Tobias Kotz, Global Head of Client Relations & Capital Funding at Real I.S. AG
The sharp rise in interest rates since 2022, the weakening economy and falling property prices have put the real estate sector under pressure. Investors continue to react cautiously, an attitude that is supported by some individual write-downs, albeit at significant levels, on just a few open-ended retail real estate fund products (OEREFs), for example. The future of OEREFs is currently a controversial subject in some parts of the industry. However, there are many good reasons to make long-term investments in OEREFs. The crucial factor here is the issuers’ ability to future-proof the portfolio.
Advantages for long-term oriented investors
OEREFs enable investors to make broadly diversified investments in real estate with small amounts and to benefit from long-term opportunities for generating returns. Even though the markets are currently challenging, a historical review shows that property markets recover well after crises, especially in economically strong regions. After the financial market crisis, for example, the prices of office real estate in the eleven major cities of Europe rose by an average of 21 per cent in 2010 (synthetic purchase price change based on yield and rental price development).
Hence, OEREFs continue to be suitable investment products, but they are generally regarded as a good choice for long-term oriented investors. Exit opportunities are subject to rules: fund units can be returned after a statutory holding period of twenty-four months only. The holding period is twelve months after the first twelve months. The regulations introduced ten years ago ensure greater stability in the industry and the liquidity of the investment fund. In addition, they increase investor protection and contribute to transparency. The legally required maximum debt ratio of thirty per cent also ensures security.
What are the arguments against a quick sale of OEREF units?
Despite the advantages, some investors may consider selling their units due to the current market situation. Units in open-ended real estate funds (OEREF) are transferable as securities and can be sold on the stock market, in addition to being returned to the fund company after the holding and notice period. However, this may incur significant discounts, as the market prices are often lower than the redemption prices. Moreover, the trading volume of many OEREFs is rather small. This can result in a high price volatility, because usually investors who trade on the stock exchange wish to quickly sell their units.
Short-term sales on the secondary market are possible, but often at a discount to the net asset values. It may therefore make more sense to be patient in difficult market phases and hold on to the units.
In addition, anyone who redeems their units now is taking a risk for twelve months (due to the notice period) and can then no longer get the units back. In an environment in which the market expects temporary upheaval and a recovery, this is a rather large risk.
A large number of redemptions could pose major problems for the investment fund and lead to distress sales of assets on unfavourable terms, where these assets would not have been sold under ‘normal’ circumstances. If a lot of investors wish to redeem their units at the same time, it may also lead to a temporary suspension of redemptions in order to ensure the liquidity and stability of the investment fund and to protect the interests of all investors. This is aimed at preventing an excessive outflow of capital from causing liquidity bottlenecks for the investment fund and at ensuring that the properties in the portfolio can be sold at a fair market value.
Property quality determines stability and value retention
Given the dynamic nature of the markets, issuers must make their property funds resilient and future-proof. Decisive are a solid strategy, a diversified quality portfolio, and the inclusion of sustainability criteria. Usage types such as ‘core’ office properties in European metropolitan regions or logistics real estate are interesting investments provided they fulfil high quality and sustainability standards.
The K-Tower in Lisbon is an example of a property that is well suited to an open-ended property fund because it takes into account key sustainability aspects, in addition to meeting the requirements for location, building structure and tenant selection. Completed in 2023, the property offers a total rental space of around 15,000 square metres. Real I.S. acquired the office complex for its open-ended retail real estate fund REALISINVEST EUROPA. The K-Tower is excellently located in Lisbon’s office sub-market Parque das Nações. The fully-let property is BREEAM-certified as ‘excellent’ and counts among the first European Taxonomy-compliant buildings in Portugal.
This makes the K-Tower a very good addition to the REALISINVEST EUROPA portfolio. That is because it is not only one of the first OEREFs with a taxonomy-aligned investment ratio – but rather because the real estate fund’s Europe-wide commercial portfolio has one of the highest taxonomy ratios of all OEREFs offered on the market. More than 50 percent of all properties (based on market values) are in compliance with the Taxonomy Regulation and Article 8 and all portfolio assets meet the ecological criteria set out in the EU Sustainable Finance Disclosure Regulation (SFDR).
All properties are certified according to the Building Research Establishment Environmental Assessment Method (BREEAM) or the German Sustainable Building Council (DGNB) standards for sustainable building design, or are currently undergoing a certification process. The tenancy occupancy rate is around 98 per cent. More than 76 per cent of the real estate assets are younger than ten years. This reduces the maintenance costs. The real estate fund holds properties in thirteen locations in eight European countries. The portfolio includes the usage types: Office, Logistics, Retail/Food and Beverage Services, and Residential. Its diversification contributes to the portfolio stability.
Backed by a careful selection and operation of the properties, the strategy and quality of the REALISINVEST EUROPA fund aim at generating stable returns and long-term value enhancements for investors. The K-Tower is an example for the successful implementation of this strategy. Since acquisition, the market value of the property has already increased.
Conclusion
Open-ended real estate funds continue to provide attractive opportunities for long-term oriented investors wishing to diversify their portfolio, on condition that they are professionally managed. Overall, it is expected that the value retention and future viability of portfolios will be increasingly influenced by the extent to which the properties comply with the environmental requirements under Article 8 of the Sustainable Finance Disclosure Regulation (SFDR) and the additional sustainability criteria for climate protection under the Taxonomy Regulation.
New developments, such as European Long-Term Investment Funds (ELTIFs) 2.0, offer additional flexibility and enhanced terms and conditions that could benefit both issuers and investors as well as revitalising the market. It is up to the real estate industry to actively structure this change and take advantage of the opportunities that arise.