity that is notavailable for G-REIT investors.In the United Kingdom, property development is per-mitted only when it is related to a REIT’s investment pur-poses – for example, if a UK-REIT intended from thebeginning to retain a building or buildings as investmentrental property.110 Practitioners had called for an unlim-ited amount of development activity to be permittedunder the UK regime, also bearing in mind that in com-peting collective investment vehicles in the UK market,up to 50% of gross asset value may be directed towardsproperty development.111 Gains from the sale of devel-oped properties within three years of completion aretaxable. However, UK-REITs can conduct further prop-erty development either within their 25% quota of tax-able activities or through taxable subsidiaries. Neitheroption is possible under Germany’s REIT regime.

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Permitting property development, at least for REITs’ ownportfolios, was essential for the two European REITstructures. One of the hoped-for results of introducingREIT regimes in the United Kingdom and Germany wasthat property that was initially in poor condition wouldbe taken over by REITs and improved. REITs in thosecountries obviously had to be permitted to undertakeproperty development activities for this result to occur.Furthermore, permitting some measure of propertydevelopment activity ensures the vehicles’ competitive-ness. Retail investors benefit if the quality of the invest-ment is maintained through development, which, inturn, should improve REITs’ performance over the longterm. With regard to property development undertakenon behalf of third parties, however, UK and G-REITs areunlikely to be appropriate vehicles due to their borrow-ing restrictions and high mandated distribution levels.112

In addition, considering the level of risk that normallyattaches to property development projects, the investorsthat REIT regimes hope to attract are unlikely to beinterested in property development projects.Both property investment and effective portfolio man-agement involve selling properties from time to time.However, REITs are generally not designed as propertytrading vehicles, as the expectation is that they receiveincome from holding properties, rather than from sell-ing them. The G-REIT Act, therefore, imposes therestriction that, over a five-year period, G-REITs maydispose of property generating profits of only up to 50%of the average market value of its property over thatsame period.113 The US and UK regimes are more flexi-ble: US-REITs can trade property through taxable REITsubsidiaries114 and UK-REITs can do so within theirquota of non-qualifying income. Once a property is sold“by way of trade” or is “developed for sale”, it crosses linefrom ring-fenced to taxable non-ring-fenced activi-ties,115 but there are no restrictions on the type of non-qualifying income.116

In the United States, a REIT’s property may be leased to ataxable REIT subsidiary. The taxable REIT subsidiarycan then use the property to, for example, provide serv-ices to the REIT’s tenants. One kind of property that isoften managed in this way is a hotel building, as long asthe hotel is managed by a third-party manager.117 Underthe UK regulations, the rules on “owner-occupied” prop-erty result in property not being considered part of aREIT’s property rental business if it is leased out tocompanies in which the REIT holds a controlling inter-est.118 At the same time, UK-REITs are free to holdowner-occupied property themselves, within the 25%

109. Due to reform under the Taxpayer Refund and Relief Act of 1999.110. Guidance GREIT 02075.111. Berwin Leighton Paisner & DTZ Group, supra note 75.112. HM Treasury, Inland Revenue, supra note 15, Para. 2.35.113. Sec. 14 G-REIT Act.114. EPRA, supra note 60, p. 223. 115. Guidance GREIT 04040.116. Guidance GREIT 4505.117. McCall, supra note 9, p. 6.118. Guidance GREIT 01030.


quota of non-qualifying assets. Although there are nocomparable rules on owner-occupied properties underthe German regulations, the G-REIT regime is morerestrictive than either the US-REIT regime or the UK-REIT one in terms of permitted activities. The Germanrules do not allow REITs to engage in any kind of non-real estate-related activities, not even through a taxableservice subsidiary. This restriction deprives investors ofa reasonable portion of revenues that could be generatedfrom these kinds of businesses.The United States originally had more restrictive rulesregarding permitted activities for taxable REIT sub-sidiaries, but it relaxed these via the Taxpayer Refundand Relief Act of 1999. The Act amended the regime sothat taxable REIT subsidiaries can now provide both“customary” and “non-customary” services to tenants.The real estate industry warmly welcomed this move andsome credit the amendment with reviving the REIT mar-ket. Even though taxable REIT subsidiaries are subject tofull corporate income tax, US-REITs as well as theirshareholders benefit from the income generated from“synergistic” businesses and enable the REIT to be man-aged more effectively.119 Despite these experiences ofreform and its effects on the US market, the German legislators opted for more restrictive regulations, whichmight turn out to be disadvantageous for the G-REIT’scompetitiveness and performance in the long run.

