Comparison of Reits in US-UK-Germany

Bull_7_2010_Version 2_bit-7-2010_artikel 03 07-06-10 14:41 Pagina 367 (Zwart Plaat)
Articles
Nicola Fritsch*, John Prebble**
International, United States, United Kingdom, Germany and Rebecca Prebble***
A Comparison of Selected Features of Real

Estate Investment Trust Regimes in the United
States, the United Kingdom and Germany
This is the last in a series of four articles, in which 2. Comparison of Features of US, UK and
the authors compare specific aspects of the real German REITs
estate investment trust (REIT) regimes in the
2.1. The stock listing requirement
United States, the United Kingdom and
Germany. Previous articles dealt separately with There are a number of requirements that feature in
the REIT regimes in each of these countries. many, but by no means all, REIT regimes. The require-
ment that REITs be listed is an example: when the United
1. Introduction Kingdom and Germany enacted REIT regimes in 2007,
the legislators in both countries decided that REITs
The United Kingdom1 and Germany2 have recently
should be listed on a stock exchange. This approach con-
enacted legislative regimes setting up entities known as
trasts to the approach taken in the United States, where
real estate investment trusts (REITs), with the intention
there is no such requirement, and the decision conse-
of encouraging indirect investment in real estate in those
quently faced considerable criticism from within the two
countries. The United States3 has had a REIT regime
countries. In the United States, unlisted REITs are an
since the 1960s and was, in many respects, a model for
established part of the real estate investment market. The
the UK and German regimes. However, both of the new
National Association of Real Estate Investment Trusts
regimes diverged from the US example and, indeed, from
(NAREIT) estimates that one third of US-REITs are pri-
each other, in a number of ways. It is often difficult to
vate.4 Similarly in Australia, with the world’s second-
guess at the reasons why national legislators choose one
largest REIT market, as well as Japan, with its still young
particular option over another, but this article considers
but very successful REIT structure, both public and pri-
the differences in national circumstances that might
vate REITs are permitted and operate successfully.
have led to the three countries enacting (or, in the case of
the United States, continuing to use) different REIT Beyond the fact that a listing requirement is in itself
models. The article also evaluates the advantages and comparatively restrictive, the specific characteristics of
disadvantages of certain features of each regime, and the listing requirements adopted by the United Kingdom
speculates about the future of REITs. and Germany appear to be unusually strict. UK-REITs
must be listed on a “recognized stock exchange” – a def-
Many jurisdictions have regimes that they call “REIT
inition that excludes the United Kingdom’s Alternative
regimes”, but this uniform designation perhaps obscures
Investment Market (AIM). The AIM is a sub-market of
the many differences between national regimes. “REIT” is
not a legal term of art in the same way that, for example,
“company” is. Company law differs from country to
country, but the essential elements of companies are the * Dipl. jur., University of Augsburg, LLM Victoria University of
Wellington, and Rechtsanwältin (attorney at law). The author can be con-
same across jurisdictions. Companies all have legal per- tacted at fritschnicola@aol.de.
sonality separate from their shareholders and act ** BA, LLB (Hons) Auckland, BCL Oxon, JSD Cornell, Inner Temple,
through their directors. Their permitted activities are Barrister, Professor and former Dean of Law, Victoria University of
Wellington, and Senior Fellow, Taxation Law and Policy Research Insti-
limited by their articles of association and relevant tute, Monash University, Melbourne. The author can be contacted at
statutes. No such general statements can be made about John.Prebble@vuw.ac.nz.
REITs: REITs take many legal forms and, in spite of their *** BA (Hons), LLB (Hons) Victoria University of Wellington, LLM
Columbia, and Analyst, New Zealand Treasury. The author can be con-
name, are not necessarily trusts. To be considered a REIT, tacted at beckyprebs@gmail.com.
a vehicle must invest primarily in real estate and be
1. Nicola Fritsch, John Prebble and Rebecca Prebble, “Real Estate Invest-
granted tax advantages for doing so, but, broadly speak- ment Trusts in the United Kingdom”, Bulletin for International Taxation 5
ing, all other characteristics of REIT regimes are up to (2010), pp. 259-270.
the discretion of the country concerned. Most national 2. Nicola Fritsch, John Prebble and Rebecca Prebble, “Real Estate Invest-
ment Trusts in Germany”, Bulletin for International Taxation 6 (2010), pp. 320-
legislatures try to design REITs so that they mirror the 329.
tax effects of investing in real estate directly, but the 3. Nicola Fritsch, John Prebble and Rebecca Prebble, “Real Estate Invest-
mechanisms used to achieve this aim vary considerably. ment Trust Regimes Viewed Through the Lens of the US Paradigm”, Bulletin
for International Taxation 4 (2010), pp. 211-223.
4. NAREIT, available at www.reit.com. The authors follow the industry
convention 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 United
States, a US-REIT.
© IBFD BULLETIN FOR INTERNATIONAL TAXATION JULY 2010 367
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Articles
the London Stock Exchange and was designed with the Investor protection is also likely to be an ongoing con-
objective of giving smaller companies the opportunity to cern for Germany, in particular, because, under the G-
float their shares under a less restrictive regulatory sys- REIT regime as it currently stands, G-REITs are not
tem than the main market. For example, unlike supervised by the German financial supervisory author-
companies listing on the main London Stock Exchange, ity (Bundesanstalt für Finanzdienstleistungsaufsicht). The
they do not have to provide a financial track record or stock exchange effectively takes the place of a govern-
trading history.5 The UK property industry had been ment regulator as far as G-REITs are concerned. In the
lobbying for an amendment that would allow REITs to United States, institutional investors appear to favour
be listed on the AIM, as a compromise position instead public REITs due to the higher level of transparency,17 so
of private REITs. The ability to list on the AIM would there is perhaps some justification for reliance on listing
facilitate entities’ conversion to REITs and, therefore, also as a governance tool. Listed vehicles also tend to provide
hopefully encourage residential REITs6 because the pool a higher level of liquidity than unlisted structures. Fur-
of potential companies that can convert to REIT status is thermore, at least in the case of Germany, the legislators
currently very small and would most likely become reasoned that the German market did not need a new
larger with a more generous rule regarding stock listing.7 unlisted vehicle held only by a small number of (institu-
Currently, property companies that wish to convert to tional) investors, since the open real estate fund fulfilled
REITs and are already listed on the AIM must seek stock this function.18 The UK legislators, who wished to intro-
listing with a “recognized” stock exchange. The compli- duce a vehicle distinct from already existing forms of
ance obligations involved with seeking a second listing indirect real estate investment (in particular, unlisted
might well discourage otherwise eligible companies open-ended investment companies), took similar con-
from becoming REITs. cerns into consideration.19
The lack of a requirement that US-REITs be listed is par- Another possible benefit of listing on a stock exchange is
tially credited with the success of the US REIT industry that it can help to ensure that small investors – one of the
in the 1990s. No listing requirement meant that special- major target groups of the new vehicle – get the widest
ized REIT structures such as UpREITs could be created, 8 access possible.20 However, it is questionable whether a
and trusts, partnerships and private property companies listed vehicle necessarily attracts more interest on the
could transition easily into the publicly listed REIT sec- part of small investors than an unlisted structure. In the
tor.9 This development contributed to the US REIT mar- United Kingdom, listed vehicles offering investments in
ket starting to boom in the early 1990s.10 An AIM listing asset portfolios by pooling money (in particular,
could be an option for investors holding few property approved investment trust companies) have tended to
assets to transfer property to a REIT, as well as for small attract less interest from retail investors than their
REIT start-ups to obtain a full listing at a later stage, once unlisted counterparts, such as open-ended investment
they are established.11 companies, although investment trust companies have
been present in the market for some time.21 The phe-
Whilst the German REIT regime also requires that
nomenon suggests that the objective of making REITs
REITs be listed, it is perhaps more flexible than the UK
regime, in that an entity wishing to become a G-REIT
can gain “Pre-REIT” status and enjoy tax privileges in
5. Id
relation to the transfer of properties to the entity prior to 6. Freshfields Bruckhaus Deringer, “UK-REITs: an Updated Guide to the
stock listing.12 Considering the effort typically involved New Regime” (December 2006, available at www.freshfields.com), p. 1.
in obtaining stock listing, this allowance seems reason- 7. Savills L & P Limited, “REITs and Residential Investment”, available at
www.reita.org.
able. In contrast, UK law provides that the entity has to 8. An earlier article of the authors described the various REIT structures
satisfy the listing requirement already at the time of that began to appear in the US market in the late 1980s and early 1990s. See
notice to join the UK regime.13 This requirement would Fritsch, Prebble and Prebble, supra note 3, 4.10.-4.12.
9. Jack H. McCall, “A Primer on Real Estate Trusts: The Legal Basis of
be difficult for newly established companies to comply REITs”, 2 Transactions: The Tennessee Journal of Business Law (2001/02), 1, p. 8.
with. Accordingly, it seems reasonable to interpret the 10. Savills L & P Limited, supra note 7.
rule in a way that the entity is required only to affirm that 11. Id.
