As a result of new dividend and income laws in the Netherlands, Dutch REITs might be rather unfavorable in the long term.
Last week, the Dutch government announced a lot of good news for investors in its most recent governmental agreement. In an effort to accommodate investing in the Netherlands, policymakers announced a decrease in company taxes from 25% to 21%. Furthermore, dividends will no longer be taxed. This is very good news for most Dutch businesses, but there is also a darker side to these tax decreases, especially for Dutch REITs.
The reason why REITs do not share the enthusiasm of the other sectors is the following sentence from the governmental agreement:
Before this policy change, Dutch REITs did not have to pay company taxes if their full-year profit was paid out as a dividend. The idea behind this was that the profit would then be taxed at 15%, via dividend taxes. Now that these taxes are gone in the new policy, the Dutch government sees no other option than to tax their REITs like regular companies. This implies a tax on profits of 16% on profits up to €200,000 and 21% on the profits over €200,000. As a result, investment institutions are no longer allowed to directly invest in Dutch REITs, which will probably hit them hard.
So, how will this new law affect Dutch REITs? In our opinion, the effects will be twofold. First, on the company side, there will be a lot of extra pressure given that profits will be significantly lower due to the income tax. In the long run, this will make it harder on companies to maintain the same growth levels and profit margins they had in the past, as part of their profits will be taken away by taxes. There will also be less cash for investing and growth.
Second, REITs will become far less attractive for investing in the long run. Margins will be lower, and neighboring countries will soon offer a more attractive alternative. European alternatives currently include Finland, France, Germany, Italy and the United Kingdom, all of which have an income exemption policy for REITs. This could hit them extra hard given that not only regular funds will make the shift, but also the average Dutch person's pension fund, as they favor a relatively high percentage of REITs in their portfolios.
There are three Dutch companies that we believe will take the hardest hits: Wereldhave (OTC:WRDEF), NSI (OTCPK:NIUWF) and Vastned (OTC:VSNDF). At the opening on Monday, Oct. 16, these companies were down on average 2%. We believe that this will be a continuing trend for the short term. These companies all have a considerable amount of real estate that is Dutch: Vastned has the lowest with 37.5%, but Wereldhave has 40% and NSI has 100% Dutch real estate. As a result, these companies will report lower profits and will have less cash to invest in the years to come.
We believe that the companies all will be able to survive, given that the income tax does not pose a significant structural problem, yet it is almost certain that the stocks will get hit rather hard based on lower rentability and profit margins. These three companies all have decent net profit margins of between 60% and 80%, allowing them to pay out strong dividends. NSI pays out €2.16 (yielding 7.50%), Wereldhave pays out €3.05 (yielding 7.25%), and Vastned pays out €2.04 (yielding 5.50%). We expect these dividends to remain on the higher end of the spectrum, yet the new taxes put a lot of pressure on the stability of growth for these dividends.
Of course, there is the advantage that, from now on, Dutch REITs' dividends (and all other industries' dividends as well) will be tax-exempt. Once supply and demand has settled in the REIT sector, these three companies will benefit again, given their relatively high dividends. We believe that this will happen in the long term, after investment funds and pension funds have stopped pulling their capital.
Our strategy: Stay away from Dutch REITs for the short to medium term. Investment funds and pension funds will be looking for European alternatives with a more favorable tax-situation, and so should investors. In the long term, we believe that the situation will eventually settle down. At that time -- when Dutch REITs are cheap -- investors should look into these companies again, as their dividends are now tax-exempt and their stocks should be priced relatively low.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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