Are real estate Spezialfonds about to become a thing of the past as a result of Germany’s implementation of AIFMD? Barbara Ottawa reports

Institutional investors have grown to love it: it is simple to invest in, fits the necessary risk management procedures perfectly, is tax-efficient and easy to understand.

Trying to explain to anyone outside Germany the complex nature of an Immobilien-Spezialfonds can prove tricky. It is a vehicle especially constructed to suit the needs of institutions in Germany, especially those falling under insurance supervisory regulations which have strict limits regarding investments via funds, particularly on holding periods and transparency.

Furthermore, the special legal construct Kapitalanlagegesellschaft (KAG) is required under German law for companies to offer real estate and other Spezialfonds.
Since inception of the Spezialfonds at the turn of the century, the vehicle has attracted close to €34bn in capital from institutional investors, mainly insurers and pension funds divided up into currently over 174 Spezialfonds.

In 2011, the share of foreign investor capital in the vehicle increased significantly from €1.3bn to €3.3bn. Till Entzian, lawyer at Veritas Investment Trust and author of the annual report on German Spezialfonds, produced in cooperation with the German investment fund association BVI (see ‘The success story continues’), hopes this was not just a one-off phenomenon but that “foreign investors have realised the benefits of this investment vehicle”.

However, the discussion could be rendered irrelevant. A government draft on the law implementing the Alternative Investment Fund Managers Directive (AIFMD) in Germany, the “Kapitalanlagegesetzbuch” (KAGB), would abolish all forms of open-ended real estate funds in the future, including real estate Spezialfonds.

The government is citing consumer protection following major liquidity problems at German open-ended funds (GOEFs) in the wake of the crisis. Several are still closed for redemption and some are already being dissolved.

However, the threat to the Spezialfonds has prompted a wide range of German institutions onto the barricades, from real estate lobbyists to fund associations as well as the insurance industry.

“It is a very positive experience to see so many different associations in the real estate sector and beyond fighting for one goal”, says Bärbel Schomberg, vice-president of German real estate association Zentraler ImmobilienAusschuss (ZIA).

This common enemy may well have helped the various real estate associations to finally agree on a joint working group, the Bundesarbeitsgemeinschaft Immobilienwirtschaft Deutschland (BID), to allow them to speak with one voice on domestic issues and pan-European level.

Today, ZIA’s aim is to save both the open-ended Spezialfonds as well as the GOEFs. To this end, the organisation established a panel with members of parliament prior to the draft being forwarded by the government.

Schomberg notes positively that “all of them had at least basic information on the subject” and that almost all delegates were in favour of keeping open-ended real estate Spezialfonds up and running. “What we see in the KAGB goes far beyond the AIFM, and we have to act now as the EU wants to see it implemented by July 2013,” she says.
Schomberg says the greater professionalisation of fund managers as demanded by AIFMD was “a good thing and the right thing to do” but that Germany “went too far”.

She paints a bleak picture of investors fleeing Germany and urged the government to be more “pragmatic” in implementing the directive and not “unnecessarily hurt the fund market”. She adds: “If German investors no longer have the Spezialfonds to invest in then they will turn to Luxembourg vehicles – this is what investors told us.”

Schomberg’s fears are shared by the largest German insurance association GDV, which predicts “major non-foreseeable effects on the asset allocation behaviour of German insurers” that will, in turn, lead to “market distortions”.

Institutional investors themselves are a bit less outspoken on the subject, stressing that the draft bill is still under review by parliament and nothing is yet finalised.

Hans-Wilhelm Korfmacher, managing director at the professional pension fund for chartered accountants in the German province of North Rhine-Westphalia (WPV), noted briefly that he was “opposed” to abolishing real estate Spezialfonds. But he added that he could not make any more substantiated comments on the subject yet as it was still under discussion.

Indeed, most of the investment managers and KAG providers do expect the government to give in to the industry’s demands and alter the law at least slightly.

“We are confident that there will be no ban on real estate Spezialfonds, as numerous experts do not think it is sensible and various politicians said they think changes to the law are likely,” says Henning Klöppelt, board member at Warburg-Henderson.

Martin Lemke, managing director at Patrizia GewerbeInvest KAG, agrees. “It cannot be the political will to present institutional investors with a dilemma,” he says. “They want to further increase their real estate quota via indirect investments, but the existing vehicles are either banned or regulated in a way bringing problems regarding legal, tax and accounting issues.”