12. Sec. 2 G-REIT Act.
it reasonably believes that it will meet the condition 13. Secs. 106(1) and 109(1) Finance Act 2006.
when actually joining the regime.14 14. Freshfields Bruckhaus Deringer, supra note 6, p. 5.
15. HM Treasury and Inland Revenue, “Promoting More Flexible Invest-
One of the justifications for a mandatory listing requirement in Property: A Consultation” (March 2003, available at www.hm-
ment is the greater initial as well as ongoing disclosure 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 Estate
requirements and market scrutiny that public companies Finance, Vol. 4, No. 1 (2004), pp. 8-9.
face under capital markets law.15 Increased disclosure 16. German Bundestag Commentary on the G-REIT Bill BT Drs 16/4026,
and reporting requirements, in turn, provide a higher p. 15.
17. Petersen, supra note 15, p. 9. Although this preference for public REITs
level of investor protection.16 Investor protection was a could be due to other factors, such as greater fungibility of units.
particular priority for the UK and German governments 18. German Bundestag Commentary on the G-REIT Bill BT Drs 16/4026 8,
due to recent scandals in real estate investment markets. 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 the
Considering the crisis in global financial markets that REIT. See Fritsch, Prebble and Prebble, supra note 2, 3.
directly followed the introduction of both regimes, 19. HM Treasury and Inland Revenue, supra note 15, Para. 2.9.
investor protection is likely to increase in importance. 20. Id., Para. 2.8.
21. Id., Para. 2.10.
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Articles
available to small investors could also have been advantages of a tax-transparent clear-cut investment
achieved through an unlisted structure, similar to the vehicle with the simplicity of an unlisted vehicle. Of
existing authorized unit trusts and open-ended invest- course, unlisted REITs would need to be subject to the
ment companies, which are well established and, more- same regulatory, disclosure, and publication require-
over, a product that small investors are already familiar ments as public REITs if they hope to attract the same
with.22 The listing requirement also means that existing calibre of investors. Alongside the public REIT, the pri-
limited partnerships or unit trusts are hindered from vate REIT could provide certain investors with a choice
converting to REITs directly. Collective offshore vehicles and perhaps a more flexible alternative investment vehi-
are, in particular, unlikely to consider converting to a cle with advantages over the public REIT.31 Private REITs
REIT to be an attractive option.23 could moreover serve as important vehicles for entities
in the stage prior to going public as well as pose an alter-
Although unlisted vehicles are not subject to the same
native to popular offshore structures. On the interna-
level of publication and disclosure requirements as listed
tional stage, giving investors the free choice between a
vehicles, unit prices are regularly published and investors
private and public REIT has been an important factor for
are provided with a reasonable level of liquidity through
market efficiency and performance.32
the obligation to redeem units.24 In order to achieve suf-
ficient protection for investors, one possible approach
2.2. REITs and investments in residential property
might be to implement a number of restrictions into the
regime governing unlisted REITs, for example, to ensure The US REIT regime contains no restrictions on REITs
that only “sophisticated” investors have access to this investing in residential property and consequently
investment option.25 investments in residential properties are an established
part of the US REIT market. In 2007, the residential sec-
The German Association of Independent Real Estate
tor was among the top-three sectors within the North
and Housing Companies (Bundesverband freier Immo-
American region, amounting to about 17%.33 In the
bilien- und Wohnungsunternehmen e.V., BFW) presented
United States, REIT institutional investors have been
a number of strong arguments in favour of unlisted
entering the residential market in increasing numbers.
REITs in a discussion document on the “Importance of
This development is generally considered to be positive,
non-stock exchange-traded REITs for the success of
as allowing for better maintenance and renewal of prop-
REITs in Germany” (“Bedeutung von nicht-börsengehan-
erties as well as for more efficient property manage-
delten REITs für den Erfolg von REITs in Deutschland”).26
ment.34
According to the BFW, there is room in the German mar-
ket for a private REIT vehicle for indirect real estate In spite of the success of US-REITs in residential prop-
investment alongside the existing ones and complemen- erty markets, the German legislators decided not to allow
tary to the listed REIT; both in terms of market volume G-REITs to invest in residential property built before
and the potential competitive market position that such 2007 (2007 being when the German REIT regime was
a structure might have on the national as well as Euro- enacted). Germany has a relatively large percentage of
pean stage. The existing market in property building and people living in private and communal rental housing
developing is partly dominated by small and medium- compared to elsewhere in Europe.35 Around 15% – 3.1
sized companies.27 In this respect, the option of a private million apartments – of the total rented housing is held
REIT might open up new opportunities. Especially for by public and communal housing companies.36 Because
smaller companies, it can be particularly difficult to gain of these statistics, some feared that the introduction of
access to stock markets, not least due to the high costs REITs might have unwelcome effects for tenants and
involved and considering that initial public offering nor- interfere with public-sector social and sustainable hous-
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 real
estate funds.29 Closed real estate funds, which are cur- 22. Id., Paras. 2.12 and 2.13.
rently the most important investment vehicles for real 23. Savills L & P Limited, supra note 7.
24. HM Treasury and Inland Revenue, supra note 15, Para. 2.12.
estate investment on the German market, could be trans- 25. Petersen, supra note 15, pp. 9-10.
ferred into private REITs. This would be an important 26. Ramon Sotelo et al., “Bedeutung von nicht-börsengehandelten REITs für
step towards more transparency and professional man- den Erfolg von REITs in Deutschland”, BfW, available at www.reits-in-
deutschland.de.
agement and fungibility for this sector; a step that does 27. Id., p. 2.
not seem possible with only public REITs on the market. 28. Id., p. 6.
If entities are given the free choice whether and when to 29. Id., p. 3.
30. Id., p. 6.
go public, they can more thoroughly prepare their real 31. Petersen, supra note 15, pp. 9-10.
estate portfolios, position themselves on the market, 32. Sotelo et al., supra note 26, p. 7.
avoid unfavourable price cycles on capital markets and 33. Ernst & Young,“Global REIT Report 2007” (October 2007, available at
www.reita.org), p. 71.
then go public once they feel ready for the capital mar- 34. HM Treasury and Inland Revenue, supra note 15, Para. 1.1.3.
ket.30 35. Bundesamt für Bauwesen und Raumordnung, “Comparison of
Approaches to Housing Policy in EU Countries”(November 2005, available at
Private REITs are certainly an option worth considering www.bbr.bund.de).
for the UK and German markets, thereby combining the 36. German Bundestag Commentary on the G-REIT Bill BT Drs. 16/4026,
p. 18.

Articles
ing policies and urban development.37 One particular other countries have tended to show positive effects for
worry was that rents might rise, based on the assumption tenants through professional management, and more
that REITs’ main concern would be to maximize efficient cost structures and maintenance.47
profits.38 However, these concerns do not appear to be
Similarly, fears of rising rents due to luxury renovations
fully justified, since German residential tenancy laws are
or profit-maximizing business strategies do not seem to
sufficiently strong that residential G-REITs are unlikely
be justified. In practice, institutional investors tend to be
to be able to raise rents much, even if they wanted to.
at least as cooperative and understanding as amateur
Germany’s attitude towards the possibility of REITs landlords, with a willingness to draft contracts to exclude
investing in residential property contrasts with the rent increases, lease terminations and the resale of the
United Kingdom’s, which does not restrict REITs from property or luxury renovations for a certain period of
investing in residential property. The United Kingdom time.48 But even without these kinds of safeguarding
saw REITs as having potential to help “address the prob- contractual agreements, tenants are well protected under
lem of the provision of affordable housing including for German landlord and tenant law, which is one of the
key workers in areas of high house prices”, 39 whereas the world’s most comprehensive and favourable as far as ten-
German government feared that REITs might cause a ants’ rights are concerned.49 Sec. 559 of the German Civil
steady increase in rents and a decline in affordable hous- Code (Bürgerliches Gesetzbuch, BGB) limits rent
ing. increases in cases of modernization to 11% annually.
Moreover, only costs of modernizations increasing the
Both the UK and the German residential housing sectors
“utility value of the leased property” – a term that
differ from the North American one. In the United King-
excludes the costs of luxury modernizations – can be
dom, investments in the private rented and residential
passed on to tenants. A landlord may increase the rent up
property sector have increased in recent years, leading to
to the level of the reference rent that is customary in the
a significant expansion in the “buy-to-let” market. 40 Even
locality concerned,50 but only if there have been no prior
so, over 70% of privately rented housing remains in the
rent increases within the last 15 months and the rent
hands of landlords who manage only a small number of
increase does not exceed 20% within the last three years.
properties.41 Consequently, there initially might be few
These aspects of the comprehensive tenancy law frame-
potential properties suitable for institutional REIT
work under the BGB suggest that tenants are not likely to
investments on the market in the short term. In the
become deprived of any rights if their property is taken
longer term, however, specialized residential REITs are
over by a REIT. The BGB provides sufficient protection
expected to develop newly purpose-built rental flats in
for tenants and there seem to be no rational reasons for
locations of high demand. Different REIT structures are
excluding residential property as an investment target.
also expected to emerge due to this, with institutional
investors entering the market, smaller companies mer- Compared to the sale of residential properties to private
ging or, in the best possible scenario, even facilitating equity funds, which is already common practice,51 the
access for small companies to the REIT market. 42 Unlike sale of property to a REIT might even be the more
the German experience, the UK government at an early socially advantageous alternative, considering that
stage saw REIT investments as a means to increase REITs’ investments tend to be longer term than those of
investments by institutional investors in the residential private equity funds. Perhaps incongruously, there are no
sector, 30% of which comprises the private rented and restrictions under German law preventing foreign REITs
social housing sectors.43 from investing in German residential property. Barring
only German REITs from residential property invest-
Considering that no other county seems to have
imposed restrictions on investments in residential prop-
erty, it is questionable whether the concerns of German
legislators are justified. During the development of the 37. Id.