2.9. REIT governance and conflicts of interestThere are various disclosure and publication require-ments that deal with conflicts of interest under the USsecurities laws – in particular, the Securities Act of 1933and the Securities Exchange Act of 1994. In spite of thesesafeguards, governance issues still arise from time totime in relation to REITs. Most common are issues sur-rounding transactions between REITs and their affili-ated entities. For example, issues may arise if entitiesowned by a REIT, or affiliated with a REIT or membersof its management, manage or lease that REIT’s proper-ties. Furthermore, there may be conflicting interests withregard to office space or services provided by a REIT toits affiliates or by the affiliates to the REIT, or the REITacquiring properties owned by its affiliates or membersof its management.120 Generally, such conflicts of interestare triggered by parties’ different financial or tax inter-ests with regard to a specific transaction.Some varieties of REITs that have developed in theUnited States produce heightened opportunities for con-flicts of interest. One such structure is the UpREIT,which was developed to circumvent the problem ofbuilt-in gains being taxable on the transfer of property toa REIT. UpREITs do not directly hold interests in realassets. Instead, an UpREIT holds a direct interest in an“umbrella limited partnership” (this is the “Up” of thename) of which the UpREIT is the general managingpartner. The umbrella partnership (also referred to as theREIT’s operating partnership), in turn, directly ownsinterests in property, contributed to the partnership bytheir owners in exchange for limited partnership inter-

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ests. These interests are generally convertible into com-mon REIT stock.121

Conflicts might well arise between the original propertyowners, now holding interests in the umbrella partner-ship, and the common REIT shareholders. This isbecause the former property owners and the stockhold-ers in the REIT are following different objectives withtheir investments. The latter are generally interested inmaximizing their dividends and stock appreciation,whereas the individuals contributing property are gener-ally more concerned about tax privileges and diversifica-tion.122

In an UpREIT structure, the REIT holds the position ofgeneral partner of the limited partnership. As such, theREIT is responsible for the administration and the man-agement of the partnership’s properties as well as for itsstrategic direction.123 The publicly listed REIT is, in turn,owned by stockholders, who, through the REIT as gen-eral partner, also have a say regarding the umbrella part-nership’s management.124 If or when the UpREIT limitedpartners make use of their right to convert their limitedpartnership interest into common stock of the REIT, theinterests of the initial property owners are likely to coin-cide with those of the stockholders to a considerableextent. However, the original property owners may havedifferent interests with respect to some transactions.125

Potential conflicts of interest between the limited part-ners of the umbrella partnership and the REIT’s share-holders may arise from many ordinary business transac-tions, generally involving differing economic or taxconcerns. For example, the sale of property might havesevere tax implications for the limited partners, whomust recognize built-in gains released on the sale,126

whereas the shareholders are not exposed to this tax liab-ility and, therefore, might favour a sale that is perceivedas economically disadvantageous by the limited part-ners.127 Similarly, conflicting tax interests may ariseregarding the paying-down of umbrella partnership debtfrom property acquisitions with REIT funds or regard-ing merger and acquisition activities.128 In merger andacquisition scenarios, it can easily happen that the stock-holders’ and limited partners’ interests are diametricallyopposed. The shareholders might want to accept a highcash tender offer, whereas the limited partners mightfavour a stock swap, even though it is worth less in value,

119. McCall, supra note 9, p. 6.120. Id., p. 15.121. Chadwick Cornell, “REITs and UpREITs: Pushing the Corporate LawEnvelope”, University of Pennsylvania Law Review (1997) 145, p. 1578.122. Id., p. 1566.123. See, generally, Robert W Hamilton, Fundamentals of modern business(Boston: Little Brown, 1989), Para. 13.5.124. Cornell, supra note 121, p. 1581.125. Id.126. IRC, Sec. 704(c).127. Russel J. Singer, “Understanding REITs, Up-REITs, and Down-REITS,and the Tax and Business Decisions Surrounding Them”, 16 Virginia TaxReview (1996), p. 335 and Cornell, supra note 121, p. 1586.128. Cornell, supra note 121, pp. 1584-1592.


