Attempts to package property investments in a way that will appeal to pension funds are gathering momentum. Pension funds that do not want the hassle of buying and managing properties might be considerably more enthusiastic about property investments that are re-engineered as market-traded securities. One current initiative involves a UK-US link. Another is being promoted in Ireland.
But the history of real estate in Britain is littered with attempts to securitise properties as tradable pieces of paper. The past 20 years have seen plans for PINCs (property income certificates), SAPCOs (single asset property companies) and SPOTs (single property ownership trusts). With the possible exception of the SAPCO, which did not prove very attractive to the markets, these efforts have foundered on the UK's tax regime and the authorities' unwillingness to allow concessions for property.
The basic problem is that income from a property held via a company structure suffers deduction of corporation tax at 30% or 31%, and none of this loss can now be reclaimed by the pension funds. If they hold properties via a company, they only get 70% of the income they would receive from a property held direct. But holding property direct involves considerable management effort, and property often comes in individual chunks that are too big for the smaller funds.
Hence the search for tax-transparent vehicles which would allow the rental income from a property to reach the investor without prior deduction of tax. This is where the UK/US initiative comes in.
CIN La Salle in London, whose US parent company is the world's second biggest manager of real estate investment trusts (REITs), has plans to adapt this US vehicle for investment in UK property. It has canvassed pension fund investors and claims strong support for the idea in Britain and continental Europe, particularly in the Netherlands.
The REIT structure has two great advantages from the pension fund viewpoint. Under US tax law, provided at least 95% of income is distributed it flows through to investors without deduction of tax. And there is already an established $120bn market in REIT securities in the US, with the liquidity that implies.
CIN La Salle plans to establish a US REIT that would invest in UK property. It is now looking for initial investment and hopes to make the first property purchase this year. The idea is to seek a quote for the REIT in about two years, though this would depend on market conditions. Not least among the advantages of REITs in the US is the fact that their securities normally stand at a premium to net asset value - rather than the discount from which UK property shares suffer in the stock market. A market launch would therefore be timed to maximise the benefit from this premium.
It is also claimed that the REIT in the US moves in line with the property cycle rather than the equity cycle, mirroring more accurately a direct investment in property. UK property company shares, while they have a cycle of their own, are also influenced by general stock market trends.
The plans for a new property vehicle in Ireland are rather more modest. Property consultant Bill Nowlan, who proposed the idea many years back, has the support of a property unitisation group which includes real estate agents, accountants, lawyers, bankers and brokers. He says that it would be possible to launch a vehicle owning a single Irish property which would allow income to flow through to investors without deduction of tax. The securities of this vehicle would be quoted on the stockmarket and it could operate in a tax-transparent manner without any changes in the Irish tax regime. In Ireland's booming property market the search is on for a single property - probably in the Ir£10m price range - as a first candidate for securitisation.
However, the proposed structure exploits specific features of Irish taxation and property law. If the idea were to be extended to the securitisation of multiple properties in a single vehicle, or to the securitisation of overseas (perhaps British?) properties, then some changes in the tax regime would be a prerequisite.
In Britain, the real estate industry lives in hope that the tax authorities will abandon their opposition to tax-transparent quoted vehicles for property investment. But it has been hoping for all of 20 years. The attempts to develop overseas vehicles are good news nonetheless. If US REITs, for example, do offer a liquid and tax-efficient vehicle for investment in UK real estate, and British and continental European pension funds start channelling their UK property investment this way, the UK tax authorities will have to take note. The sight of a significant slug of the business moving overseas might persuade them to moderate their stance.
The UK is still Europe's most attractive location for property investment, but its lead is slipping as continental European markets come out of recession. These findings come from PRICOA Property Investment Management, the US-owned manager of three European property funds.
Pricoa publishes a quarterly review of the relative merits of the main European markets. The latest Euro Matrix shows the UK still well ahead, but Spain and the Netherlands are closing. The tables look at current prospects for rental and capital growth in each market, but they also compare other factors which affect investment decisions such as market liquidity, tax regimes and the balance of power between landlord and tenant under different lease structures.
The UK scores well for the current state of its market, with good short-term prospects for rental growth. It also scores highly for its property infrastructure - the tax regime and legal structures which surround property ownership. However, with the UK government pledged not enter EMU until 2001 at the earliest, Pricoa detects significant currency risk for international players looking to buy UK property.
It is significant that mainland Europe's two biggest property markets - France and Germany - remain firmly rooted to the bottom of the table, although Pricoa's sentiment towards France is gradually warming.
This is slightly paradoxical, because in the past year France has seen a wave of cross-border investment, especially from North American and UK investors. And in November an informal poll of European investors by agents Jones Lang Wootton found that Paris offices were the most sought-after property in Europe.
But according to Richard Plummer, chief executive at Pricoa Property Investment Management, there are fundamental problems with French property which militate against institutional investment. The main problem is an extremely unattractive tax regime," he says. "There is an 18.5% property transfer tax, with agents' fees on top, which means that, if you are in any way responsive to valuations, the day after you buy a French property you find your valuation is 20% below your book cost."
Plummer says that by structuring property acquisitions through corporate deals, some investors are able to halve the tax burden, "but it is difficult to find suitable properties with no skeletons in their corporate closet".
In addition, the conventional French 3/6/9 occupational lease means that investors only ever have a maximum of three years' certain income stream. "This doesn't compare favourably with the UK where there is typically 20 years-plus certainty, with no tax problems," says Plummer. Initial yields on Paris offices of 6-6.5% simply do not reflect the inherent drawbacks, he says, when compared with initial yields of around 6% on UK offices.
However, Plummer concedes that "the slight improvement in the French economy means that the market there is starting to revive".
The Netherlands is the fastest-improving market on Pricoa's calculations, reflecting the healthy domestic economy and the strong potential for rental and capital growth which follows on from this. In addition, the inherent liquidity of the busy Dutch property market is a strong attraction.
One market which performs well in the Euro Matrix but which features in very few international property portfolios is Denmark. But Pricoa has put its money where its mouth is and actually bought property there. Graham Parker"