UK REIT regime, some even suggested introducing an 38. Id. and Deutscher Mieterbund, “Wohnungspolitk muss Mieterinteressen
Berücksichtigen” (November 2006, available at www.mieterbund.de).
obligatory requirement that REITs hold a certain per- 39. HM Treasury and Inland Revenue, supra note 15, Para. 1.13.
centage of their assets as residential property.44 Accord- 40. Id., Para. 1.11.
ing to the discussion document produced by the BFW, 41. Id., Paras. 1.11 and 2.43.
42. Savills L & P Limited, supra note 7.
there is no evidence of a conflict between a REIT’s policy 43. Kate Baker, “Review of Housing Supply: Securing our Future Housing
objectives and Germany’s socio-economic objectives.45 Needs (Interim Report to the United Kingdom Government)” (2003, available
Large stocks of apartments held by communal bodies at www.hm-treasury.gov.uk).
have been suffering from a lack of maintenance and little 45. Sotelo et al., supra note 26, p. 2.
effective management. These apartments could be sold 46. Guido Eusani, “Regierungsentwurf zum Real Estate Investment Trust-
to REITs; thereby not only providing länder and commu- Gesetz (REIT-Gesetz) – nur eine kleine Lösung”, Neue Zeitschrift für Miet- und
Wohnungsgrecht (2007), p. 72.
nities with extra funds, but also avoiding further 47. Id., p. 73.
expenses caused, for example, through cost-intensive 48. Id., p. 72.
demolitions of inefficient and rundown buildings.46 49. Michael Voigtländer, “Mietwohnungsmarkt und Wohneigentum: Zwei
Seiten einer Medaille” (November 2006, available at www.hypverband.de).
Contrary to the concerns of interest groups and the Ger- 50. Sec. 558 BGB.
man legislators, experiences with private equity invest- 51. Oliver Puhl, “Deutsche Wohnungen im Focus internationaler Investoren
ments in residential property and residential REITs in – Dritte Welle von Investoren drängt auf den Markt”, Special Edition G-REITs
(Wolfratshausen: Going Public Media AG, 2006), p. 88.

Articles
ments seems inconsistent with the aim of ensuring com- Although these concerns are reasonable in one sense,
prehensive protection of the residential tenancy market gearing is an important and necessary capital source for
if foreign REITs can invest in communal and social any kind of company on the market. For REITs, some
housing freely. level of borrowing seems essential to be able to acquire
new properties and to meet unforeseen liabilities with-
The German government might, therefore, consider that
out having to hold large cash reserves.63 Considering that
half of German property holdings are in residential real
real estate requires ongoing maintenance, servicing and
estate, leaving a considerable amount of dead capital that
refurbishment, imposing gearing restrictions might hin-
could be better used.52 If Germany continues to restrict
der the effective and dynamic management of REITs and
REITs’ access to the residential property market, it might
their potential projects.64
find that German companies begin to establish REIT-
like structures that formally do not have REIT status,53 Gearing restrictions should also be considered in the
via holding structures on foreign markets,54 to circum- context of the distribution requirements REITs in all
vent German restrictions. Instead, Germany should regimes must comply with. The rule that a REIT must
ensure that the G-REIT is internationally competitive to distribute around 90% of its income to its shareholders
prevent more German real estate landing in the hands of leaves the vehicle with few net proceeds and little finan-
foreign REITs, a process that has already started – for cial scope to manoeuvre. Consequently, if REITs are
example, in 2006, 40,000 apartments were taken over by restricted in their borrowing power, the capital markets
a French REIT, listed on the Paris stock exchange.55 are their only viable source of finance, through increases
Unless German REITs are permitted to participate in the in share capital and private or public stock offerings. 65
residential property market, it is hard to see how they Raising money in this way can be costly and is not always
will become competitive with international REITs. in the interests of existing shareholders.66 The issue is
even more acute in the context of the current economic
It is worth remembering, however, that simply permit-
downturn, where REITs are finding themselves in
ting REITs to invest in residential property does not
straightened circumstances. The United Kingdom has
ensure that they will do so. The United Kingdom hoped
faced criticism from the property industry for its failure
that UK-REITs would invest in residential property, but
to relax the gearing ratio or take other measures to help
to date there are no residential REITs in the United King-
REITs.67
dom.56 Opinions on why there is institutional reluctance
to invest in residential property differ, with some blam- In practice, the average debt ratio of REITs in the United
ing the fact that yields from residential property in the States has generally been below 55% for much of the last
United Kingdom have historically been low and such decade and around 65% of REITs are rated investment
investments require considerable administrative effort. 57 grade, which is also due to their relatively moderate
Others, however, blame defects in the UK-REIT regime leverage levels.68 Accordingly, in spite of the fact that
itself, in particular, the application of stamp duty land
tax.58 Whatever the underlying reasons, the failure of
52. Sibeth Partnerschaft, “Legislation – Optimistic Start for G-REITs?”, avail-
UK-REITs to move into residential property investment able at www.sibeth.com.
is regarded by many as an indication of overall poor 53. On synthetic REITs in general, see Volkert Volckens, “Der Synthetische
design of the United Kingdom’s REIT regime. REIT – Mehr Als Nur Plan B?”, Beiten Burkhardt Rechtsanwaltsgesellschaft
mbH (November 2006, available at www.deutsche-boerse.de).
54. Eusani, supra note 46, p. 71.
2.3. Gearing restrictions 55. “Franzosen kaufen 40 000 Wohnungen”, Die Welt (6 October 2006). See
also Peter von Barkow, “Der G-REIT aus Kapitalmarktsicht – Die Struktur
Although there are no gearing restrictions in the US entscheidet über den Erfolg”, Special Edition G-REITs, supra note 51, p. 68.
REIT regime, both the UK and German legislators chose 56. United Kingdom House of Lords Select Committee on Economic
Affairs, “The Finance Bill 2009” (Third report of session 2008-2009), 23 June
to impose borrowing limits on REITs when designing 2009, Para. 258.
their own regimes. The G-REIT’s leverage is limited to 57. Id., Para. 263.
55% of the value of its immovable property. The UK 58. Id., Para. 261.
59. Guidance GREIT 02200.
regime indirectly limits gearing by imposing a tax charge 60. HM Treasury and Inland Revenue, supra note 15, Para. 2.3.1 and Euro-
if the finance cover ratio falls below 1.25. The United pean Public Real Estate Association (EPRA), “EPRA Global REIT Survey”
Kingdom’s reasoning was that REITs should not be bur- (August 2007, available at www.epra.com).
61. HM Treasury and Inland Revenue, supra note 15, Para. 2.3.1.
dened with high debt servicing costs that would reduce 62. German Bundestag Commentary on the G-REIT Bill BT Drs. 16/4026,
profits and result in fewer potential distributions to p. 23.
investors,59 thereby transferring returns from income 63. HM Treasury and Inland Revenue, supra note 15, Para. 2.3.2.
64. Petersen, supra note 15, pp. 9-14.
oriented to capital oriented.60 The intention was to create 65. Id. McCall, supra note 9, p. 5; and HM Treasury and Inland Revenue,
a structure different from that of an ordinary property supra note 15, Paras. 2.3.2 and 2.3.3.
company,61 as well as to ensure that REITs maintained 66. Petersen, supra note 15, pp. 9-14.
67. United Kingdom House of Lords Select Committee on Economic
sufficient financial power and stability. The gearing Affairs, “The Finance Bill 2009” (Third report of session 2008-2009), 23 June
restrictions set out under the UK and German regula- 2009, Para. 250.
tions lie significantly below the level of less risk-averse 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 of
private equity funds, which are typically 90% to 95% REITs have increased significantly over the last 18 months, however, in
leveraged.62 response to market pressures. See Larry Light, “Cracks in the REIT Rally’s
Foundation”, Wall Street Journal (5 September 2009, available at
www.wsj.com).