which would allow them to further defer gains instead ofhaving to recognize them on the sale.129

2.10. Judicial review in cases of conflict of interestIn a small number of cases, courts in the United Stateshave addressed conflict of interest issues in REIT struc-tures, in particular, in relation to conflicting interestsbetween the board or a controlling limited partner andthe REIT shareholders. Although most cases are rootedin the federal and state tax laws, they effectively concernthe decisions of corporate fiduciaries, since the boardmembers have fiduciary duties towards the stockhold-ers.130 Generally, courts have treated REITs like any otherbody corporate, i.e. reverting to the standards of reviewdeveloped in corporate litigation, when reviewing deci-sions of UpREIT fiduciaries.131

One rule that is likely to be applied to business decisionsof corporate fiduciaries is the “business judgement rule”,under which the court presumes “that in making a busi-ness decision, the directors of a corporation acted on aninformed basis, in good faith and in the honest beliefthat the action taken was in the best interest of the com-pany”.132 This also transfers the burden of proof from theboard to the plaintiff.Additional tests and burdens of proof are applied on theboard in the case of takeover bids. The board must show“good faith and reasonable investigation” in reaching adecision, as well as the proportionality and reasonable-ness of its decision, before it may take advantage of thebusiness judgement defence.133 Generally, boards havebeen considered to have a broad scope of discretion inmaking decisions. A much stricter standard of reviewmay, however, be applied under the “entire fairness” testin cases where there is actual evidence that the fiduciar-ies took a decision conflicting with the shareholders’interests.134 In these circumstances, the burden of proofis placed on the board, which has to prove the “entire fair-ness” of the transaction in terms of fair dealing as well asfinancial and economic considerations.135 Another sce-nario where courts apply an increased level of scrutiny iswhere decisions are intended to affect or impede theshareholders’ voting power.136 For example, the boardmight try to manipulate the shareholders’ voting rightsby amending the by-laws or increasing the size of theboard, as happened in Blasius Industries v. Atlas Corp.137

In such circumstances, the board bears the burden ofproof and must demonstrate a “compelling justificationfor such action”.138

Courts seem to have applied these doctrines to REITseasily enough.139 However, the UpREIT structure is farmore complex and gives rise to more potential conflictsof interest than more straightforward corporate entities.Because of the relatively small number of UpREITs, thereis little litigation to date dealing specifically with thisstructure. Nevertheless, due to the many potential con-flicts with regard to UpREIT governance and the popu-larity of this structure, more litigation can be expected inthe future. Some commentators consider that, due to theunusual characteristics of UpREITs, courts should apply

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a different standard of review.140 The significantly higherpotential for conflicts of interest that the UpREIT struc-ture presents when compared to a standard corporationmake it seem inappropriate to apply the “business judge-ment” rule to fiduciaries of UpREITs automatically.Instead, a more frequent and higher level of scrutinyshould be applied to the board’s decisions.141 However, afair balance has to be found between the common stock-holders’ interests and those of the limited partners whooriginally contributed their assets to the umbrella part-nership with the objective of saving taxes. When assess-ing the board’s fiduciary duties, it is important to remem-ber that many of the controlling individuals areprofessional or experienced real estate investors pursu-ing their own financial interests. The original intentionand policy reasons proclaimed when enacting the earlyREIT laws were, however, to further the cause of thesmall, middle-class investor.