Dietmar Fischer, partner at Ernst & Young is more cautious, likening the debate on the real estate Spezialfonds to the one on Solvency II. “There, the real estate lobby also put up a fight, but still it is highly likely that the main points of the government proposal will be implemented – [that is] capital requirements of 25% or more for real estate investments by insurers,” he says.

Replacing the irreplaceable

Few German fund managers see a positive side to the KAGB draft, but one of them is Invesco Real Estate. “As an internationally-focused investment adviser for institutional money, we are actually not all that concerned about the Kapitalanlagegesetzbuch,” says Robert Stolfo, senior director for client portfolio management. “There are gaps to be closed and elements to be clarified, in particular on the tax side – [that is] the planned changes to the Investment Tax Act – but the law also provides for some opportunities.”

Stolfo thinks the proposed changes in abolishing Spezialfonds are “tax-motivated” as these are sometimes difficult to handle for international tax authorities, especially when it comes to foreign investments since there is no separate legal entity.

“A vehicle has to be found that can be labelled more easily in an international environment,” he says, such as a listed investment company or a Kommanditgesellschaft (limited partnership).

Both listed investment companies and limited partnerships were suggested in the government’s initial KAGB draft. They would be more strictly regulated but less suited to the needs of institutional investors than a Spezialfonds, which under German law counts as a Sondervermögen (assets designated for a special purpose).

However, Stolfo emphasises his view that there is “no good reason to reduce the number of available vehicles” and that Invesco would “welcome the possibility to utilise Sondervermögen as well” in future under certain circumstances “to meet in particular specific German investor needs”.

The current draft would, of course, break up current strict regulations around setting up a real estate Spezialfonds and would make it easier for investment managers – domestic and foreign – to offer institutional products.

“This draft is threatening the business model of KAGs to some extent, as the managing company for the fund would no longer have to be a KAG but any regulated manager,” Stolfo says.

Alexander Taft, managing director for structured finance at Invesco Real Estate, adds: “It might make sense to still use the construction of a Master KAG in some cases.” An example would be to pool several asset managers.

However, the benefits of a limited partnership owned by an investor, or investors, would be that “you can ensure that the KAG, like in a German Sondervermögen, is not the actual owner of the property”, says Taft. This makes it easier to swap managers and KAGs.

Taft is more worried about other aspects of the AIFMD, such as the yet unclear wording around limits on debt capital for special alternative investment funds. He is also concerned that tighter restrictions on private placements will make it more difficult to market US or Asia funds. Taft says: “This is a requirement in the registration process going beyond the AIFMD.”

Stolfo is convinced that “there will be a certain amount of friction to begin with” after the KAGB law is implemented, such as compatibility issues with supervisory regulations for insurance companies – but in the end “there will be appropriate forms of German investment vehicle for institutional investors”.

While ZIA and other critics agree there will eventually be a solution, they fear the phase in between – especially as several laws and regulations are linked to the Spezialfonds, such as investment rules for insurers or tax requirements.

According to Schomberg, there will be a “phase of deadlock” before investors will eventually reorient themselves towards new vehicles. “And this is something the German real estate market cannot afford as it is very dependent on large investors.” She stresses the importance for German investors, particularly in the domestic residential market, and their role as source of financing now that the banks are not providing as much anymore.
Klöppelt predicts that a ban on real estate Spezialfonds in Germany would “probably” drive investors back to Luxemburg vehicles, which had been used by German institutions before the introduction of the Spezialfonds.

He adds that the new vehicles proposed by the government to replace the open real estate funds and Spezialfonds are not suited to most institutional investors as they “do not fulfil their regulatory requirements”.

According to Klöppelt, a ban would “not be a problem for investment houses offering a wide range of vehicles”, but it “would be a shame for Germany as a financial centre if the success story of the real estate Spezialfonds would be ended abruptly and unnecessarily by a rashly implemented law”.

Lemke stresses the importance of real estate Spezialfonds for smaller institutions for which real estate investments would otherwise be too complex, especially for cross-border investments.

Fischer sees real estate debt as another alternative investment path for institutions should a ban on Spezialfonds be implemented. However, he thinks it equally possible German institutions might “put a break on real estate investments” entirely.

Even after a ban, real estate Spezialfonds would be around for some time as the law protects existing funds.  But according to Fischer this situation would distort the level playing field.