Joint Recommendations to the European Commission on an EU Passport for Open Ended Real Estate Funds (OEREFs)

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1 Joint Recommendations to the European Commission on an EU Passport for Open Ended Real Estate Funds (OEREFs) by the European Landowners Organization, the European Property Federation, the Royal Institution of Chartered Surveyors and The European Group of Valuers Associations (description of each in Annex) 17 June 2008 ELO, EPF, RICS and TEGoVA support and request EU legislation enabling OEREFs to collect investment in host member states as easily as they can currently purchase property there. This would be a significant contribution to improving the Internal Market for Real Estate, providing, in particular, economies of scale and lower transaction costs. The Essential elements for a European regime for OEREFs outlined in the Expert Group Report generally correspond to what is needed. However, the future Commission Communication should project a more balanced view of the range of real estate investment vehicles, avoiding the impression given by the drafting of the Expert Group report that OEREFs merit priority intervention by the EU legislator because, supposedly, obstacles to their cross-border business are somehow greater than for other vehicles such as real estate investment trusts (REITs), or because OEREFs would be the superior, safer retail investment vehicle. Also, certain aspects need to be carefully reviewed by the Commission, in particular valuation. I. An EU passport for OEREFs should be taken forward without delay, but it should be part of an overall EU strategy for cross-border real estate investment Real estate investment is not yet part of the Commission s culture. The various directorate generals have only recently become conscious of the challenges of cross-border real estate investment, and they have approached the subject in a piecemeal manner, with perhaps insufficient coordination between Commission services. DG TAXUD catalogued the obstacles to cross-border business by REITs and the Treaty issues that they raised 1. These problems and their solutions were also addressed in a Maastricht University report 2 and brought to the Commission s attention by the European real estate industry represented by the same signatories to these recommendations and the Urban Land Institute Europe 3. 1 Taxation Issues of REIT Schemes in the Community DG TAXUD GT4/07026/doc/en The EU REIT and the Internal Market for Real Estate Prof.dr Piet Eichholtz and Drs Nils Kok Maastricht University November Letter to Commissioners Kovács and McCreevy ELO, EPF, RICS, TEGoVA, ULI Europe 6 November

2 The signatories to these recommendations will soon present the Commission with a more detailed plan for REITs, and we see no problem in the meantime with making progress on OEREFs, but EU legislation for OEREFs must stand on its own merits and the Commission Communication should avoid giving the impression, pervasive in the Expert Group report, that OEREFs merit priority treatment based on two rationales which, in our view, are flawed: 1) that listed real estate companies have a greater capacity to benefit from EU cross-border investment freedoms and 2) that OEREFs are the superior, safer, real estate investment product for the retail market with comparatively low default risk, easy redemption and high liquidity. We believe that: 1. Listed real estate investment companies do not have a greater capacity to benefit from the Internal Market, precisely because their investment vehicle of choice is the REIT, and REITs can only enjoy the key tax transparency benefits of that investment vehicle if they set themselves up as a separate REIT in each member state with REIT legislation, just as OEREFs need to establish a separate company in each member state in order to attract funds. 2. As for OEREFs being the superior retail product, it is easy to argue the contrary: that REITs are in fact the superior retail instrument due to easier and far more accurate valuation, based on daily stock market pricing (as compared to OEREFs appraisal valuations which are often laggard, smoothed valuation), higher transparency, less redemption risk, better liquidity and less systemic risk. In particular, liquidity requires a product suitable for both retail and professional investors, because the professionals provide the liquidity that retail needs. Only REITs create this liquidity; institutional investors will not favour OEREFs. Furthermore, OEREFs are not pure real estate instruments; they also have to include money market instruments to cover redemptions, all of which carries increased transaction costs. In fact, it is the market which will decide which instrument is best, and for whom. In the meantime, in the Commission s Communication, as in its overall plan for a legislative framework for the Internal Market for Real Estate, OEREFs should be viewed and presented objectively and in the context of the entire real estate investment market and its various vehicles. Giving the EU brand only to OEREFs would distort the market because it would sway non-sophisticated/retail investors in OEREFs favour, to the detriment of other possible instruments. Investors need several alternative investment vehicles to choose from. II. Valuation is a key part of the legislative package. Commission work on this must go much farther than the Expert Group report, because if it gets this component wrong, it will undermine the credibility of the whole product. Valuation in the report seems to be treated as an afterthought as well as being fragmented, with no real overall structure. The Commission needs to review many important aspects: 2