Articles
there is no restriction on gearing under the US regime, The US experience might lead to questioning whether
US-REITs tend to have made moderate rather than the German and UK exit tax and entry charge were set at
excessive use of debt financing. They are, nevertheless, sufficiently low levels so as not to discourage potential
free to have a high leverage if needed to finance property investors from transferring property to REITs. Too oner-
acquisitions or other necessary investments. As far as ous a charge discourages existing property vehicles from
investors are concerned, they can choose whether they converting to REITs and investors from transferring
wish to invest in a more or less risk and cost-adverse property to a REIT,75 although the UK and German legis-
REIT, as long as they are aware of the REIT’s leveraging lators are presumably well aware that too low a charge
practices and debt servicing costs involved. creates a way for entities to dispose of built-in gains
without giving rise to taxable events. With these con-
Worldwide, permitted gearing levels for REIT structures
cerns in mind, the UK entry charge seems to have been
vary significantly. However, in many countries, there are
set at a relatively low and reasonable level. France, for
no borrowing restrictions imposed on the vehicle, as is
example, set a 16.5% exit charge on latent capital gains on
the case with the successful and established Australian
properties transferred to REITs.76 The French charge is a
and Japanese REITs.69 Given these international exam-
50% tax reduction on the capital gains tax normally
ples, it seems likely that the UK and German REIT mar-
payable on the transfer of assets.77 In the United King-
kets could benefit from a less restrictive position on
dom, however, industry bodies called for a total tax
gearing.
exemption on capital gains released on conversion to
REIT status. The motivation for suggesting such a gener-
2.4. Exit tax and entry charges
ous rule seems to have been a feeling that any tax charge,
The United States, the United Kingdom and Germany however minimal, might prevent offshore vehicles from
have each taken distinct legislative positions regarding returning.78
the tax consequences of transferring assets to REITs. In
The German entry charge, on the other hand, could per-
the United States, there is generally no tax-privileged
haps have been set lower. A 50% tax reduction for capital
treatment for the transfer of property to a REIT or the
gains realized on conversion is certainly within the range
conversion into a REIT. “Built-in gains” are subject to
of reasonableness, but it is worth noting that during the
corporate income tax, as are other kinds of capital gain.70
consultation period in the United Kingdom, practition-
An exemption may apply if the REIT concerned holds
ers had considered a tax amounting to around 10% of
the assets in question for at least 10 years, i.e. if it does
embedded capital gains reasonable.79 It remains to be
not sell them or enter into any other kind of taxable
seen how innovative practitioners will be in developing
transaction with those assets during that time. 71
more advanced REIT structures that reduce the tax bur-
Both the United Kingdom and Germany have chosen den for investors.
not to follow the approach of the US model. They were
Which out of the UK and German approaches is most
anxious to ensure that their respective REIT regimes did
effective, in practice, probably depends on the specific
not produce an overall loss in tax revenues for the state.72
circumstances of each market. The more built-in capital
Under the UK regulations, built-in gains realized on the
gains potential REITs have, the more favourable the
transfer of property are tax-free. However, there is a 2%
United Kingdom’s flat 2% entry charge on the property
flat tax conversion charge on the market value of the
rental business assets seems. In any case, the three-year
property rental business assets. In Germany, by contrast,
transition period granted by the German legislators in
the conversion into a REIT or sale of properties to a
providing for a reduced exit tax seems short, given that
REIT always constitutes a taxable event. However, there
the REIT market will need several years to develop. This
is a 50% tax reduction (exit tax) for the gain realized on
projection seems particularly true in the light of recent
the transfer. This privilege was limited until 1 January
events in the global real estate market, which will delay
2010 and is subject to further restrictions. 73
the full development of new REIT industries for some
The tax treatment of built-in gains set free on the trans- time. Full taxation on conversion or transfer of property
fer of property to a REIT or conversion of an entity into
a REIT is an important aspect of all REIT regimes. The
US experience has shown that the taxes arising on con- 69. HM Treasury and Inland Revenue, supra note 15, Table 2.1.
version deterred companies from directly converting 70. Built-in gains are gains from the appreciation of property that must be
recognized on conversion to a REIT.
into REITs. Instead, practitioners developed advanced 71. EPRA, “EPRA Global REIT Survey” (December 2008, available at
structures that allowed for a tax-free or tax-deferred www.epra.com), p. 250.
transfer of property. The introduction of the UpREIT 72. HM Treasury and Inland Revenue, supra note 15, Para. 4.5.
73. Sec. 3 Income Tax Law (Einkommensteuergesetz).
structure, which gave investors a way to avoid taxation 74. McCall, supra note 9, p. 8.
on built-in gains, led to a significant revival of the REIT 75. Berwin Leighton Paisner & DTZ Group, “Promoting More Flexible
market in the 1990s.74 No corresponding structures have Investment in Property (Joint Submission to HM Treasury & Inland Rev-
enue)” (2004, available at www.blplaw.com), Para, 2.17 and Petersen, supra
been developed in Germany or the United Kingdom, but note 15, p. 11.
this is perhaps not surprising given the relatively recent 76. EPRA, supra note 60, p. 27.
introduction of these regimes and the global recession 77. HM Treasury and Inland Revenue, supra note 15, Para. 4.5.
78. Id.
that immediately followed their introduction. 79. Berwin Leighton Paisner & DTZ Group, supra note 75 and Von Barkow,
supra note 55, p. 77.

Articles
to a REIT certainly deters potential investors if at least most literally true of US-REITs, which may deduct dis-
some postponement of the tax or relief is not granted tributions to shareholders from their taxable income).
under specific circumstances.80
The three regimes share an underlying philosophy, but
the manner in which they put this philosophy into prac-
2.5. Taxation at the corporate level
tice differs. In particular, there are differences as to the
Under Germany’s REIT regime, all income and capital scope and type of income that has to be distributed. Ger-
gains are exempt from corporate or trade income taxes, man REITs, which are tax exempt regardless of the
irrespective of whether the income stems from real source of their income, must distribute 90% of their total
estate-related sources or not. In contrast, UK-REITs are net income.88 In contrast, REITs in the United Kingdom
not totally exempt from corporate and trade income tax are required to distribute 90% of only their tax-exempt
simply by virtue of being REITs; rather, only the profits income from property rental business. They are not
that stem from their property rental business are tax- required to distribute any particular percentage of their
free.81 All other income, including income from a REIT’s income that does not enjoy tax privileges. The distinc-
interests in other REITs, is fully taxable.82 This difference tion between tax-exempt and non-tax-exempt income
in tax treatment means that UK-REITs have more free- for distribution purposes might have a positive effect on
dom to engage in secondary activities related to real UK-REITs’ ability to hold cash reserves.89 The difference
asset management than G-REITs. At the same time, how- in the distribution requirements between G-REITs and
ever, the income from those activities of a UK-REIT is UK-REITs are a necessary consequence of the different
fully taxable.83 The fact that non-property rental income tax regulations, considering that only UK-REIT income
is not tax privileged in any way might encourage UK- that stems from property rental business is tax exempt,
REITs to engage primarily in property rental business, whereas the G-REIT’s total income is subject to the tax
which was after all the United Kingdom’s aim in intro- privilege. The distribution requirement, therefore, corre-
ducing a REIT regime.84 sponds to the respective tax exemption granted under
the regimes.
In the United States, dividends that are distributed to
shareholders are deducted when calculating a REIT’s Similar to the German regime, the relevant US rules
income.85 All retained income and capital gains are sub- require REITs to distribute 90% of their taxable income,
ject to corporate income tax. The downside of this but income in this respect excludes capital gains. 90 In
approach is that it encourages the entity to distribute practice, US-REITs might feel tempted or even com-
more of its income than is legally required to take advan- pelled to distribute a higher percentage, since only dis-
tage of the tax privilege. US-REITs are, therefore, disin- tributed income is exempt from taxation.91 Conse-
clined to hold cash reserves, which may become prob- quently, some US-REITs have only small amounts of net
lematic if unforeseen circumstances arise. proceeds readily available for investments or other
expenditures.92 This result is a downside of the distribu-
The German REIT regime offers the most comprehen-
tion requirement: REITs have only a small amount of
sive tax exemption at the entity level, totally and person-
retained earnings that can be invested in growing the
ally exempting G-REITs from corporate and trade
businesses internally.93 Another consequence is that
income tax. The German approach is, perhaps, preferable
REITs are highly dependent on rising funds from the
to the UK one, which makes the tax exemption depend-
capital markets and through borrowing (although bor-
ent on the type of activity the income stems from.86 Dis-
rowing is also restricted in Germany and the United
tinguishing between two types of REIT income unneces-
Kingdom).
sarily complicates the already complex tax regimes for
UK-REITs and their managers. At the same time, how-
2.7. Legal form and minimum share capital
ever, it is difficult to assess which method of entity taxa-
tion is better overall as this question is closely tied with In the United States, a REIT can be of any kind of US
the policy objectives of the particular national regime. 87 entity (for example, a partnership, corporation, limited
2.6. The distribution requirement 80. Andreas Knebel, “Einbringung von Immobilien in REITs – Steuer-
rechtliche Anreize zur Mobilisierung von Immobilienbeständen”, Special Edi-
One of the core requirements of any REIT regime is that tion:G-REITs, supra note 51, p. 64.
REITs must distribute most of their profits to sharehold- 81. The authors have described the mechanics of this tax treatment in more
detail in Fritsch, Prebble and Prebble, supra note 1, 4.9.
ers. REIT regimes aim to allow small investors the 82. Secs. 105(3)(c) and 119(2) Finance Act 2006.
opportunity to invest in real estate in a similar way to 83. Katrin Gänsler, “REITs in Deutschland und Großbritannien – ein Ver-
large investors who are able to invest directly. Accord- gleich”, Internationales Steuerrecht (2007), p. 104.
ingly, a key component of any regime must necessarily be 85. Internal Revenue Code (IRC), Sec. 857.
a requirement that the indirect investment vehicle actu- 86. Uwe Stoschek and Helge Dammann, “Internationale Systeme der
ally pays out its profits to its shareholders regularly. Con- Besteuerung von REITs”, Internationales Steuerrecht (2006), p. 407.
