The German open-ended real estate fund industry is going through some changes, following a number of redemption freezes and regulatory reforms. Reinhard Kutscher looks at what the future holds for the sector
Real estate has a long tradition in Germany as an asset class, offering reliable returns combined with a high level of security. The financial crisis threatened to spoil its track record when some open-ended real estate funds experienced difficulties, but politicians responded by creating an environment in which the success story could be resumed. Let us take a look back - and forward.
Open-ended real estate funds for private investors have been around since 1959. Offering steady returns and high-value stability, they have provided a solid foundation for many portfolios, while giving people unable to afford a house or apartment of their own the opportunity to invest in real estate. Over the past 10 years, this type of fund has achieved average annual growth of 4%, with a volatility of just 0.8% per annum. But consistency alone does not guarantee success.
Accordingly, funds changed over the years, as reflected in recent figures. According to the German Investment and Asset Management Association (BVI), in 2001 investors could choose from a total of 19 funds. By 2010, the number of funds available had risen to 44. Fund volumes increased from €55.9bn in 2001 to more than €85bn by the end of 2010. With their demands for greater choice and a more diversified offering, investors were key in influencing to this trend.
Established and new providers responded to changing investment requirements by boosting the number of funds available and also addressing other factors, such as regional diversification. In 2001, real estate funds were heavily biased towards Germany, where 61% of the average portfolio was invested.
Today, the figure is just 29.2%. Ten years ago only 20% of fund assets were located in the euro-zone and 14% elsewhere in Europe. Non-European investments accounted for just 5% of portfolio holdings. Today, euro-zone investments (excluding Germany) represent an average of 40.9% of the fund total; European countries outside the euro-zone, 16.5%, and non-European investments, 13.5%.
Types of use have also changed, although to a lesser extent. The office property share has fallen from 71.4% of portfolios in 2001 to 62.8% today, with a corresponding rise in hotels and retail properties.
Despite ongoing diversification, parts of the sector were nonetheless hit by the financial crisis. With virtually all asset classes losing value, many investors - particularly institutional investors - embarked on a desperate search for liquidity and often turned to open-ended real estate funds, withdrawing billions of euros. This development forced a number of funds to suspend redemptions due to insufficient cash reserves, with the result that the remaining investors were unable to access their money. Nearly a third of the money invested in open-ended real estate funds is still unavailable to investors because of these closures.
The situation spurred politicians into action. A new Investor Protection Act introduced fundamental changes, including a minimum holding period for fund units. From 2013, new investors will have to hold units for at least two years before being able to redeem them.
A notice period of one year applies after the minimum holding period. This deadline is also new. Previously, units could be redeemed without delay on any trading day. However, every investor will be permitted to redeem units worth up to €30,000 per calendar half year.
The new regulations will prevent scenarios where large (mostly institutional) investors invest millions, only to withdraw them shortly afterwards. This was largely responsible for the closures of 2008. Small investors can still access their money at short notice. Although fund closures are not impossible under these new rules, they are certainly far less likely.
The revised rules for retail open-ended real estate funds ensure that large institutional investors can no longer abuse a form of investment that was originally designed for private investors. However, special institutional real estate funds are available to this category of investor. Such funds can be exactly matched to individual interests and investment objectives and typically also have special redemption rules.
In particular, pension funds and insurance companies, but also foundations, use these special institutional funds because they match their risk-return profiles or requirements for regular income. Some special institutional funds also have a thematic focus. For example, Union Investment has established a dedicated European shopping cente fund for institutional investors.
The dependable cash flows and low vacancy rates of such properties offer attractive medium-term total returns, allowing institutional investors to broaden their property holdings and leverage selected thematic funds to gain exposure to high-return segments. This improves the risk-return profile of their overall portfolios.
But back to retail funds, whose appeal in unsettled times is apparent from the figures. Some €1.6bn of new money was invested in retail funds during 2010. The indications are that growth will continue in 2011, although at a much lower rate.
It is not yet clear whether all the funds whose unit redemptions are currently suspended will reopen or whether more fund liquidations will occur, but thanks to an overall improvement in the market environment they will not automatically be accompanied by substantial losses for the investors affected.
There is every reason to assume that those products that remain open will continue to be extremely popular with investors. Their combination of security and liquidity, allied with a revival in performance, is a strong argument in favour of such funds as a key investment option for private investors.
Reinhard Kutscher is chairman of the management board at Union Investment Real Estate