New rules have made investments in real assets more accessible. Fund providers will have to adapt to a more regulated world, finds Barbara Ottawa

A new investment landscape for real assets is taking shape in Germany. Closed-end  fund providers in the real estate and infrastructure markets are now more closely regulated and will need to adapt to an institutional market pushing greater transparency.

“The old product world is dead,” says Michael Schneider, managing director at IntReal Service-KVG. “Former closed-end fund providers have to use innovation to adapt the products to the clients’ needs.” 

Driving the change is the new regulatory framework adapted to implement the EU’s Alternative Investment Fund Managers Directive (AIFMD). Through the new Kapitalanlagegesetzbuch (KAGB), Germany has introduced new regulatory requirements for former closed-end funds, making them more accessible to institutional investors. Together with amendments to investment regulations for insurers and Pensionskassen – the Anlageverordnung (AnlV-E) – new vehicles and new asset classes are being brought into the institutional sphere. 

Under the AnlV-E, which is also adopted on a voluntary basis by most Versorgungswerke (first-pillar pension funds for professions such as lawyers and doctors), it is now easier for investors to become direct lenders or to invest in private equity funds. 

Sonja Knorr, senior analyst at Scope Ratings, says: “The possibility to invest in non-securitised loans, such as infrastructure loan receivables allows for the launch of specific funds, which will also allow smaller institutions to invest in infrastructure.”

However, at a conference in Berlin, Benedikt Weiser, partner of international law firm Dechert, told delegates that the German supervisor BaFin “still has to issue some clarifications” on certain parts of the new guidelines. For example, direct lending is permitted if the senior loan is “sufficiently secured”. But the law does not give details on how to assess what is deemed “sufficient”. 

According to Weiser, the legal text mentions  senior loans as suitable for infrastructure investments. The legislator “saw there was a need to create rules for this asset class”, he says. 

At the pension fund for German energy company E.ON, an infrastructure portfolio has been in the making for five years. Christian Rouette, head of pension finance and asset strategy at E.ON, says investments are behind schedule because demand is too high for this asset class, pushing returns below the pension fund’s expectation threshold.

The latest research by Mercer and Towers Watson into the pension funds of German companies listed on the DAX reveals a significant increase in exposure to other asset classes from 16% to 19% year-on-year, with investments mainly going into infrastructure, real estate, timber, private equity and private debt. 

And the share is set to increase, as bond portfolios with relatively high yields are maturing and the pressure on re-investments is growing – especially with Versorgungswerke, which are mandatory and often have millions of euros of net inflows every month. 

Another incentive for increased interest in alternative investments is the new investment guidelines. At the Handelsblatt conference on occupational pensions in March, Hans-Dieter Ohlrogge, chairman at IBM Germany’s Pensionskasse and Pensionsfonds, said the Pensionskasse can consider private equity investments “now we know we do not need complicated structures to invest in this asset class”.  

Evolving for an institutional era
Fund providers are having to adapt as well – particularly the former closed-end funds which traditionally had limited dealings with institutional investors and were far less regulated than providers of open-ended or Spezialfonds.

Under new rules, providers had to decide whether they wanted to file for a full licence as Kapitalverwaltungsgesellschaft (KVG) or, for example, use an outsourced third-party Service-KVG to issue Spezialfonds for them. 

A case in point is IntReal client Hamburg Trust, which has a limited KVG licence to issue Investment KG vehicles – funds similar to former closed-end fund structures but with a higher regulatory demand. They have also enlisted IntReal’s services to issue open Spezialfonds, or offene Spezial-AIF as they are now termed. 

Hans-Peter Renk, chief sales officer at Hamburg Trust, thinks many of his company’s competitors are “underestimating their homework” regarding regulatory requirements but they also “fail to see the advantages of the new legal framework”. 

He says: “For institutional investors, the most important thing is the segregation of powers, as they want asset managers coupled with professional partners for the underlying, reporting and other services.” 

Eitel Coridaß, managing director at Warburg-Henderson (which is to change its name to Warburg-HIH Invest Real Estate following a change in ownership), agrees that Service-KVG will be the biggest source of growth for pension providers. “Clients want flexibility, want to be able to ditch their manager if it becomes necessary, without having to sell the holdings,” he says. This is something they have been able to do in other asset classes but which was only made legally possible in Germany with real estate investments five years ago. 

Jochen Reith, group head of institutional clients at Patrizia, thinks investors will be willing to follow managers they trust into new territories. “Fewer asset managers are getting larger sums, as investors do not want, for example, 40 funds with 18 different asset managers anymore,” he says. 

Coridaß says clients are looking for more focused strategies from managers. “The demand for pan-European products increases further, but the diversification is not as broad as it used to be in 2002,” he says. He explains that this is also a form of specialisation for which there is a growing demand among investors – also in the domestic segment. 

And this specialisation is sometimes the only way for institutional investors to find alternatives to dwindling core properties with similar return-risk profiles. “They have several options, including going abroad or approaching domestic properties differently,” says Reith. He sees the “willingness to think about investing abroad increasing” – but often without the currency risk and in countries where the interest spread is not as wide. 

SFIX puts pressure on managers

Transparency in the real estate investment universe is set to increase as more information is collected. For example, this year, for the first time, sufficient data was available on the Spezialfonds SFIX index to reveal the long-term performance of the institutional vehicles. The index is estimated to cover two-thirds of the real estate Spezialfonds market in Germany.

The data showed that Spezialfonds invested solely in German real estate performed poorly at the beginning of the period (2005-14) but ended it strongly with an overall return of 3.6%, while pan-European funds only returned 2.2%. Researchers were ‘surprised’ by the strong influence of fund vintages on returns. 

Ingo Bofinger, head of real estate investments at German insurer Gothaer, says that he is placing managers that do not provide data to the SFIX on “a red list. Otherwise we cannot compare them,” he explains.

With the rise in the need for niche managers and a general intent by Spezialfonds to increase real estate exposure (currently at around 8.3%, according to Feri) via funds rather than direct property investments, such comparisons will grow in importance.

However, a Feri survey revealed that the share of investors with properties in North America has doubled to over 15%, while investments in Western Europe have fallen by almost the same amount. 

According to Reith, investors’ differentiation strategy for domestic markets is either an increase in the risk from core to value-add or a move into new sectors like hotels, logistics and care homes. 

Erik Marienfeldt, managing director at HIH Real Estate, says “niches like logistics will not fully fill the gap”. He is also very sceptical about dedicated secondary city approaches – and not only because of a possible lack of liquidity. “Managers need a critical mass in certain regions, and only a few have the infrastructure to manage regional real estate, which will stay in their portfolio for decades,” he says. 

Timothy Horrocks, head of Germany at TIAA Henderson Real Estate, says secondary-city office strategies “get all the talk but have yet to raise significant capital to date”. He confirms continued interest in new segments outside the office sector, including retail, logistics, hotels, car parking and residential, but with a focus on well-let core assets. 

Another strategy to widen the definition of core is to accept flaws in one or two features of a property. “Investors are assessing rental risk differently now and managers should not ignore this, as letting is actually their core business,” says Marienfeldt. He notes a mixed tenant base with five-year contracts on average is now more sought after than a single tenant with a 10-year lease. “Investors have realised they have to ‘let according to the market’ not according to their business plan,” he says.

Investor Universe: Germany - Brave new investment world