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German funds look to Europe for returns

The German property funds which made such an impact on the UK property market are now spreading their net further afield, and they are already making their presence felt in France and Spain.
German agents calculate that the open-ended funds sold 16 UK properties - with a combined value of £360m (E525m)-in 1998. The largest disposal saw Despa sell One Exchange Square at Broadgate in the City of London to British land for £206m. But this should not be seen as a wholesale disinvestment, according to Andrew Yeandle of agent Strutt & Parker. Rather, it represents more of a repositioning," he says, pointing to a number of high-profile purchases by German funds late in the year. And John Rigg of DTZ Debenham Thorpe agrees. "Expectations that a possible weakening of sterling would encourage the Germans to liquidate assets were not realised and the total of around £440m invested by them reflects their willingness to remain in the UK market."
Key purchases include Despa's £140m forward commitment to a development at 25 Chiswell Street in the City and Difa's £59m purchase of the Readers Digest headquarters at Canary Wharf.
But while German sentiment to-wards London has been broadly neutral, there has been a marked upsurge in interest in other markets. France has been the main beneficiary, attracting over FFr2.9bn (E442m) of German money in 1998 from virtually zero a year previously.
German funds captured over 10% of the French property investment market last year, focusing almost exclusively on prime office properties in the best locations. But to secure these trophy properties they have been forced to pay top prices, in some cases accepting initial yields of lower than 6%. For example at the year end it was rumoured that an important German fund representing a consortium of German insurance companies was negotiating to buy 5-7 rue des Italiens for approximately FFr300m, producing an initial yield of 5.5%.
The removal of exchange rate risk as EMU approached was a key element in making France more attractive to German players, but other technical factors were involved as well. The French government has traditionally levied a transfer tax - the equivalent of the UK's stamp duty - of over 18% on all property sales, and this has been a disincentive to active portfolio management. A popular way of circumventing this punitive tax was to buy out the share capital in a company set up specifically to own the property, as share transfers attracted a much lower rate of tax. However, this route was blocked to the German funds by German legislation, which specified that they were only permitted to invest directly in bricks and mortar.
In 1998 two things happened to change this: firstly, German law was amended to permit the open-ended funds to invest through corporate structures and secondly, the French government moved to reduce the transfer tax, bringing it down to a more comfortable 6%. Equally in Spain, German funds have been increasing their market share. But here they have been more willing to venture away from the capital city and to build a balanced local portfolio which is not totally reliant on offices. For example, DGI bought the Gran Via Shopping Centre in Alicante from the Dutch/Spanish joint venture ING-Promodeico for Pts9.0bn (E54m). Belgium and the Netherlands also saw strong inflows from German investors, although this is part of a longer-established trend.
Looking ahead, cross-border activity by the German property funds looks likely to continue. The disappointing performance of the German DAX share index has led private investors to once again consider property as a safe haven for their investments. This means that the open-ended funds - which saw cash inflows dip during 1998 - could have even more to invest during 1999. With German property yields still among the lowest in Europe, they will be forced to look abroad in search of competitive returns.
Inevitably, Euroland will attract the majority of their capital because of the lack of exchange rate risk, but many expect the UK - as Europe's biggest and most liquid property market - to continue to attract funds.
DTZ's John Rigg notes: "While the UK remains out of EMU it may well benefit from capital seeking to diversify outside the Euro-zone.""

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