INDUSTRY IMPLICATIONS OF THE REITS DEBATE IN

UNCLAS SECTION 01 OF 02 BERLIN 002344

SIPDIS

SIPDIS

STATE FOR EB/IFD, TREASURY FOR BRIAN COX

E.O. 12958: N/A
TAGS: ECON EFIN EINV PGOV GM
SUBJECT: INDUSTRY IMPLICATIONS OF THE REITS DEBATE IN
GERMANY

REF: 05 BERLIN 2269


1. SUMMARY: Germany's Finance Ministry is nearing the
completion of a draft law to legalize Real Estate Investment
Trusts (REITs). The decision to legalize REITs, however,
must first receive the approval of Chancellor Angela Merkel's
"Coalition" Cabinet, which is deeply divided on the issue.
While the Christian Democrats are in favor of REITs, some
members of the Social Democrats have been actively publishing
position papers and opinion articles in which they label
REITs as "locusts" and dangerous for the German housing
market. Industry experts believe that the legalization of
REITs could reinvigorate Germany's currently sluggish,
although potentially lucrative, real estate market (Germany's
real estate market is valued at an estimated USD 9.5
trillion). The finance and investment industry is especially
paying attention to the REITs debate, as experts believe its
outcome could be an important indicator of how other
finance-related legislation evolves. END SUMMARY.

REITS: TWO YEARS IN THE MAKING
--------------


2. A REIT is a property investment fund that allows real
estate holdings to be packaged as publicly traded companies
that pay dividends from rent proceeds and property sales.
The increased liquidity and transparency of being listed on a
stock exchange is expected to attract a new class of
investors, as well as more properties to the market. German
proponents look to the success of the REITs model created by
the United States in the 1960s and the experiences of several
European countries that, according to a European Public Real
Estate Association (EPRA) study, have REITs of their own
(France, Italy, Spain, Belgium, the Netherlands, and,
effective 1 January 2007, the UK). Finance Ministry
officials claim that, if REITs are legalized in Germany, the
market would be the largest in Europe; one estimate puts the
potential market value of REITs in Germany at up to USD 290
billion. The Finance Ministry, which first organized a
committee to discuss REITs in 2004, had hoped to introduce
REITs into the market by 1 January 2006. Several firms, such
as UBS, Morgan Stanley and Fortress, have already been
preparing to offer German REITs in the expectation of its
legalization, calling REITs "the hottest issue of 2006."


3. Political opposition to the introduction of REITs stems
from a fear that foreign investors will descend on Germany
like "locusts" and "prey" on the German real estate market in
search of profits -- to the detriment of local residents and
the federal government. (Note: The term "locusts" in
reference to foreign investment companies was originally
coined during the 2005 election cycle, when Social Democratic
Party's former Chairman Franz Muentefering called foreign
private equity firms in Germany "locusts". The word has
since been used not only to criticize the legislation
introducing REITs but also to call for greater regulation of
the hedge fund industry (reftel). End Note.) Under pressure
from the new Left Party, members of the Social Democratic
Party have taken the lead on criticizing the plans for
legalizing REITs, raising the concern that REITs will
increase the cost of rents to unaffordable levels and force
middle-class residents to seek cheaper housing elsewhere.
Even Chancellor Merkel has weighed in on the REITs debate,
noting that the "social consequences" of REITs must be taken
into consideration. Additionally, critics of REITs point to
the potential losses the government will assume as a result
of lost taxation revenue. With the on-going struggle to
close financial holes in the budget, this argument has
resonance in certain government circles. Through REITs,
investment firms can avoid high corporate taxation rates by
distributing all REITs profits to investors, who are then
individually taxed at a lower rate. Critics have also
pointed to the potential loss of government revenue as yet
another example of how foreign investment firms are taking
advantage of the German system.


4. Tensions within the "Grand Coalition" over the
legalization of REITs escalated just before the beginning of
its summer recess in June. After discussion in a Coalition
working-group on the REITs issue, the group Chairman,
Christian Democrat Leo Dautzenberg, announced that
disagreements over the legalization of REITs had been
resolved and that the Finance Ministry would begin drafting
the REITs law. His statement provoked an angry response from
SPD leaders that the group had not agreed on moving forward
and claimed that critical obstacles to the legalization of
REITs remained. Social Democrats went so far as to call

BERLIN 00002344 002 OF 002


Dautzenberg's announcement a "betrayal of trust" within the
Grand Coalition.

REITs IN GERMANY: ILLUSORY OR SOON TO BE REAL?
-------------- -


5. Embassy contacts at the Finance Ministry are hopeful of a
successful legalization of REITs in Germany, although they
acknowledge the political outcome is too uncertain to
predict. If all goes according to the Finance Ministry's
plan, the Coalition Cabinet will decide on the REITs draft
law 20 September 2006, the Parliament will begin discussing
it 19 October 2006, the Parliament's finance committee will
give its opinion on the law 29 November 2006, and the
Bundesrat will pass it 15 December 2006 so that the new
legislation can come into effect in the first part of 2007.
Coalition leaders and REITs advocacy groups, however, are
doubtful that REITs will be legalized before the end of the
year. Christian Democrats are supportive of the REITs
legislation and note that their legalization is now dependent
on whether Social Democrats decide to support REITs. Despite
the Finance Ministry's concrete plans, Social Democrats in
the Bundestag claim the REITs issue is currently at a "very
vague state," making its future political direction difficult
to assess.


6. Further complicating prospects for the legislation is the
recent negative press given to high-profile American private
equity firms investing in Germany's real estate market. In
late July, German newspapers and magazines reported that a
Texas-based private equity firm has been buying up mortgage
debt in Dresden and hiking the interest rates to the point
where families could no longer afford their monthly mortgage
payments. Other critical news stories have emerged to
tarnish the real estate investment industry. Finance
Ministry State Secretary Thomas Mirow also noted at a German
conference recently that REITs would inevitably suffer from
an image problem in Germany because of the general public's
deeply-rooted, cultural distrust of the finance and
investment industry.


7. Industry experts are especially anxious about the outcome
of the REITs debate in Parliament as the REITs draft bill is
the first opportunity for the industry to determine the
political parties' true positions on legislation for
promoting Germany's financial industry. Industry experts
hope that the introduction of REITs will be the first of
several finance industry-friendly laws passed under
Chancellor Merkel's watch. As early as this fall, the
Finance Ministry plans to propose to Parliament a wholesale
revision of the current investment laws in Germany, including
current hedge fund regulation laws, with an eye toward
reducing the regulatory burden on investment firms and
fostering Germany's finance industry (reftel).
KOENIG