Florian Kurth, Head of Product Development at Real I.S. AG
Real estate investors are facing multiple challenges. Besides the rise in interest rates, regulatory requirements are also constantly increasing. Professional property management has become essential due to the latest amendment to the German Minimum Requirements for Risk Management at banks (MaRisk) in particular, as well as the upcoming reporting obligations under the EU Central Securities Depositories Regulation (CSDR). This poses considerable hurdles for smaller savings banks, regional central institutions of savings banks (Landesbanken) and credit cooperatives in particular.
Regulatory requirements increase pressure to take action.
In the seventh amendment to the German Minimum Requirements for Risk Management at banks, the German Federal Financial Supervisory Authority (BaFin) implemented the guidelines of the European Banking Authority (EBA) on lending and credit monitoring at the end of June 2023. This significantly increased the requirements for risk management. A transitional period until 1 January 2024 applied in some cases for implementing the changes. This means that there is a great need for action. And there are additional requirements resulting from sustainability reporting: the CSDR came into force at the beginning of 2023 and must be transposed in EU member states within 18 months. It also applies to directly held real estate investments. Against this background, banks and savings banks are being asked to examine how they intend to present the real estate asset class in their own investments in future. Even relatively small market players cannot avoid making organisational adjustments and building up their own capacity.
The German Federal Financial Supervisory Authority's new requirements, which are already in force, include taking operational risk into account through appropriate risk management. Processes must now be established both for the company's own property investments and for the real estate transactions conducted by its subsidiaries. All risks, including environmental, social and corporate governance (ESG) risks, must be identified and assessed at least once a year. The complexity of the analysis and reporting as well as the resources and time required should not be underestimated, as this involves documenting which properties meet the climate targets and which will leave the decarbonisation pathway, and when. In addition, options for action and investment must be identified for those properties that do not yet meet the climate targets. Information on market price risks must also be provided at least quarterly in risk reports for directly held real estate.
However, historical time series are missing for some ‘B’ cities, but especially for many ‘C’ and ‘D’ towns and cities, or the data is not valid for determining the market price risk. This could lead to problems when -defining and validating an appropriate limit as part of the risk assessment.
Flexible investment solutions are needed.
Certain investment fund vehicles can provide a solution for achieving a balanced, diversified, risk-appropriate and supervisory-compliant real estate allocation at reasonable cost. In the case of a specialised property investment fund (Einbringungsfonds), which Real I.S. also offers, the investor transfers its property portfolio to a regulated fund vehicle and receives limited partnership (Kommandit) shares or fund units in return. Note: the investor remains the legal and economic owner of the property portfolio, continues to make the key decisions and defines the strategy. The direct portfolio brought into the investment fund is professionally managed by an investment management company (Kapitalverwaltungsgesellschaft or KVG). The practical aspect of this is that the investor can ‘book’ additional services from the investment management company as required, similar to a modular system. This benefits the investor in a number of ways, such as professional reporting and active asset management by interdisciplinary teams. In addition, by recognising market values and eliminating regular depreciation in the regulated investment fund vehicle, the investor generates a higher ordinary yield or higher income for distributions. The investor also has the option of leveraging available hidden reserves within the scope of the transfer and thus utilising one-off effects. The option of using leverage means that the portfolio can be expanded, and the risk minimised through diversification.
Examples of tailor-made Real I.S. products
At the beginning of the year, Real I.S. launched a special fund for an occupational pension scheme. Seven residential buildings with a total of more than 800 residential units and a commercial building were added to the investment vehicle launched by us specifically for the pension scheme. The properties included are owned by the occupational pension fund itself, which is the sole investor in this vehicle. Real I.S. is charged with ensuring that the buildings retain their value and making them fit for the future. A strategic expansion of the investor’s property allocation is planned for the long term. Under the asset and portfolio management of Real I.S., the vehicle is to be upgraded systematically to Article 8 classification in line with the EU Sustainable Finance Disclosure Regulation (SFDR). We have a track record in this field. In 2023, Real I.S. upgraded an aggregate investment fund volume of around 8.4 billion, and thus about 75 percent of its total portfolio, to Article 8 classification.
This specialised institutional property investment fund is a good example of how we structure and implement new customised solutions for our customers based on high-performance asset management. It demonstrates that institutional investors trust us to optimise their property portfolios.
A second example for an individual solution: the specialised institutional real estate alternative investment fund REAL I.S. SCF has been launched for a club with seven institutional investors in total. The fund is fully invested and broadly diversified. The total investment volume exceeds 250 million euros. The aggregate portfolio comprises six fully let office and logistics complexes with long-term leases. The properties are highly sustainable and meet all requirements for being classified as a sustainable product under Article 8 of the EU Sustainable Finance Disclosure Regulation. The distribution already made of approximately 4.5 percent on average per year and the investment fund forecast are significantly higher than the target distribution that had been announced. This demonstrates our strengths in strategic portfolio design and asset management.
Conclusion
Volatile times and increasing regulatory requirements call for new solutions. One of these could be new fund vehicles, also in the form of closed-end funds for more than one institution. These provide investors with scope for diversification in the property asset class without having to build up significant capacities of their own. Professional asset management, including administration by a specialised investment management company (KVG), ensures compliant processes from a regulatory viewpoint. This enables cluster risks and operational risks to be avoided, and flexible solutions can be used for managing the property portfolio. This ensures that all aspects of the investments are managed sustainably throughout the entire investment cycle, while also making the portfolio more resilient and higher yielding.