2.11. Avoiding conflictsIn practice, REITs try to avoid potential conflicts ofinterest by appointing boards of trustees or directorsthat can be considered to be independent in an effort tobalance any conflicting interests between the REIT man-agement and the shareholders.142 Many institutionalinvestors as well as underwriters see the formation of anindependent board of directors as a necessary precondi-tion for publicly listing a REIT.143

In the US context, the NAREIT has adopted a code ofethics, which requires member REITs to have a largelyindependent board of trustees or directors.144 In practice,

129. Id., p. 1588.130. Id. The fiduciary position of the board members towards the stockhold-ers is recognized as a fundamental concept of corporate governance. See, forexample, Arnold v. Society for Sav. Bancorp., Inc. (1996) 678 A.2d 533, 540 (Del.)and Harden v. Eastern States Pub. Serv. Co. (1923) 122 A. 705, 712 (Del.Ch.).131. See Paramount Communications, Inc. v. QVC Network, Inc. (1993) 637A.2d 34, 44 (Del.) and Realty Acquisition Corp. v. Property Trust of Am. (1989)No CIV. JH-89-2503, 1989 WL 214477, at 3 (D. Md. Oct. 27), where the courtsapplied the general principles of review applied in corporate governance liti-gation to REITs. Up to the mid-1990s, many UpREITs were incorporated inMaryland. With favourable legislation being enacted in other states, they nowchoose the state where they are located. Nevertheless, Delaware serves as agood example, because it still is the “most persuasive precedent” in the area ofstate corporate law (see Cornell, supra note 121).132. Aronson v. Lewis (1984) 473 A.2d 805, 812 (Del.) and Cinerama, Inc. v.Technicolor, Inc. (1995) 663 A.2d 1156, 1162 (Del.).133. Unitrin, Inc. v. American Gen. Corp. (1995) 651 A.2d 1361, 1372 n.9 (Del.)and Unocal Corp. v. Mesa Petroleum Co. (1985) 493 A.2d 946, 954 (Del.).134. Weinberger v. UOP, Inc. (1983) 457 A.2nd 701, 710 (Del.) and Kahn v.Lynch Communication Sys. (1994) 638 A.2d 1110, 1115 (Del.).135. Cornell, supra note 121, p. 1595.136. Blasius Industries v. Atlas Corp (1988) 564 A. 2d 651 (Del. Ch.) and Schnellv. Chris-Craft Industries, Inc. (1971) 285 A.2d 437 (Del).137. Blasius Industries v. Atlas Corp (1988) 564 A. 2d 651 (Del. Ch.).138. Id.139. See Paramount Communications, Inc. v. QVC Network, Inc. (1993) 637A.2d 34, 44 (Del.) and Realty Acquisition Corp. v. Property Trust of Am. (1989)No CIV. JH-89-2503, 1989 WL 214477, at 3 (D. Md. Oct. 27) for examples ofcases where courts applied the general principles of review applied in corpo-rate governance litigation to REITs.140. Cornell, supra note 121, p. 1600.141. Id., p. 1567.142. McCall, supra note 9, p. 16.143. Id.144. Available at www.reit.com.


REITs also incorporate provisions in their by-lawsrequiring that, in the previously noted scenarios givingrise to potential conflicts of interest, decisions regardingthe sale of properties must be made by independenttrustees or directors.145 Moreover, the individual part-nership agreements of a REIT structure may need to beshaped differently to satisfy the individual interests inview of the varying financial and tax situations and inter-ests regarding certain properties.146 For example, theREIT as the general partner of the Up or Down-REITpartnership may even be barred from selling specificpieces of property contributed to the partnership.147

Aside from compliance with applicable SEC rules andprovisions of state business codes, REITs must alsoensure that they comply with any relevant stockexchange regulations (for example, the US StockExchange and New York Stock Exchange regulations)which require shareholder approval for certain transac-tions. Private, unlisted REITs should examine the NorthAmerican Securities Administrators Association’s poli-cies on oversight and administration with regard to bor-rowing and investment practices.148 As with any corpora-tion, the establishment and effective operation ofindependent bodies to review the REIT’s accountingpractices and policies are crucial.149

2.12. UK and German casesREITs in the United Kingdom and Germany are subjectto the same corporate governance principles as any othermajor company in those jurisdictions. However, consid-ering that the UK and German REIT regimes have beenoperating for not quite three years, it will take some timeuntil the first REIT cases involving with conflicts ofinterest and governance are heard.Perhaps surprisingly, the problem of possible conflicts ofinterest was barely discussed in consultations for anappropriate REIT format in the United Kingdom andGermany. This absence might be due to the fact that thelegislation itself only sets the basis for REITs. That is, thelegislation provides for a basic structure, consisting ofjust one entity. These entities must ensure their compli-ance with the laws governing capital markets and dealwith conflicts of interest in the same way as any othercorporation of their type. The German Stock Corpora-tion Act also incorporates a Corporate GovernanceCode (Deutscher Corporate Governance Kodex), drawnup by the government,150 which companies are recom-mended to comply with. However, once practitionersstart developing more advanced REIT structures withaffiliated companies, the United Kingdom and Germanymight have to face governance issues similar to the onesexperienced in the United States.