87. Berwin Leighton Paisner & DTZ Group, supra note 75, Para. 2.14.
sequently, the US, UK and German REIT regulations 88. Sec. 13(1) G-REIT Act.
require REITs in each country to distribute the lion’s 89. Gänsler, supra note 83.
share of their income to shareholders. In return for doing 90. IRC, Sec. 857.
91. Id.
so, they receive a tax exemption (this quid pro quo is 92. Petersen, supra note 15, pp. 8-12.
93. McCall, supra note 9, p. 5.

Articles
liability company or business trust), as long as it has Although there is no minimum share capital requirement
elected to be treated as a domestic corporation for tax under the US REIT regime, both the German and the UK
purposes.94 The REIT regimes in the United Kingdom legislators introduced a minimum share capital require-
and Germany are more restrictive, requiring REITs to be ment for their structures, i.e. EUR 15 million104 and GBP
established in a certain legal form. There is only one per- 50,000,105 respectively. A REIT might, indeed, require a
mitted legal form for G-REITs: that of the stock corpora- higher minimum capitalization than a normal stock cor-
tion (Aktiengesellschaft, AG) under the German Stock poration, due to the increased costs arising from the
Corporation Act (Aktiengesetz, AktG).95 UK-REITs must obligatory stock listing and related publication require-
be closed-ended companies that are tax resident in the ments. Nevertheless, the increase in the normal mini-
United Kingdom, although their place of incorporation mum share capital requirement for stock corporations
may be elsewhere.96 under the German regulations from EUR 50,000 to EUR
15 million is an enormous one, thereby further prevent-
In Germany, the stock-listed AG is an established vehicle
ing smaller companies from entering the REIT market.
for indirect real estate investment in form of the “Immo-
bilien-AG”, a vehicle investors are already familiar with,
2.8. The scope of REITs’ business activities
although the structure has not been particularly success-
ful.97 Even on the international stage, the AG is a recog- The UK REIT regime contains a rule requiring REITs to
nized corporate structure. This legal form was not the hold at least three separate assets.106 The existence of this
only possible vehicle considered, however: during the rule is perhaps surprising, since neither the German nor
development stage of the German REIT regime, one the US rules provide for a corresponding requirement.
model that enjoyed a considerable measure of support The requirement to hold a minimum of three properties
was the trust model, which is similar in form to the struc- prevents highly specialized UK-REITs from investing in
ture provided for under US law.98 German lawmakers just a single property, such as a hotel. A shopping mall, on
ultimately rejected the trust option, probably because the other hand, would be an eligible property for REIT
there is no tradition of trust structures being active in investments because the individual shops are considered
the German market, and legislators were concerned that to be separate properties, being units that are designed,
the unfamiliar structure would make investors wary of fitted and equipped for separate rental.107 Malls and
participating. Furthermore, there was no existing legal hotels are clear cases on either side of the single-property
framework in Germany that would support the kind of line, but there are many potential borderline cases where
trust structure that a REIT would require. German law it is not clear how this requirement will be interpreted in
contains provisions for trusts, but they do not provide the long run. It is difficult to guess at the motivation for
for a separation of the real assets from the actual stock the UK rule, but one possible reason for its inclusion
corporation, as a REIT regime relying on the structure might have to been provide for a minimum diversifica-
would require.99 Faced with these impediments, Ger- tion for investors, in view of the fact that one of the rea-
many’s decision to use the AG structure for its REIT sons for the regime’s enactment was to provide smaller
regime seems reasonable. investors with opportunities to invest in diverse property
portfolios.108 This explanation is not fully satisfactory,
In the United Kingdom, the main question regarding
because surely smaller investors would also benefit from
legal form was whether to opt for an open-ended or a
being able to invest in single-property REITs, but in the
closed-ended vehicle. The advantage of choosing an
absence of any other rationale it is probably correct.
open-ended structure would have been that there are
already well-established products on the market, such as
authorized unit trusts and open-ended investment
companies, which are familiar to investors. However, the 94. IRC, Sec. 846(a).
UK legislators ultimately decided in favour of a closed- 95. Sec. 3 G-REIT Act.
96. Sec. 134 Finance Act 2006.
ended vehicle, with one of the determining factors being 97. Eusani, supra note 46, p. 66 for an explanation of the many drawbacks of
that there are a number of dangers inherent in investors’ Immobilien-AGs.
redemption rights in open-ended structures, which is a 98. For example, Initiative Deutsche Wohnimmobilien – REITs, “Schriftliche
Stellungnahme zum Entwurf eines Gesetzes zur Schaffung Deutscher Immo-
requirement to qualify for authorization as a collective bilien-Aktiengesellschaften mit Börsennotierten Anteilen” (prepared for the
investment scheme.100 Open-ended vehicles investing in German Bundestag (28 February 2007, available at www.bundestag.de).
illiquid assets such as real estate might encounter diffi- 99. Hanspeter Gondring and Yvonne Weick, “Formen von REITs als indi-
rekte Immobilienanlage”, Special Edition G-REITs, supra note 51, p. 27.
culties if they can be required to redeem units on 100. HM Treasury, Inland Revenue, supra note 15, Paras. 2.15-2.17.
request, since real assets might be difficult to liquidate 101. Id.
quickly or only under unfavourable market conditions at 102. Id.
103. See Berwin Leighton Paisner & DTZ Group, supra note 75, Para. 2.6.
the time of the request.101 As a result, existing open- 104. Sec. 4 G-REIT Act.
ended structures for real estate investment have been 105. The minimum share capital requirement is a requirement of listing on
unable to invest all of their assets in property,102 which is the London Stock Exchange, rather than a requirement of being a UK-REIT
per se. UK-REITs must be listed, but they do not necessarily need to be listed
another reason why they did not seem the ideal legal on the London Stock Exchange. Any recognized stock exchange suffices, so, in
form for a REIT structure. Furthermore, considering that theory, it is possible for a UK-REIT to be subject to a different minimum share
there are already open-ended structures on the market, a capital requirement, depending on the exchange it lists on.
106. Sec. 107 Finance Act 2006.
closed-ended structure would mean more diversifica- 107. Guidance GREIT 02030.
tion and flexibility for investors.103 108. HM Treasury and Inland Revenue, supra note 15, Para. 1.22.

Articles
In order to justify their tax privileges, REITs’ core busi- Permitting property development, at least for REITs’ own
ness is typically limited to passive real estate activities. portfolios, was essential for the two European REIT
National legislators typically do not intend their REIT structures. One of the hoped-for results of introducing
regimes to provide tax advantages to property develop- REIT regimes in the United Kingdom and Germany was
ers. The UK and German regimes are good examples in that property that was initially in poor condition would
this respect: both countries impose restrictions on their be taken over by REITs and improved. REITs in those
REIT structures regarding property development activi- countries obviously had to be permitted to undertake
ties. Aside from the letting and leasing of property, the property development activities for this result to occur.
Gesetz zur Schaffung deutscher Immobilien-Aktienge- Furthermore, permitting some measure of property
sellschaften mit börsennotierten Anteilen (“the G-REIT development activity ensures the vehicles’ competitive-
Act”) limits a G-REIT’s activities to real estate-related ness. Retail investors benefit if the quality of the invest-
ancillary activities regarding the entity’s own portfolio. ment is maintained through development, which, in
This restriction includes property development. Activi- turn, should improve REITs’ performance over the long
ties for third parties may only be rendered through tax- term. With regard to property development undertaken
able REIT subsidiaries. However, the general scope of on behalf of third parties, however, UK and G-REITs are
activities of such taxable REIT subsidiaries is limited to unlikely to be appropriate vehicles due to their borrow-
real estate-related ancillary services. This limitation ing restrictions and high mandated distribution levels. 112
means that G-REITs may not generate “bad income” In addition, considering the level of risk that normally
from non-real estate-related sources, such as pure oper- attaches to property development projects, the investors
ating services provided to its tenants (for example, that REIT regimes hope to attract are unlikely to be
through hotel management, security services, etc.). interested in property development projects.
