Specialised investment funds in Germany

17 September 2010

2007 saw the introduction of German real estate investment trusts (G-REITs). G-REITs have not yet become common. Specialised investment funds (SIFs) which are long-established in the real estate market and have been deregulated further, potentially provide an attractive alternative.

Against this background, this article examines:

  • G-REITS.
  • SIFs.
  • Setting up SIFs.
  • Managing a SIF.
  • Competitive advantages of SIFs.

1. G-REITs: an unsuccessful contender?

The long-awaited Law on the Creation of German Real Estate Stock Corporations with Shares Listed on Stock Exchanges of 28 May 2007 (G-REIT Law) came into effect retroactively on 1 January 2007.

The G-REIT is a real estate stock corporation (REIT-AG) with statutory domicile and its place of business in Germany. To qualify for G-REIT status and receive the accompanying tax benefits, specific restrictions and conditions must be fulfilled including that:

  • Its corporate objective is essentially limited to acquiring, holding and selling ownership or other rights in rem in real property.
  • At least 15% of the shares must be held by shareholders with no more than 3% of the voting rights in the G-REIT (free float requirement), and no shareholder can directly hold 10% or more of the shares or voting rights (maximum participation requirement).
  • At least 75% of the assets must consist of real estate. The equity of the G-REIT must be at least 45% of the assessed value of the real property.
  • Because the G-REIT has an advantageous tax regime (it is exempt from corporate income tax and trade tax), it has to pay at least 90% of the annual profit to investors as dividends. These dividends are subject to 25% withholding tax (and a 5.5% solidarity surcharge on the withholding tax), both for domestic and foreign investors.
  • To protect tenants, residential property built before 1 January 2007 cannot be held by a G-REIT.

G-REITs were introduced to encourage listed companies to invest in the real estate market, which was dominated by non-listed investment funds. However, as yet, G-REITS have not been successful, with only two launched so far, due to:

  • A difficult real estate market environment in general and for IPOs in particular.
  • The combined maximum participation requirement and tax regime, which may have discouraged foreign investors.
  • The exclusion of residential property, which forms a substantial share of the real estate market.

2. Specialised investment funds: a classic revisited

2.1 Background

Compared to G-REITs, SIFs (Spezial-Sondervermögen) have been a constant of the real estate market for some time. They are closed to small investors, and open only to corporate and institutional investors that do not require the same level of protection. Consequently, SIFs are subject to softer rules, allowing for more flexibility.

SIFs are not novel in Germany and have come back into the focus of attention. As of 28 December 2007, the Law Amending the German Investment Act (Gesetz zur Änderung des Investmentgesetzes) brought further deregulation. German lawmakers were reacting to a liberalisation that had occurred in Luxembourg in the same year.

2.2 Investors

Generally, individuals are barred from investing in a SIF. However, the German banking supervision authority (Bundesanstalt für Finanzdienstleistungsaufsicht, BaFin) tends to accept indirect investment by individuals through partnerships, requiring as a minimum for the partnership to have a representative body and a common pool of assets.

Aside from this, there is no restriction on who may hold shares. SIFs are therefore open to both national and international corporate investors. The previous limitation on a maximum number of 30 investors has been waived as of 28 December 2007, which should benefit smaller institutions.

2.3 Structure

SIFs share a common trait with other types of investment funds. They merely constitute a separate set of assets and lack legal personality. Therefore, a distinct corporate entity, the investment management company (Kapitalanlagegesellschaft), is needed to acquire and administer assets on the fund's behalf. The German Investment Act provides strict rules to ensure the SIF's assets are kept separate from the investment company's assets.

The fund's assets are entrusted to a depository bank for safekeeping. The bank, which also carries out supervisory tasks concerning the legality of fund transactions, must be based in Germany or be a German subsidiary of a bank based in the European Economic Area (EEA).

In practice, as SIFs only have a limited number of professional investors, they are able to closely monitor the investment management company's activities. The management company is assumed to act in consultation with the investors.

3. Setting up a SIF

3.1 Simplified authorisation

In principle, the contractual terms of an investment fund, which regulate the relationship between the investors and the investment management company, have to be approved by the BaFin. This applies if the investment management company is to be replaced by another, which also requires BaFin approval.

