With so much choice when it comes to domiciling new real estate products, finding the right home is less a choice between onshore and offshore jurisdictions and more a decision over regulated versus unregulated, Richard Lowe discovers
The choice of domicile for a real estate fund is invariably driven by a number of technical considerations, but one of the most persuasive factors seems to be investor perception and familiarity. "The location of the fund vehicle is driven very largely by investor familiarity with that location," says Matt Batham, partner at the real estate tax division of Deloitte in London. "It almost comes down to marketing as opposed to actual tax structuring." Andrew Smith, head of funds management at Aberdeen Property Investors, agrees from an investment manager perspective, pointing out that familiarity becomes an incentive for both investors and managers. "To some extent it is self-reinforcing," he says. "Once you have established a reputation and a wider spread of acceptance among investors, in many ways they will find it easier to replicate processes they have already become familiar with across a range of different funds. It becomes more efficient to investors and it is more efficient for the fund managers."As real estate investment capital becomes more globalised and the investor base of property funds become increasingly diversified, the practice of finding the most suitable jurisdiction and fund structure to suit a wide collection of investors becomes potentially more challenging.
"The investor mix might come from a wider spread of different territories and they have all been used to seeing different things," Batham says. "Unless you are going to start creating parallel funds, you have to go for one vehicle."This could be seen as a balancing act if some prospective investors are going to be more comfortable with a chosen vehicle or jurisdiction than others. "Sometimes you do have to go through the pain of explaining to a particular type of investor that this vehicle does not give them any specific problems - they just might not be familiar with it."It is interesting to look at Aberdeen Property Investors' present fund range, which includes, among others, a number of locally domiciled Danish, Finnish, Swedish and Norwegian fund structures, as well as several Luxembourg-domiciled open-ended variable capital investment companies (Société d'investissement à capital variable or SICAV). The former are aimed at Nordic investors investing in their own respective countries but in order to appeal to a more global investor base for its new funds, Aberdeen is increasingly turning to the latter. The regulatory environment in Luxembourg, with its wide range of available fund structures, tends to be "the most tax-efficient for the widest range of investors," Smith explains. "Increasingly that has been the model for new fund launches." Underlining Aberdeen's intentions towards Luxembourg is the fact that the asset manager has established a local presence in the Grand Duchy. "It has been going very much Luxembourg's way," Smith says. "The key thing we have done is to put in place the Luxembourg team to bring some of this work in-house."
Since its launch in February 2007, the Specialised Investment Funds (SIF) regime in Luxembourg has been an undeniable success for new funds across alternative asset classes. It offers the SICAV and the fonds commun de placement (FCP or open-ended collective investment fund), both within a light-touch regulatory environment.
Mark Stapleton, partner at Dechert, describes the success of the regime over the past 18 months as an "incredible story". He adds: "It seems if you are marketing across Europe they are very attractive, and one of the advantages is they are lightly regulated and you kick them off before you have had regulatory approval." Bas Kundu, partner at PricewaterhouseCoopers (PwC), says the Luxembourg fund industry has grown massively in recent years. "This has been partly driven by the fact that Luxembourg has a very favourable holding company regime which encourages people to locate there anyway," he says. The Association of the Luxembourg Fund Industry (ALFI) conducts an annual survey of real estate funds, and the latest version shows that, despite the tougher capital-raising environment, there was a continued increase in the number of active real estate funds in 2007. Some 123 regulated real estate funds were launched and active as at December 31, 2007, almost double the equivalent figure a year earlier. Michael Hornsby, partner and leader of the Ernst & Young Luxembourg Real Estate Group, is co-chair of the survey's reporting committee. He says: "This is largely to do with the implementation of the SIF regime, which has been hugely successful. If you look at the first half of 2008, although there has been a downturn in capital-raising, there have been a number of fund launches - things haven't stopped. Certainly, we have been working on a few and I know our competitors have as well." The two largest origins of asset managers that have launched Luxembourg-domiciled real estate funds are the UK and Germany, contributing two-thirds of fund launches between them. The next is the US, at around 20%, according the latest ALFI survey, with the balance coming from other European countries (predominantly France and Italy) and Asia Pacific. Hornsby explains that business from US asset managers has always been strong but in 2007 there was a significant increase from 2006 when the US only accounted for 10% of fund launches. One explanation for this development could be the increasing focus from US investors on international real estate and the need to access European markets from a tax-efficient perspective.