The US regime is less strict. In the United States, 5% of a Both property investment and effective portfolio man-
US-REIT’s income may stem from non-qualifying agement involve selling properties from time to time.
sources. The United Kingdom is even more liberal, per- However, REITs are generally not designed as property
mitting 25% of REIT income to be non-qualifying, trading vehicles, as the expectation is that they receive
although this income does not receive the same tax ben- income from holding properties, rather than from sell-
efits as qualifying income. ing them. The G-REIT Act, therefore, imposes the
restriction that, over a five-year period, G-REITs may
Like the G-REIT, the US-REIT may develop real estate
dispose of property generating profits of only up to 50%
only for its own portfolio. Unlike the G-REIT, however,
of the average market value of its property over that
US-REITs may conduct real estate development for third
same period.113 The US and UK regimes are more flexi-
parties via taxable REIT subsidiaries. The scope of activ-
ble: US-REITs can trade property through taxable REIT
ities a US-REIT may undertake through taxable sub-
subsidiaries114 and UK-REITs can do so within their
sidiaries seems significantly broader than that of the G-
quota of non-qualifying income. Once a property is sold
REIT. Taxable REIT subsidiaries in the United States
“by way of trade” or is “developed for sale”, it crosses line
were at one stage permitted to perform only “customary”
from ring-fenced to taxable non-ring-fenced activi-
real estate services to tenants, but even this mild restric-
ties,115 but there are no restrictions on the type of non-
tion has now been lifted.109 Not restricting the services
qualifying income.116
taxable REIT subsidiaries may engage in enables US-
REITs to provide a wider range of competitive services to In the United States, a REIT’s property may be leased to a
their tenants (for example, Internet or cleaning services). taxable REIT subsidiary. The taxable REIT subsidiary
The income from those services ultimately benefits the can then use the property to, for example, provide serv-
US-REIT and its investors – an opportunity that is not ices to the REIT’s tenants. One kind of property that is
available for G-REIT investors. often managed in this way is a hotel building, as long as
the hotel is managed by a third-party manager.117 Under
In the United Kingdom, property development is per-
the UK regulations, the rules on “owner-occupied” prop-
mitted only when it is related to a REIT’s investment pur-
erty result in property not being considered part of a
poses – for example, if a UK-REIT intended from the
REIT’s property rental business if it is leased out to
beginning to retain a building or buildings as investment
companies in which the REIT holds a controlling inter-
rental property.110 Practitioners had called for an unlim-
est.118 At the same time, UK-REITs are free to hold
ited amount of development activity to be permitted
owner-occupied property themselves, within the 25%
under 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 towards
property development.111 Gains from the sale of devel- 109. Due to reform under the Taxpayer Refund and Relief Act of 1999.
oped properties within three years of completion are 111. Berwin Leighton Paisner & DTZ Group, supra note 75.
taxable. However, UK-REITs can conduct further prop- 112. HM Treasury, Inland Revenue, supra note 15, Para. 2.35.
erty development either within their 25% quota of tax- 113. Sec. 14 G-REIT Act.
114. EPRA, supra note 60, p. 223.
able activities or through taxable subsidiaries. Neither 115. Guidance GREIT 04040.
option is possible under Germany’s REIT regime. 116. Guidance GREIT 4505.

Articles
quota of non-qualifying assets. Although there are no ests. These interests are generally convertible into com-
comparable rules on owner-occupied properties under mon REIT stock.121
the German regulations, the G-REIT regime is more
Conflicts might well arise between the original property
restrictive than either the US-REIT regime or the UK-
owners, now holding interests in the umbrella partner-
REIT one in terms of permitted activities. The German
ship, and the common REIT shareholders. This is
rules do not allow REITs to engage in any kind of non-
because the former property owners and the stockhold-
real estate-related activities, not even through a taxable
ers in the REIT are following different objectives with
service subsidiary. This restriction deprives investors of
their investments. The latter are generally interested in
a reasonable portion of revenues that could be generated
maximizing their dividends and stock appreciation,
from these kinds of businesses.
whereas the individuals contributing property are gener-
The United States originally had more restrictive rules ally more concerned about tax privileges and diversifica-
regarding permitted activities for taxable REIT sub- tion.122
sidiaries, but it relaxed these via the Taxpayer Refund
In an UpREIT structure, the REIT holds the position of
and Relief Act of 1999. The Act amended the regime so
general partner of the limited partnership. As such, the
that taxable REIT subsidiaries can now provide both
REIT is responsible for the administration and the man-
“customary” and “non-customary” services to tenants.
agement of the partnership’s properties as well as for its
The real estate industry warmly welcomed this move and
strategic direction.123 The publicly listed REIT is, in turn,
some credit the amendment with reviving the REIT mar-
owned by stockholders, who, through the REIT as gen-
ket. Even though taxable REIT subsidiaries are subject to
eral partner, also have a say regarding the umbrella part-
full corporate income tax, US-REITs as well as their
nership’s management.124 If or when the UpREIT limited
shareholders benefit from the income generated from
partners make use of their right to convert their limited
“synergistic” businesses and enable the REIT to be man-
partnership interest into common stock of the REIT, the
aged more effectively.119 Despite these experiences of
interests of the initial property owners are likely to coin-
reform and its effects on the US market, the German
cide with those of the stockholders to a considerable
legislators opted for more restrictive regulations, which
extent. However, the original property owners may have
might turn out to be disadvantageous for the G-REIT’s
different interests with respect to some transactions. 125
competitiveness and performance in the long run.
Potential conflicts of interest between the limited part-
2.9. REIT governance and conflicts of interest ners of the umbrella partnership and the REIT’s share-
holders may arise from many ordinary business transac-
There are various disclosure and publication require-
tions, generally involving differing economic or tax
ments that deal with conflicts of interest under the US
concerns. For example, the sale of property might have
securities laws – in particular, the Securities Act of 1933
severe tax implications for the limited partners, who
and the Securities Exchange Act of 1994. In spite of these
must recognize built-in gains released on the sale, 126
safeguards, governance issues still arise from time to
whereas the shareholders are not exposed to this tax liab-
time in relation to REITs. Most common are issues sur-
ility and, therefore, might favour a sale that is perceived
rounding transactions between REITs and their affili-
as economically disadvantageous by the limited part-
ated entities. For example, issues may arise if entities
ners.127 Similarly, conflicting tax interests may arise
owned by a REIT, or affiliated with a REIT or members
regarding the paying-down of umbrella partnership debt
of its management, manage or lease that REIT’s proper-
from property acquisitions with REIT funds or regard-
ties. Furthermore, there may be conflicting interests with
ing merger and acquisition activities.128 In merger and
regard to office space or services provided by a REIT to
acquisition scenarios, it can easily happen that the stock-
its affiliates or by the affiliates to the REIT, or the REIT
holders’ and limited partners’ interests are diametrically
acquiring properties owned by its affiliates or members
opposed. The shareholders might want to accept a high
of its management.120 Generally, such conflicts of interest
cash tender offer, whereas the limited partners might
are triggered by parties’ different financial or tax inter-
favour a stock swap, even though it is worth less in value,
ests with regard to a specific transaction.
Some varieties of REITs that have developed in the
United States produce heightened opportunities for con-
flicts of interest. One such structure is the UpREIT,
which was developed to circumvent the problem of 119. McCall, supra note 9, p. 6.
120. Id., p. 15.
built-in gains being taxable on the transfer of property to 121. Chadwick Cornell, “REITs and UpREITs: Pushing the Corporate Law
a REIT. UpREITs do not directly hold interests in real Envelope”, University of Pennsylvania Law Review (1997) 145, p. 1578.
assets. Instead, an UpREIT holds a direct interest in an 122. Id., p. 1566.
123. See, generally, Robert W Hamilton, Fundamentals of modern business
“umbrella limited partnership” (this is the “Up” of the (Boston: Little Brown, 1989), Para. 13.5.
name) of which the UpREIT is the general managing 124. Cornell, supra note 121, p. 1581.
partner. The umbrella partnership (also referred to as the 125. Id.
126. IRC, Sec. 704(c).
REIT’s operating partnership), in turn, directly owns 127. Russel J. Singer, “Understanding REITs, Up-REITs, and Down-REITS,
interests in property, contributed to the partnership by and the Tax and Business Decisions Surrounding Them”, 16 Virginia Tax
their owners in exchange for limited partnership inter- Review (1996), p. 335 and Cornell, supra note 121, p. 1586.
128. Cornell, supra note 121, pp. 1584-1592.

Articles
which would allow them to further defer gains instead of a different standard of review.140 The significantly higher
having to recognize them on the sale.129 potential for conflicts of interest that the UpREIT struc-
ture presents when compared to a standard corporation
2.10. Judicial review in cases of conflict of interest make it seem inappropriate to apply the “business judge-
ment” rule to fiduciaries of UpREITs automatically.
