German institutional investors seeking diversification should “take a close look” at listed real estate investment trust (REIT) vehicles, according to Dirk Söhnholz, chief executive at Veritas.

Listed real estate has yet to form part of most German institutional portfolios, and with diversification hard to achieve via direct investment, the REIT structure offers investors an alternative route into property, Söhnholz said.

The only other option, he said, was closed-end funds and German open-ended funds, which are much less liquid.

REITs, he said, are not equity sector funds but a “separate asset class in its own right and not a short-term fad but a long-term necessity”.

The main reason for institutional investors’ collective “inertia”, he said, has been the perception that REITs behave like equity sector funds, not as an alternative for exposure to real estate.

“We are beginning to see increased interest from institutional investors in REITs,” Söhnholz said.

However, Söhnholz acknowledged, drawing on his previous experience at institutional consultancy Feri, that there was “still a lot of convincing to do” if Germany were to emulate the Netherlands, where large pension funds are quite keen on listed real estate.

Söhnholz also cited a 2012 Swiss Finance Institute study as the “most profound” analysis of the subject to date.

The ‘Are REITs Real Estate?’ report states that “while the short-term co-movement between REITs and stocks is typically stronger than that between REITs and direct real estate, REITs are likely to bring a similar exposure to various risk factors as direct real estate into a long-horizon investment portfolio”.

REITs are, the report said, are also expected to have similarly attractive diversification characteristics as direct real estate investment in the long term, at least in the US and UK, he said.

Söhnholz noted that REITs and real estate equities were chosen from a global portfolio according to various quality and value criteria, with ESG and ‘extreme value-at-risk screening’ coming top of the list.

Söhnholz said ESG was another area where German investors still “needed convincing”.

“Now they accept it – if they are sure it does not cost performance,” he said. “But we are aiming to generate outperformance from this ESG screening.”

Geographically, real estate REITs consist mainly of equities from the Asia-Pacific region – mostly Australia – and North America and the US, said Chris Jakobiak, portfolio manager at Veritas.

European equities are also included, but “no stocks from either Germany or Austria have ever been selected – either because of a too-high tail risk or a shortfall regarding the ESG criteria,” Söhnholz said.

He said this was unlikely to change in the near future.

Veritas, meanwhile, is looking to offer a similar product for infrastructure as well as bespoke mandates for institutional investors.

Pure core and basic infrastructure, such as grids and physical infrastructure, will be considered, rather than airlines or utilities, which are included by some infrastructure ETFs and are equities many investors already have in other portfolios, Jakobiak said.