For SIFs that invest in real estate, the authorisation procedure has been relaxed. The contractual terms and any change in the investment management company do not have to be approved by the BaFin. Authorisation requirements are limited to the approval of the designated depository bank.

3.2 Prospectus

SIFs are exempt from the requirement to publish and distribute a selling prospectus.

3.3 Minimum capital and equity

Investment funds are not subject to minimum capital requirements, as the German Investment Act only targets the investment management company, which is subject to the following:

  • The investment management company must have at least EUR300,000 (about US$422,600) of initial capital.
  • If the total assets administered by it exceed EUR1.125 billion (about US$1.58 billion), it must in addition hold at least 0.02% of the value of the exceeding assets (maximum EUR10 million (about US$14 million)). Up to 50% of this additional equity can be provided as a financial guarantee issued, in principle, by an EEA-based credit institution or insurance company.
  • The company must always hold equity that covers at least 25% of the incurred costs, which is determined based on the profit and loss statement of the previous year's annual accounts.

Consequently, SIFs are not required to hold minimum equity.

4. Managing a SIF

4.1 Investment policy

While the German Investment Act is relatively strict on the investment policy of investment funds, this is no longer the case for SIFs. The reform effected on 28 December 2007 brought about considerable change. In principle, the only requirement SIFs are subject to is risk spreading.

Aside from this, SIFs can acquire any of the assets listed in section 2( 4) of the German Investment Act, provided the investors approve. This broad interpretation is shared by the BaFin. The list of assets includes:

  • Securities.
  • Money market instruments.
  • Derivatives.
  • Bank deposits.
  • Ownership or other rights in rem in real property, including comparable rights under foreign law.
  • Shares in real estate companies.
  • Shares in investment funds.

Consequently, a real estate SIF is not barred from taking other assets, such as securities or derivatives into its portfolio. However, SIFs that invest in real estate are subject to limitations on granting and raising credit and mortgaging real estate belonging to the fund.

In principle, a SIF can grant credit to a real estate company in which it owns shares provided it occurs under market conditions. However, the credit sum is subject to a double limit of 50% of the value of the real estate detained by the company and 25% of the SIF's assets.

The investment management company can raise a short-term credit on behalf of the fund of up to 30% of the fund's total assets value, and up to 50% of the market value of the SIF's real estate assets.

The real estate assets owned by the SIF can be mortgaged up to 50% of its market value.

4.2 Reporting obligations

The SIF's reporting obligations have been significantly reduced. The obligation to issue semi-annual reports has been removed. SIFs only have to issue an annual report which does not require publication or communication to the BaFin, unless required by BaFin.

4.3 Return of shares

The reform of 2007 has softened the rules on the return of shares. In principle, investment management companies are required to take back shares of an investment fund if the investor wants to return them.

However, according to the new German Investment Act, the contractual terms of a SIF can now provide that shares can only be returned at certain dates, at least once every two years. In addition, the SIF only has a limited number of investors. These factors can greatly mitigate the danger of investor panic leading to a return run, where the SIF's obligation to buy back shares could not be met without selling off real estate.

5. Competitive advantages of SIFs

The rules on German SIFs were further liberalised to meet the increased competition of Luxembourg-based investment vehicles, where the Law of 13 February 2007 on Specialised Investment Funds effected a similar deregulation.

Although not all issues have been addressed by German lawmakers, the SIF appears to have competitive advantages, including that:

  • Authorisation requirements have been greatly reduced.
  • SIFs do not require the set up and the publication of a prospectus.
  • SIFs are not subject to minimum capital and equity requirements, while the investment management company is required to have at least EUR300,000 (about US$422,600) as initial capital.

The SIF's tax regime is comparable to that of G-REITS, as the SIF is equally exempt from corporate income tax and trade tax, while the shareholders are subject to 25% withholding tax (and 5.5% solidarity surcharge on the withholding tax). The withholding tax applies both to dividends and to retained earnings. However, as the SIF is not listed on the stock market and not subject to free float and maximum participation requirements, it is more exclusive and less volatile. Without notable developments in the field of G-REITS, the SIF could prove to be more suitable for institutional investors.

 

Dirk-Reiner Voß and Daniel Barth, Salans LLP