In a small number of cases, courts in the United States
Instead, a more frequent and higher level of scrutiny
have addressed conflict of interest issues in REIT struc-
should be applied to the board’s decisions. 141 However, a
tures, in particular, in relation to conflicting interests
fair balance has to be found between the common stock-
between the board or a controlling limited partner and
holders’ interests and those of the limited partners who
the REIT shareholders. Although most cases are rooted
originally contributed their assets to the umbrella part-
in the federal and state tax laws, they effectively concern
nership with the objective of saving taxes. When assess-
the decisions of corporate fiduciaries, since the board
ing the board’s fiduciary duties, it is important to remem-
members have fiduciary duties towards the stockhold-
ber that many of the controlling individuals are
ers.130 Generally, courts have treated REITs like any other
professional or experienced real estate investors pursu-
body corporate, i.e. reverting to the standards of review
ing their own financial interests. The original intention
developed in corporate litigation, when reviewing deci-
and policy reasons proclaimed when enacting the early
sions of UpREIT fiduciaries.131
REIT laws were, however, to further the cause of the
One rule that is likely to be applied to business decisions small, middle-class investor.
of corporate fiduciaries is the “business judgement rule”,
under which the court presumes “that in making a busi- 2.11. Avoiding conflicts
ness decision, the directors of a corporation acted on an
In practice, REITs try to avoid potential conflicts of
informed basis, in good faith and in the honest belief
interest by appointing boards of trustees or directors
that the action taken was in the best interest of the com-
that can be considered to be independent in an effort to
pany”.132 This also transfers the burden of proof from the
balance any conflicting interests between the REIT man-
board to the plaintiff.
agement and the shareholders.142 Many institutional
Additional tests and burdens of proof are applied on the investors as well as underwriters see the formation of an
board in the case of takeover bids. The board must show independent board of directors as a necessary precondi-
“good faith and reasonable investigation” in reaching a tion for publicly listing a REIT.143
decision, as well as the proportionality and reasonable-
In the US context, the NAREIT has adopted a code of
ness of its decision, before it may take advantage of the
ethics, which requires member REITs to have a largely
business judgement defence.133 Generally, boards have
independent board of trustees or directors.144 In practice,
been considered to have a broad scope of discretion in
making decisions. A much stricter standard of review
may, however, be applied under the “entire fairness” test
in cases where there is actual evidence that the fiduciar- 129. Id., p. 1588.
ies took a decision conflicting with the shareholders’ 130. Id. The fiduciary position of the board members towards the stockhold-
ers is recognized as a fundamental concept of corporate governance. See, for
interests.134 In these circumstances, the burden of proof example, Arnold v. Society for Sav. Bancorp., Inc. (1996) 678 A.2d 533, 540 (Del.)
is placed on the board, which has to prove the “entire fair- and Harden v. Eastern States Pub. Serv. Co. (1923) 122 A. 705, 712 (Del.Ch.).
ness” of the transaction in terms of fair dealing as well as 131. See Paramount Communications, Inc. v. QVC Network, Inc. (1993) 637
A.2d 34, 44 (Del.) and Realty Acquisition Corp. v. Property Trust of Am. (1989)
financial and economic considerations.135 Another sce- No CIV. JH-89-2503, 1989 WL 214477, at 3 (D. Md. Oct. 27), where the courts
nario where courts apply an increased level of scrutiny is applied the general principles of review applied in corporate governance liti-
where decisions are intended to affect or impede the gation to REITs. Up to the mid-1990s, many UpREITs were incorporated in
Maryland. With favourable legislation being enacted in other states, they now
shareholders’ voting power.136 For example, the board choose the state where they are located. Nevertheless, Delaware serves as a
might try to manipulate the shareholders’ voting rights good example, because it still is the “most persuasive precedent” in the area of
by amending the by-laws or increasing the size of the state corporate law (see Cornell, supra note 121).
132. Aronson v. Lewis (1984) 473 A.2d 805, 812 (Del.) and Cinerama, Inc. v.
board, as happened in Blasius Industries v. Atlas Corp.137 Technicolor, Inc. (1995) 663 A.2d 1156, 1162 (Del.).
In such circumstances, the board bears the burden of 133. Unitrin, Inc. v. American Gen. Corp. (1995) 651 A.2d 1361, 1372 n.9 (Del.)
proof and must demonstrate a “compelling justification 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.
for such action”.138 Lynch Communication Sys. (1994) 638 A.2d 1110, 1115 (Del.).
135. Cornell, supra note 121, p. 1595.
Courts seem to have applied these doctrines to REITs 136. Blasius Industries v. Atlas Corp (1988) 564 A. 2d 651 (Del. Ch.) and Schnell
easily enough.139 However, the UpREIT structure is far v. Chris-Craft Industries, Inc. (1971) 285 A.2d 437 (Del).
more complex and gives rise to more potential conflicts 137. Blasius Industries v. Atlas Corp (1988) 564 A. 2d 651 (Del. Ch.).
138. Id.
of interest than more straightforward corporate entities. 139. See Paramount Communications, Inc. v. QVC Network, Inc. (1993) 637
Because of the relatively small number of UpREITs, there A.2d 34, 44 (Del.) and Realty Acquisition Corp. v. Property Trust of Am. (1989)
is little litigation to date dealing specifically with this No CIV. JH-89-2503, 1989 WL 214477, at 3 (D. Md. Oct. 27) for examples of
cases where courts applied the general principles of review applied in corpo-
structure. Nevertheless, due to the many potential con- rate governance litigation to REITs.
flicts with regard to UpREIT governance and the popu- 140. Cornell, supra note 121, p. 1600.
larity of this structure, more litigation can be expected in 141. Id., p. 1567.
the future. Some commentators consider that, due to the 143. Id.
unusual characteristics of UpREITs, courts should apply 144. Available at www.reit.com.

Articles
REITs also incorporate provisions in their by-laws areas within commercial real estate.151 Regardless of real
requiring that, in the previously noted scenarios giving estate and economic business cycles and downturns, it
rise to potential conflicts of interest, decisions regarding seems clear that they will remain.152 Apart from relatively
the sale of properties must be made by independent stable and above-average returns over the last decades, 153
trustees or directors.145 Moreover, the individual part- there are a number of further multifaceted benefits
nership agreements of a REIT structure may need to be inherent in this structure that make it particularly attrac-
shaped differently to satisfy the individual interests in tive.
view of the varying financial and tax situations and inter-
However, it seems clear now that the heyday of REITs is
ests regarding certain properties.146 For example, the
over. The astounding success that REITs enjoyed during
REIT as the general partner of the Up or Down-REIT
the late 1990s and the first half of the 2000s was closely
partnership may even be barred from selling specific
tied to the real estate boom, which became a real estate
pieces of property contributed to the partnership. 147
bubble. The structural benefits of the REIT model cer-
Aside from compliance with applicable SEC rules and tainly played a large role in allowing investors to access
provisions of state business codes, REITs must also the extraordinary profits that were available, but the pri-
ensure that they comply with any relevant stock mary reason for the success of REITs was the success of
exchange regulations (for example, the US Stock real estate. Post-bubble, it is hard to see how REITs could
Exchange and New York Stock Exchange regulations) ever reach their previous heights. Real estate prices are
which require shareholder approval for certain transac- cyclical, and the current slump will end eventually, but it
tions. Private, unlisted REITs should examine the North is unlikely that real estate prices will ever reach 2006 lev-
American Securities Administrators Association’s poli- els again, and it is, indeed, better that they should not.
cies on oversight and administration with regard to bor-
Nevertheless, the fact that REITs will never again be the
rowing and investment practices.148 As with any corpora-
runaway profit vehicles that they were for the decade
tion, the establishment and effective operation of
from 1995 to 2005 does not mean that there is no future
independent bodies to review the REIT’s accounting
at all for REITs. Their tax advantages mean that they are
practices and policies are crucial.149
usually the most favourable vehicle for property invest-
ment. The UK and German REIT regimes were intro-
2.12. UK and German cases
duced with high expectations, and the regimes’ initial
REITs in the United Kingdom and Germany are subject performance was very encouraging, especially in the
to the same corporate governance principles as any other United Kingdom.154 Forecasts are more subdued now,155
major company in those jurisdictions. However, consid- but the inherent benefits of REITs remain unchanged.
ering that the UK and German REIT regimes have been Both the UK and German regimes perhaps could be
operating for not quite three years, it will take some time revised to encourage investors to embrace the new vehi-
until the first REIT cases involving with conflicts of cles more enthusiastically, but fundamentally the
interest and governance are heard. regimes are sound. The role of REITs is likely to change
to that of a quiet achiever, rather than a star player, but
Perhaps surprisingly, the problem of possible conflicts of
this development should be seen as positive, as it reflects
interest was barely discussed in consultations for an
the true nature of real estate as an investment.
appropriate REIT format in the United Kingdom and
Germany. This absence might be due to the fact that the Essentially, REITs thrive wherever there is money to be
legislation itself only sets the basis for REITs. That is, the made from property investment. Most developed
legislation provides for a basic structure, consisting of economies are experiencing steep declines in property
just one entity. These entities must ensure their compli- values, but in some countries that are at a less advanced
ance with the laws governing capital markets and deal stage of development, property continues to be a growth
with conflicts of interest in the same way as any other sector. One example is China,156 where property prices in
corporation of their type. The German Stock Corpora- urban areas are expected to continue to rise for at least
tion Act also incorporates a Corporate Governance
Code (Deutscher Corporate Governance Kodex), drawn
up by the government,150 which companies are recom-
mended to comply with. However, once practitioners 146. Singer, supra note 127, p. 336.
start developing more advanced REIT structures with 147. Id.
affiliated companies, the United Kingdom and Germany 148. Id.
might have to face governance issues similar to the ones 150. Sec. 161 AktG.
experienced in the United States. 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).
3. Outlook and Concluding Remarks 153. NAREIT, compound annual total returns in per cent, December 1976 –
December 2006 at www.nareit.com.