3 1. Frequency of valuation The Expert Group report s chart on essential elements of a European OEREF regime (page 31) suggests that the EU rule be that valuation take place on a regular basis not exceeding one year; but exceptional situations will require more regular valuations to avoid unit pricing based on stale values. That turn of phrase suggests that valuation at one year intervals could be the norm outside of exceptional situations. This is different from the rules prevailing in most OEREF member states. For instance, UK funds have valuations done quarterly, monthly or even every two weeks. The not exceeding one year proviso can be retained so as to accommodate existing practice on markets where a low degree of valuation frequency works satisfactorily, but the Commission s stance should be neutral and avoid phraseology linking more frequent valuations to exceptional situations. 2. Fair Market Value and Market Value There seems to be a confusion of terminology. EU legislation on OEREFs must acknowledge that market value is key. 3. The valuation standards to be used The Expert Group report refers to "international valuation standards". We recommend that this would be better expressed as internationally recognised valuation standards. This is in view of the fact that in addition to International Valuation Standards (produced by IVSC), the RICS red book and TEGoVA s European Valuation Standards (EVS) are also commonly applied in Europe. RICS and TEGoVA both support the role of IVSC and seek to ensure that their standards are aligned with the requirements of IVS. 4. Valuation and the sale and purchase price In the Expert Group report, page 45, under Ideal regulatory features of an EU regime on OEREF, subsection 2(ix) sale and purchase price, it is stated that The OEREF may not buy a property at a price significantly higher or sell a property significantly lower than the valuation price determined by the independent valuer.. This does not take account of grouped selling of properties by a fund. If the fund sells, say, a lot of ten assets, it may sell at a discount to the price that could be obtained by the sale of each property separately. It might be more than the 5% deviation the Expert Group regards as significant. 5. Notification of the valuer to the regulator This requirement is listed in the report s chart of Essential elements for European regime for OEREFs. In many OEREF countries there is no such requirement. Indeed, the regulator is not qualified to judge one valuer against another. What criteria would be used for the judgement and who would set them? The name of the valuer should be mentioned in the OEREF s prospectus, semi and annual reports. 3

4 6. Minimum professional indemnity insurance cover This is not mentioned in the report s recommendations for essential elements of a European regime, and yet it should be. If a valuer s appraisal turns out to be, say, considerably more than 10% out, the fund unit holders can sue the valuer or valuation company for errors and omissions. Basic security for a European framework requires that minimum professional indemnity insurance cover be stipulated. III. Taxation questions There is a three-level tax structure within OEREFs. First, at fund level, second at management level, and third at investor level. The tax regime within these three levels is organised differently from one member state to another. In Germany for example, the fund is tax transparent, i.e. its income is taxed on the management level and on the investor level. The spread out and taxation of the fund's income between the management company and the investor is a complex issue and follows national taxation policy. The principle is that most of the fund income shall be paid out to and be taxed on the investor level (in order to get high return on equity). But this varies from one country to another. Some members of the Expert Group shared the view that an EU OEREF passport would require tax harmonisation of these three levels, i.e. what is paid out by the fund to the management company has to be taxed equally in Europe and the same regarding the tax treatment of the unit's income at investor level. This is redundant, because there is no need to harmonise the tax regime for a European passport. A management company might well be able to sell the units cross border even if it has an underlying higher tax rate than a management company of another member state. The same applies to the investor level. No passport obstacle would arise either if a member state decided to conceive the fund as a non-tax transparent structure. In Germany for example, the income from OEREF units is considered as interest revenue and taxable under this category of income. If other member states were to decide to treat this income as rental income, this would not prevent the units of the fund from being sold cross border. In the end, the tax regime of OEREFs, the level of the tax rate at management company level and the spread out of the fund's income between the management company and the investor are nothing else than competitive issues. If there is a high tax burden 'at source', the profitability of the unit for the end-investor will be lower - he might therefore not invest, but why not grant the passport? 4

5 Contacts ELO: Marie-Alice Budniok Tel: EPF: Michael MacBrien info@epf-fepi.com Tel: RICS: Sander Scheurwater sscheurwater@rics.org Tel: TEGoVA: Wolfgang Kälberer kaelberer@pfandbrief.de Tel:

6 ANNEX About the signatories of these recommendations European Landowners Organization (ELO) Created in 1972, ELO promotes a prosperous and attractive European Countryside. ELO is a unique federation of national associations from the EU27 and beyond which represents the interests of landowners, land managers, rural entrepreneurs and family businesses. It targets its actions on land use and housing, via seven major areas of European importance: environment, renewable energy, agriculture and rural development, status of private property and companies, forest, enlargement and trade. European Property Federation (EPF) EPF represents all aspects of property ownership and investment: residential landlords, housing companies, commercial property investment and development companies, shopping centres and the property interests of the institutional investors (banks, insurance companies, pension funds). Members own and manage property assets valued at 800 billion. Royal Institution of Chartered Surveyors (RICS) RICS is the largest organisation for professionals in property, land construction and related environmental issues worldwide, promoting best practice, regulation and consumer protection to business and the public. With members, RICS is the leading source of property related knowledge, providing independent, impartial advice to governments and global organisations. The European Group of Valuers Associations (TEGoVA) TEGoVA is the European umbrella organisation of national valuers associations, covering 39 professional bodies from 24 countries comprising specialist consultancies, major private sector companies and government departments both local and national. Its main objectives are the creation and spreading of harmonised standards for valuation practice, for education and qualification as well as for corporate governance and for ethics for valuers. It speaks with a common voice on valuation to European legislators and policy makers. 6