3. Outlook and Concluding Remarks

3.1. Future international REIT developmentsAlthough real estate investment trusts have become anessential part of the market for indirect real estate invest-ment worldwide, they are still one of the less understood

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areas within commercial real estate.151 Regardless of realestate and economic business cycles and downturns, itseems clear that they will remain.152 Apart from relativelystable and above-average returns over the last decades,153

there are a number of further multifaceted benefitsinherent in this structure that make it particularly attrac-tive.However, it seems clear now that the heyday of REITs isover. The astounding success that REITs enjoyed duringthe late 1990s and the first half of the 2000s was closelytied to the real estate boom, which became a real estatebubble. The structural benefits of the REIT model cer-tainly played a large role in allowing investors to accessthe extraordinary profits that were available, but the pri-mary reason for the success of REITs was the success ofreal estate. Post-bubble, it is hard to see how REITs couldever reach their previous heights. Real estate prices arecyclical, and the current slump will end eventually, but itis unlikely that real estate prices will ever reach 2006 lev-els again, and it is, indeed, better that they should not.Nevertheless, the fact that REITs will never again be therunaway profit vehicles that they were for the decadefrom 1995 to 2005 does not mean that there is no futureat all for REITs. Their tax advantages mean that they areusually the most favourable vehicle for property invest-ment. The UK and German REIT regimes were intro-duced with high expectations, and the regimes’ initialperformance was very encouraging, especially in theUnited Kingdom.154 Forecasts are more subdued now,155

but the inherent benefits of REITs remain unchanged.Both the UK and German regimes perhaps could berevised to encourage investors to embrace the new vehi-cles more enthusiastically, but fundamentally theregimes are sound. The role of REITs is likely to changeto that of a quiet achiever, rather than a star player, butthis development should be seen as positive, as it reflectsthe true nature of real estate as an investment.Essentially, REITs thrive wherever there is money to bemade from property investment. Most developedeconomies are experiencing steep declines in propertyvalues, but in some countries that are at a less advancedstage of development, property continues to be a growthsector. One example is China,156 where property prices inurban areas are expected to continue to rise for at least

145. McCall, supra note 9, p. 16.146. Singer, supra note 127, p. 336.147. Id.148. Id.149. McCall, supra note 9, p. 16.150. Sec. 161 AktG.151. Singer, supra note 127, p. 330 and McCall, supra note 9, p. 2.152. On future developments of REITs in Europe, see Fraser Hughes, “Pan-European REIT? – A Long, Long Road” (2005, available at www.epra.com).153. NAREIT, compound annual total returns in per cent, December 1976 –December 2006 at www.nareit.com.154. For example, Ernst & Young, supra note 33, p. 18.155. United Kingdom House of Lords Select Committee on EconomicAffairs, “The Finance Bill 2009” (Third report of session 2008-2009), 23 June2009, Paras. 322-323.156. See generally Noriel Rubini, “Are There Bright Spots Amid the GlobalRecession?” (6 August 2009, available at www.forbes.com).


the next year.157 China has been considering enacting aREIT regime for some time now and, as at the beginningof 2010, it appears that these plans will come tofruition.158 Similarly, other maturing economies, such asIndia and Pakistan, are putting their own plans for REITregimes into action.159

