German Funds
... contributed by the investors and the investments made by the investment company on their behalf. Apart from the normal rules and regulations of German banking law, a strict set of rules regarding permitted investments, minimum number and relative size of investments, borrowings as well as disclosure and reporting obligations apply. For example, an open-end fund must have at least 10 properties in its portfolio. However, to spread risk, none may exceed 15% of the total fund volume. Furthermore, there is a limit to the amount of funds they can invest in development projects, currently set at 20% of total fund volume. A relatively new concession is that open-end funds can now invest indirectly in real estate companies under the conditions that they own at least 51% of the company and that the real estate company has no more than three properties. The total value of third party investments cannot exceed 20% of total fund volume. Current legislation also limits spending abroad to 20% of total funds available. 2.2 Special Funds ( Spezial Fonds) This is a derivative form of the Public Fund and is offered to institutional investors rather than private investors. The founder and leading provider is Oppenheim Immobilien-Kapitalanlage GmbH in Wiesbaden and this product is now widely provided by open-end funds. An added attraction is that special funds are treated as direct investments in real estate. Accordingly, this does not effect the allocation of funds, which they are allowed to invest in shares. These special funds are limited to a maximum 10 institutional investors, and each has a direct say in which properties are purchased. If one investor objects, the investment will not proceed. Although this can complicate management, it does give the investor a greater degree of control. 2.3 Liquidity One of the most important advantages of an open-end fund is that the shares are tradable securities. Consequently, there is an unlimited guarantee by the investment company to buy back shares held by investors. The share price is determined by the value of the fund assets divided by the total number of shares and is published daily. 2.4 Taxation In accordance with the KAAG (Investment Companies Act), open-end real estate funds are defined as special purpose funds for taxation purposes. The effect is that an open-end investment fund is not a company of its own, but an accumulation of assets without legal entity. Hence, they avoid corporation, trade and net asset value taxes. The level of taxation is, therefore, at the investors personal tax rate and with careful planning it is possible to avoid paying tax on a substantial part of proceeds and income. DGI (Deutsche Grundbesitz Investment GmbH) state in their company details that over the last 10 year period, the tax- exempt share has typically been around 50% for private investors. 3 Closed-End Property Funds 3.1 Brief History Closed-end funds have been around in Germany since the early seventies. It was then realised that private individuals investing together in the legal form of a limited partnership (Kommanditgesellschaft or KG) could not only buy large prime real estate investments just as the institutions were, but could also benefit from substantial tax breaks because they were being treated as private persons and not as corporations. At the beginning of the 1990’s, special accelerated depreciation laws designed to promote commercial and residential development in Berlin and Eastern Germany inspired massive inflow into closed-end funds such as Wert - Konzept, Fundus-Gruppe and KapHag, to name a few. The special depreciation laws allowed private investors to write off 50% of their total purchase costs over a period of between one and five years. In 1993, over DM 13 billion of private money went into closed-end funds and in 1997, the last year of 50% accelerated depreciation, over DM 23 billion was invested. Prior to this period, closed-end funds invested only DM 3 – DM 4 billion per annum. (See appendix IV). 3.2 Regulations or lack of…. Closed-ended funds are not regulated by laws such as the KAGG and there are very few if any ‘barriers to entry’ for companies wishing to set up and run a closed-end fund. According to the society representing them, the VGI, there are now 200 closed-end funds in Germany with over DM 250 billion of private money invested. In simple terms, a closed-end fund can offer specific properties or projects subject to a certain financial objective, for example return on equity. They can either consist of a single asset or comprise multiple buildings, but in any event, they are defined in the fund prospectus and cannot be exchanged with other assets for the duration of the fund. The size of the fund, the equity required and the financial plan are predetermined. Based on this information, the funds offer the required equity participation to the public markets either through their own channels or by working with the banks who offer fund products to private banking clients. Once the equity has been signed up, the fund is closed. The fund initiators are not liable for changes in the financial plan during the term. If, for example, project costs are exceeded by 25% or if a major non-planned refurbishment is required in year eight, then the equity participants have to contribute at their own cost. The paramount criteria for choosing a closed end real estate fund depend on the integrity, competence and financial strengths of its initiator. The past is riddled with investors who have blindly put money into closed end funds, some of which were set up purely to defraud investors but the vast majority of funds where set up subject to rental guarantees, some as long as ten years. An old trick was to offer rental guarantees and then a couple of years down the line to declare bankruptcy , but more alarmingly, the rental guarantees which have been running on empty buildings in eastern Germany , of which there are many are due to expire shortly and the society of closed end funds forecasts a crisis period from which they expect only 60 funds from the current 200 will survive, with a total estimated loss of up to €38 billion. 3.3 Liquidity Unlike open-end property funds, the initiator of closed-end funds has no buy-back obligations. If a shareholder wishes to dispose of his shares, he has to find a purchaser by himself. This can be extremely difficult for two reasons. First, there is no defined market place for trading second hand shares in closed-end fund products and secondly the high fiscal advantages have usually already been exhausted, making participation by another investor unattractive. 3.4 Taxation For taxation purposes, income is treated as rent from ‘rental contracts and registered leases’. This is in contrast to rent from open-end funds which is treated as income from capital. A major advantage is that deductions can be made from the gross rent in order to arrive at taxable income. Deductions include interest on loan capital, management costs, repairs and maintenance, fund management and depreciation etc. Furth...