Spezialfonds are projected to grow by €10-15bn over the next five years as institutional capital leaves GOEFs. Iryna Pylypchuk explains

Discussions over institutional capital leaving Germany's open-ended real estate funds (GOEFs) have been around for a while, and CBRE has predicted that the changes to the German Investment Act will effectively separate private and institutional capital permanently.

Starting in the wake of Lehman's collapse, the flight of institutional capital has transformed the GOEF sector, with varied results. Some funds are open, are receiving positive net inflows and have grown significantly. However, a growing number are closed and liquidating.

Now that the German government has acted and passed the necessary legislation to protect retail investors and the small, traditional institutions that use open-ended funds for long-term saving and pension provision, most of the above issues have been addressed. The bottom line is that the GOEF sector is very different today.

Today, a couple of questions still need to be addressed to understand future implications for the GOEF sector and the real estate markets:

• Just how much more institutional capital is going to leave GOEFs?
• What impact will the reallocation of institutional capital have on the real estate market - in Germany and elsewhere?

So, how much more institutional capital could leave the GOEFs?

GOEFs have been through a turbulent time, with little improvement in investor sentiment and another liquidation announcement in February. As of March a total of 15 funds were closed or facing liquidation - this is a third of the sector, representing a total of €23.6bn in funds under management.

The remaining 30 funds, with €61bn in assets under management, are still open. This raises the question of whether further institutional outflows are to be expected? Not all funds publish information on their investors, but it is available for the four largest funds that are still open, and which between them account for 60% of the €61bn. All four report their investor base to be over 90% retail capital, and in some cases as high as 96%. Our analysis of all the available information suggests that, even under a worst case scenario, the maximum further potential institutional withdrawals from the open funds is around €5bn.

Four to five years from now, with most closures and liquidations dealt with or reaching their final stages, we expect GOEFs to stabilise at around €60-65bn in assets under management. This, of course, assumes no further external shocks and no significant change in the attitude of retail investors towards the sector.

The vast majority of institutional capital that will leave GOEFs is already know. But liquidating funds have been given up to four years to go through the process; so it will be a while before they get their capital back to reinvest.

What of the second question: what impact will this reallocation of institutional capital have on the real estate market - in Germany and outside?

Our expectation is that, upon exit, most of this institutional capital will be reinvested into other forms of unlisted real estate, with Spezialfonds being the main beneficiaries.

This is evident in the latest BVI statistics, which show Spezialfonds rapidly growing. Between the end of 2008 and early 2012 the Spezialfonds sector grew by more than €10bn, of which €5.5bn was in 2009 alone. Over €6bn was withdrawn from the GOEFs in September-November 2008.

In fact, it is clear that in addition to the capital that has been withdrawn from GOEFs, there is new institutional money playing a role in this growth of Spezialfonds. As this new capital no longer flows into GOEFs, it is looking for suitable real estate vehicles to invest in.

The growing strength of Spezialfonds is reflected in their acquisition activity. In 2011 German Spezialfonds invested €3.26bn in Europe, outpacing GOEFs' purchasing activity over the same period by nearly €500m. This result is even more significant when one considers that, at €33bn, the sector is some 2.6 times smaller than the overall GOEF sector.

As the GOEF sector stabilises over the next few years, we expect Spezialfonds to show continued strong growth in assets under management. Taking into account the amount of institutional capital locked in closed and liquidating funds, and combining that with expected new institutional allocations, the Spezialfonds sector should grow by around €10-15bn over the next five years.

Undoubtedly, such a shift has implications for the shape of the sector and its investment strategies. Recent fund launches are fairly mixed geographically, with some broader pan-European vehicles emerging, alongside the more traditional smaller funds with a specialist sector and geographic focus.

The latest evidence highlights the sector's bias towards Germany. In 2011, 55% of investment by Spezialfonds was domestic - a reflection of the specialist nature of the sector and the risk-averse nature of investors. But, if the sector grows as expected over the next few years, funds will not be so heavily focused on the German market, and a geographically broader Spezialfonds sector is expected to emerge.

The bottom line is that the structural shift in the GOEF sector is slowly feeding into the market to the benefit of Spezialfonds and the German investment market. In the long term, subject to the state of the wider economy or a change in attitude by heavily invested retail investors, we expect there to be more balance between GOEFs and Spezialfonds.

Eventually, we expect GOEFs to become net buyers again, while Spezialfonds will continue to expand and become more prominent investors at home and in Europe.

Iryna Pylypchuk is associate director at CBRE