In the United States at least, REITs are experiencing aminor revival as vehicles for purchasing troubled mort-gage assets. If structured correctly, such REITs can be eli-gible for government funding via the Troubled AssetRelief Program, and thereby receive both tax benefitsand also a discount on financing costs.160 Although thesestructures have the potential for great success, i.e. by buy-ing troubled assets at a discount and selling them whenthe market recovers, it is not clear whether they will besuccessful ultimately. Although, in theory, it should beeasy to purchase troubled mortgage assets from banksand other financial institutions, in practice, such organi-zations are reluctant to sell at large discounts because ofthe knock-on effect such sales would have for the valua-tions of the assets they continue to hold.161 Furthermore,the “discount” price for which such REITs can purchasetroubled assets may well turn out not to be a discount atall, but, in fact, an overvaluation of the assets once theirlong-term performance becomes clear. Nevertheless, thefact that REITs are being used for this kind of structuresuggests that innovation in the REIT market is far fromover. The tax benefits of REITs mean that they willalways be the best vehicle for real estate investment.

3.2. Quasi-REITsThe basic REIT blueprint has been used to encourageinvestment in assets other than real estate. New Zealandhas an interesting example of this kind of national mod-ification. Unlike the position in a number of other juris-dictions, there has been little call in New Zealand for thedevelopment of a specialized property investment vehi-cle. Property investment in New Zealand does not seemto have suffered from the lack of such a vehicle. The mainreasons are probably twofold. First, New Zealand has nocomprehensive capital gains tax; this absence leads ingeneral to over-investment in land. Secondly, NewZealand employs a full imputation system for taxingcompanies.162 That is, companies may pass credits for allcorporate-level tax to their shareholders. Shareholders,in turn, subtract these credits from tax otherwise payableon dividends.163 Full imputation is as close as a corporatetax system can go to the impractical ideal of full integra-tion of company and dividend taxes. As a result, prop-erty-owning companies in New Zealand probablyappear to suffer less from both corporate lock-in ofprofits and double taxation of company profits than doproperty-owning companies in many jurisdictions:hence there is little if any demand for a specialized prop-erty investment vehicle. Nevertheless, New Zealand didenact something very like a REIT regime two years ago,albeit almost by accident.Since 1 October 2007, New Zealand has had a PortfolioInvestment Entity (PIE) regime.164 The purpose of thePIE regime is to encourage smaller investors to partici-

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pate in share ownership, not necessarily property invest-ment. PIEs are tax-preferred collective investment vehi-cles that, for investors, approximate the effects of holdingshares directly, rather than through a collective invest-ment vehicle. Under initial drafts of the PIE regime,companies and trusts that invested primarily in propertywere excluded from the proposed regime:165 it was feltthat whilst New Zealanders needed encouragement toinvest in debt and equity securities, they did not needany encouragement to invest in property. However, thedraft regime was eventually amended to allow “LandPIEs” – PIEs that have one or more share classes thatinvest primarily in property holdings.There are some restrictions on Land PIEs over and abovethose on other PIEs. For example, losses from Land PIEs’land investments are ring-fenced from Land PIEs’ otherinvestments, but, by and large, Land PIEs receive thesame tax benefits as other PIEs. Essentially, as far as tax isconcerned, investors in Land PIEs are placed in a similarposition to direct investors in property. Whilst it perhapsdid not intend to do so, by enacting the PIE regime, NewZealand enacted a REIT regime, although the PIE regimecovers a good deal more than property investment.Entities that refer to themselves as REITs sprang upquickly once the PIE regime was enacted.166

Global REIT surveys of the kind published by account-ing firms and industry bodies tend to treat New Zealandas not having a REIT regime,167 although occasionallysome surveys include New Zealand REITs,168 presum-ably on the basis that the PIE regime allows for essen-tially similar entities to be created.

3.3. The outlook for REITsThe US example shows how important a responsive reg-ulatory environment is for growth in REIT markets. Thestory of US-REITs has been a history of cycles. Phases ofincreased growth have been preceded by favourable reg-ulatory changes,169 thereby facilitating market access or

