The European Public Real Estate Association (EPRA) says hundreds of billions of euros of capital could flow from the insurance industry into real estate investment trusts (REITs) if the EU’s Solvency II regulatory regime is changed.

Chief executive Dominique Moerenhout said at the association’s annual conference in London today: “One of the biggest obstacles to European insurers investing in listed real estate companies is the heavy capital weightings imposed by Solvency II.”

“It could unlock hundreds of billions of euros in capital from the insurance industry”

Mark Abramson

EPRA is lobbying the EU to change the capital requirement rules so that listed real estate is treated as direct property investment under the Solvency II rules, under the Capital Markets Union Action Plan and the Solvency II review.

Moerenhout said the solvency regime in its current form deterred insurance investors from a key source of quality assets and management, liquidity and transparency for their real estate portfolios.

“[Changes would] increase rather than reduce structural arbitrage”

John Forbes

“If insurers are able to appropriately weight listed real estate in their investment asset allocations, we believe the market capitalisation of the sector in Europe could possibly double,” he said.

Mark Abramson, director of the European REIT investment business at Heitman and a member of EPRA’s regulatory committee, said: “My 20-something years of experience in the capital markets screams at me that if the risk charge goes down on REITs, then it could unlock hundreds of billions of euros in capital from the insurance industry.”

Even a fraction of that would be extremely positive for listed real estate in Europe, he said.

The capital risk weighting required for listed real estate is 39% under the EU solvency rules which apply from the start of this year, along with equities, compared to the 25% risk weighting for direct property investments.

The weighting is smaller for direct investments because of the lower perceived risk, or volatility, of physical bricks and mortar, EPRA said.

However, a large body of academic research has concluded that the performance of listed real estate converges with direct property over the longer term, meaning there is no market rationale for treating the two as separate investment asset classes from a relative risk perspective, it said.

The association cited an MSCI study earlier this year, which found listed real estate shed the influence of the general equities market after just 18 months.

There were strong correlations in performance across individual property assets, non-listed funds and securities, particularly over three and five-year periods, the study found.

“There is no reason to apply a higher charge,” Moerenhout told the conference.

However, independent consultant and former PwC real estate leader John Forbes has described EPRA’s position as “somewhat disingenuous” and, seemingly, “an attempt to create regulatory arbitrage for REITs compared to direct real estate”.

In a note issued today, Forbes said the argument ignores the fact that the existing 39% charge is applied to the net asset value (NAV) of REITs, while the 25% charge on direct real estate is applied to the gross asset value (which includes debt).

“Trying to lobby for both a 25% SCR and applying it to NAV,” Forbes said, “will increase rather than reduce structural arbitrage”. He said it was an example of “having your cake and eating it”.

He said European regulators should adopt a transparent look-through approach to REITs as they do for unlisted real estate funds, where the GAV of a fund’s underlying assets are used to calculate the capital charge.