3.1. Future international REIT developments 154. For example, Ernst & Young, supra note 33, p. 18.
155. United Kingdom House of Lords Select Committee on Economic
Although real estate investment trusts have become an Affairs, “The Finance Bill 2009” (Third report of session 2008-2009), 23 June
essential part of the market for indirect real estate invest- 2009, Paras. 322-323.
ment worldwide, they are still one of the less understood 156. See generally Noriel Rubini, “Are There Bright Spots Amid the Global
Recession?” (6 August 2009, available at www.forbes.com).

Articles
the next year.157 China has been considering enacting a pate in share ownership, not necessarily property invest-
REIT regime for some time now and, as at the beginning ment. PIEs are tax-preferred collective investment vehi-
of 2010, it appears that these plans will come to cles that, for investors, approximate the effects of holding
fruition.158 Similarly, other maturing economies, such as shares directly, rather than through a collective invest-
India and Pakistan, are putting their own plans for REIT ment vehicle. Under initial drafts of the PIE regime,
regimes into action.159 companies and trusts that invested primarily in property
were excluded from the proposed regime:165 it was felt
In the United States at least, REITs are experiencing a
that whilst New Zealanders needed encouragement to
minor revival as vehicles for purchasing troubled mort-
invest in debt and equity securities, they did not need
gage assets. If structured correctly, such REITs can be eli-
any encouragement to invest in property. However, the
gible for government funding via the Troubled Asset
draft regime was eventually amended to allow “Land
Relief Program, and thereby receive both tax benefits
PIEs” – PIEs that have one or more share classes that
and also a discount on financing costs.160 Although these
invest primarily in property holdings.
structures have the potential for great success, i.e. by buy-
ing troubled assets at a discount and selling them when There are some restrictions on Land PIEs over and above
the market recovers, it is not clear whether they will be those on other PIEs. For example, losses from Land PIEs’
successful ultimately. Although, in theory, it should be land investments are ring-fenced from Land PIEs’ other
easy to purchase troubled mortgage assets from banks investments, but, by and large, Land PIEs receive the
and other financial institutions, in practice, such organi- same tax benefits as other PIEs. Essentially, as far as tax is
zations are reluctant to sell at large discounts because of concerned, investors in Land PIEs are placed in a similar
the knock-on effect such sales would have for the valua- position to direct investors in property. Whilst it perhaps
tions of the assets they continue to hold.161 Furthermore, did not intend to do so, by enacting the PIE regime, New
the “discount” price for which such REITs can purchase Zealand enacted a REIT regime, although the PIE regime
troubled assets may well turn out not to be a discount at covers a good deal more than property investment.
all, but, in fact, an overvaluation of the assets once their Entities that refer to themselves as REITs sprang up
long-term performance becomes clear. Nevertheless, the quickly once the PIE regime was enacted.166
fact that REITs are being used for this kind of structure
Global REIT surveys of the kind published by account-
suggests that innovation in the REIT market is far from
ing firms and industry bodies tend to treat New Zealand
over. The tax benefits of REITs mean that they will
as not having a REIT regime,167 although occasionally
always be the best vehicle for real estate investment.
some surveys include New Zealand REITs,168 presum-
ably on the basis that the PIE regime allows for essen-
3.2. Quasi-REITs
tially similar entities to be created.
The basic REIT blueprint has been used to encourage
investment in assets other than real estate. New Zealand 3.3. The outlook for REITs
has an interesting example of this kind of national mod-
The US example shows how important a responsive reg-
ification. Unlike the position in a number of other juris-
ulatory environment is for growth in REIT markets. The
dictions, there has been little call in New Zealand for the
story of US-REITs has been a history of cycles. Phases of
development of a specialized property investment vehi-
increased growth have been preceded by favourable reg-
cle. Property investment in New Zealand does not seem
ulatory changes,169 thereby facilitating market access or
to have suffered from the lack of such a vehicle. The main
reasons are probably twofold. First, New Zealand has no
comprehensive capital gains tax; this absence leads in 157. “Property prices soar in China and analysts predict 20% increases by
general to over-investment in land. Secondly, New 2010” (13 August 2009, available at www.propertywire.com).
Zealand employs a full imputation system for taxing 158. Brad Markoff and Mabel Lui, “China REITs – What’s the Latest?”, DLA
Piper Newsletter (January 2009), p. 1.
companies.162 That is, companies may pass credits for all 159. Id.
corporate-level tax to their shareholders. Shareholders, 160. For example, Kate Berry, “REITs reclaim stage as way to cash in on crisis”
in turn, subtract these credits from tax otherwise payable (31 July 2009, available at www.bankinvestmentconsultant.com).
161. Adam Weinstein, “PennyMac IPO exposes REIT weaknesses” (4 August
on dividends.163 Full imputation is as close as a corporate 2009, available at www.dsnews.com).
tax system can go to the impractical ideal of full integra- 162. Subpart OB Income Tax Act 2007.
tion of company and dividend taxes. As a result, prop- 163. Subpart LE Income Tax Act 2007.
164. New Zealand’s PIE regime was introduced in the Taxation (Savings and
erty-owning companies in New Zealand probably Miscellaneous Provisions) Act 2006. Subparts CP and HL of the Income Tax
appear to suffer less from both corporate lock-in of Act 2007 now address the income of PIEs.
profits and double taxation of company profits than do 165. New Zealand Inland Revenue, “Commentary on the Taxation (Annual
Rates, Savings Investment, and Miscellaneous Provisions) Bill”, pp. 8-9.
property-owning companies in many jurisdictions: 166. For example, the NZ-REITs referred to in Anne Gibson, “Listed property
hence there is little if any demand for a specialized prop- sector ‘starved for cash’” (13 May 2009, The New Zealand Herald, available at
erty investment vehicle. Nevertheless, New Zealand did www.nzherald.co.nz.
167. For example, EPRA, supra note 71 and PricewaterhouseCoopers,
enact something very like a REIT regime two years ago, “Worldwide Real Estate Investment Trust (REIT) Regimes: Country Sum-
albeit almost by accident. maries”(June 2009, available at www.pwc.com).
168. For example, Ernst & Young,“Global REIT Report 2008” (October 2008,
Since 1 October 2007, New Zealand has had a Portfolio available at www.ey.com).
Investment Entity (PIE) regime.164 The purpose of the 169. Tobias Just, “Was Europa von US-REITs Lernen Kann”, Deutsche Bank
Research (November 2006, available at www.dbresearch.de).
PIE regime is to encourage smaller investors to partici-

Articles
operating conditions for REITs. There was a significant problem. Germany has addressed this issue with the new
increase in REIT investment after 1986, when REITs Sec. 19(a) of the G-REIT Act, which partially eliminates
were permitted to conduct (taxable) non-qualifying this double taxation.171 The United Kingdom also
activities without losing their REIT status. Similarly, the appears to be re-examining some aspects of its regime,
REIT boom in the early 1990s was spurred on by the although so far officials have focused on minor matters,
introduction of UpREITs and regulatory changes per- rather than what critics have identified as the more
mitting REITs to provide non-customary services pressing problems with the regime.172
through their taxable REIT subsidiaries. More recently, a
In the medium term, further legislative changes can be
relaxation in the provisions relating to distribution of
expected both in the United Kingdom and Germany to
profits has to some extent eased the path for US-REITs
encourage growth in the REIT market.173 Germany, in
and allowed them to try to take advantage of new oppor-
particular, should reassess its legislation, since it is at a
tunities arising out of the mortgage crisis that started in
disadvantage in relation to the UK-REIT industry
2007.170
because of the United Kingdom’s reputation and long
The UK and German regimes seem comparatively tradition as a financial centre. If Germany wishes to
restrictive and unresponsive to changing market condi- compete with other European and international REIT
tions. Although the main reason for the relative lack of models over the long term, it must offer features that per-
success of the two European regimes is certainly the suade investors to choose the G-REIT over other struc-
global recession and a general distaste for real estate tures. Legislating for a regime providing for private
investment, some blame must fall on poor regime design. REITs is a possibility. In the United Kingdom also, a
In particular, the UK and German gearing limits seem relaxation of the regulations governing the UK-REIT
too restrictive. Moreover, private REITs could have pro- would encourage more property companies to con-
vided an attractive complementary investment option vert.174 Otherwise, as the US case reveals, those
for both markets. The German prohibition on REITs companies will become takeover targets by large and
investing in most residential property seems counter- efficient REITs that will finally dominate the market. 175
productive. Along similar lines, the UK rule providing
that REITs must hold at least three properties seems to
do nothing other than block opportunities for invest-
ment and growth. The success of single-property REITs
in the United States makes this requirement seem 170. Vivian Marino, “Some REIT dividends are part stock, part cash”, New York
Times (25 January 2009, available at www.nytimes.com).
notably perverse. 171. Provided that the income in question has already been taxed in the state
in which it arose at a rate of 15% or higher.
Both the United Kingdom and Germany seem to be 172. United Kingdom House of Lords Select Committee on Economic
addressing defects in their REIT regimes, at least to some Affairs, “The Finance Bill 2009” (Third report of session 2008-2009), 23 June
extent. In the case of Germany, a number of industry 2009, Para. 249.
173. Ernst & Young, supra note 33, p. 18.
participants identified the quasi-double taxation of 174. Savills L & P Limited, supra note 7.
REIT income generated from foreign real assets as a 175. Id.

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