157. “Property prices soar in China and analysts predict 20% increases by2010” (13 August 2009, available at www.propertywire.com).158. Brad Markoff and Mabel Lui, “China REITs – What’s the Latest?”, DLAPiper Newsletter (January 2009), p. 1.159. Id.160. For example, Kate Berry, “REITs reclaim stage as way to cash in on crisis”(31 July 2009, available at www.bankinvestmentconsultant.com).161. Adam Weinstein, “PennyMac IPO exposes REIT weaknesses” (4 August2009, available at www.dsnews.com).162. Subpart OB Income Tax Act 2007.163. Subpart LE Income Tax Act 2007.164. New Zealand’s PIE regime was introduced in the Taxation (Savings andMiscellaneous Provisions) Act 2006. Subparts CP and HL of the Income TaxAct 2007 now address the income of PIEs.165. New Zealand Inland Revenue, “Commentary on the Taxation (AnnualRates, Savings Investment, and Miscellaneous Provisions) Bill”, pp. 8-9.166. For example, the NZ-REITs referred to in Anne Gibson, “Listed propertysector ‘starved for cash’” (13 May 2009, The New Zealand Herald, available atwww.nzherald.co.nz.167. For example, EPRA, supra note 71 and PricewaterhouseCoopers,“Worldwide Real Estate Investment Trust (REIT) Regimes: Country Sum-maries”(June 2009, available at www.pwc.com).168. For example, Ernst & Young,“Global REIT Report 2008” (October 2008,available at www.ey.com).169. Tobias Just, “Was Europa von US-REITs Lernen Kann”, Deutsche BankResearch (November 2006, available at www.dbresearch.de).


operating conditions for REITs. There was a significantincrease in REIT investment after 1986, when REITswere permitted to conduct (taxable) non-qualifyingactivities without losing their REIT status. Similarly, theREIT boom in the early 1990s was spurred on by theintroduction of UpREITs and regulatory changes per-mitting REITs to provide non-customary servicesthrough their taxable REIT subsidiaries. More recently, arelaxation in the provisions relating to distribution ofprofits has to some extent eased the path for US-REITsand allowed them to try to take advantage of new oppor-tunities arising out of the mortgage crisis that started in2007.170

The UK and German regimes seem comparativelyrestrictive and unresponsive to changing market condi-tions. Although the main reason for the relative lack ofsuccess of the two European regimes is certainly theglobal recession and a general distaste for real estateinvestment, some blame must fall on poor regime design.In particular, the UK and German gearing limits seemtoo restrictive. Moreover, private REITs could have pro-vided an attractive complementary investment optionfor both markets. The German prohibition on REITsinvesting in most residential property seems counter-productive. Along similar lines, the UK rule providingthat REITs must hold at least three properties seems todo nothing other than block opportunities for invest-ment and growth. The success of single-property REITsin the United States makes this requirement seemnotably perverse.Both the United Kingdom and Germany seem to beaddressing defects in their REIT regimes, at least to someextent. In the case of Germany, a number of industryparticipants identified the quasi-double taxation ofREIT income generated from foreign real assets as a

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problem. Germany has addressed this issue with the newSec. 19(a) of the G-REIT Act, which partially eliminatesthis double taxation.171 The United Kingdom alsoappears to be re-examining some aspects of its regime,although so far officials have focused on minor matters,rather than what critics have identified as the morepressing problems with the regime.172

In the medium term, further legislative changes can beexpected both in the United Kingdom and Germany toencourage growth in the REIT market.173 Germany, inparticular, should reassess its legislation, since it is at adisadvantage in relation to the UK-REIT industrybecause of the United Kingdom’s reputation and longtradition as a financial centre. If Germany wishes tocompete with other European and international REITmodels over the long term, it must offer features that per-suade investors to choose the G-REIT over other struc-tures. Legislating for a regime providing for privateREITs is a possibility. In the United Kingdom also, arelaxation of the regulations governing the UK-REITwould encourage more property companies to con-vert.174 Otherwise, as the US case reveals, thosecompanies will become takeover targets by large andefficient REITs that will finally dominate the market.175

170. Vivian Marino, “Some REIT dividends are part stock, part cash”, New YorkTimes (25 January 2009, available at www.nytimes.com).171. Provided that the income in question has already been taxed in the statein which it arose at a rate of 15% or higher.172. United Kingdom House of Lords Select Committee on EconomicAffairs, “The Finance Bill 2009” (Third report of session 2008-2009), 23 June2009, Para. 249.173. Ernst & Young, supra note 33, p. 18.174. Savills L & P Limited, supra note 7.175. Id.


Documents

Comparison of Reits in US-UK-Germany