German investors have taken to Luxembourg very quickly in recent months. "About 12 months ago the Germans decided to do Luxembourg," Hornsby says. "They had been using their own domestic REIT regimes and everything else, and then the SIF law came out and, for various technical reasons, German promoters launching international funds suddenly started to switch to using the SIF regime. A lot of the fund launches in 2007 are from German promoters."Hornsby lists a number of factors he believes have led to the regime's popularity:
Hornsby says the key question today is less "why use Luxembourg?" and more "why not?" For example, Luxembourg's FCP is a very popular vehicle for real estate funds today, but potentially it has a direct rival in the form of the Common Contractual Fund (CCF), available through Ireland's Qualifying Investor Fund regime. "An Irish CCF is a very similar vehicle and from a tax and technical perspective delivers exactly the same attributes. But you just never see them for property funds," says Batham.
The reason? Again, it comes back to investor familiarity. "They haven't been used and therefore why use one when you have many investors who are used to seeing an FCP?" he says. The Netherlands, meanwhile, has made a deliberate attempt to compete with Luxembourg's SIF regime with its VBI, a vehicle that is fully exempt from Dutch corporate and withholding taxes. However, the VBI suffers from more red tape than its offshore competitor.
"They have made a deliberate step to try to compete with the Luxembourg vehicle," Stapleton says. "Although their regime is quite attractive, it still suffers a degree of bureaucracy that exceeds that in Luxembourg. Therefore, the general feeling is it is going to be difficult to be seen as something that is better than Luxembourg, although there have been some funds launched there."There are some things that the Luxembourg funds regime cannot offer and one of those is an unregulated option. UK limited partnerships are one of the most common institutional fund structures alongside Luxembourg FCPs but these can be launched on an unregulated basis. Regulated regimes are certainly attractive to pension fund investors but unregulated arrangements can often be suitable for funds working in the opportunistic space. It is interesting to note that according to INREV figures, the vast majority of opportunistic funds are domiciled in the UK (see table)."The choice of vehicle differs depending on the nature of the fund," says John Forbes, UK real estate industry leader at PwC. "Typically, regulated vehicles, FCPs, are used for less opportunistic funds. Unregulated structures are more common for opportunity funds."
There are certainly a number of new opportunity funds entering the market, and anecdotal evidence suggests that institutional investors are less keen to commit capital to open-ended core funds during the current market downturn.
"What has changed in the last year, which is having a knock-on effect in the choice of structure, is the increased number of opportunity funds," says Forbes. "We are in the downward part of the property cycle, so people are again looking to raise opportunistic money to take advantage of when the market turns. There has not been a lot of interest in the last few months in launching open-ended core funds. There has been quite a lot of interest in raising closed-ended opportunistic vehicles to take advantage of the bottom of the cycle. "The issue with FCPs is that they are regulated. Some investors prefer regulated vehicles to some types of fund structures that are more obvious choice to implement but it imposes restrictions that make it potentially more difficult to use for something like an opportunity fund." Jersey has also established an unregulated scheme, as of February this year. The Jersey-domiciled Eligible Investor Unregulated Fund can take on an open-ended or closed-ended structure but, most important, requires no regulatory application at the outset, along with no restrictions on investment policy, no minimum diversification requirements and no leverage restrictions. The only two requirements are that the fund document has an offering legend declaring it an unregulated fund and that all investors are, and remain, eligible (institutional investors are automatically eligible).According to Daniel O'Connor, senior associate at Carey Olsen, the thinking behind the new unregulated regime was to offer investors and asset managers two options - both regulated and unregulated - rather than relax the regulation already in place as a simple means of becoming more competitive.
"Jersey felt it was better to describe it as unregulated rather than compete with other jurisdictions for the most lightly regulated fund," he says. "Calling a fund regulated and then effectively not regulating it is potentially misleading for investors. The authorities in Jersey thought that by far the better thing to do was to be upfront about the fact that it wasn't regulated."O'Connor goes on to say that there is a g rowing belief that perhaps the onshore/offshore distinction is "starting to dissolve" and the issue is becoming more a choice between regulated and unregulated. The International Monetary Fund, for instance, has indicated that it will drop the use of "onshore" and "offshore" as a distinction in its evaluation of jurisdictions. O'Connor says the questions should be more along the lines: "Is your jurisdiction a well-regulated jurisdiction or a not-so-well-regulated one?" However, Smith says the issue really comes down to the attitude of investors. "The reason for regulation is to protect investors. On the whole - certainly in our experience - investors in regulated vehicles are quite content with the level of regulation and see it as part of their due diligence. In many ways, they like the protection the regulated framework provides."
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