As the countdown to Solvency II begins, the general consensus among institutional investors is that the new regime that comes into force in December 2012 will have few adverse effects on real estate investment as it is not directly aimed at the asset class. The feeling is that in the long run it could have a positive impact. Richard Lowe talked to a range of stakeholders

Hermann Aukamp
Nordrheinische Ärzteversorgung (NAEV)

*Large insurance companies should be able to cope with Solvency II
*NAEV is monitoring AIFM
*Changes to the German Investment Act will not affect NAEV

New regulations are not a major issue at the moment for German pension fund Nordrheinische Ärzteversorgung (NAEV), says chief investment officer
Hermann Aukamp. The fund is not affected directly by Solvency II, which will affect insurance companies, although Aukamp readily admits that it could one day be applied to the European pension fund industry.

Even among the larger insurance companies, he does not expect Solvency II to have a major impact on appetite for real estate. "The big insurance companies will adjust to it," he says. "There is a lot of talk about at it at the moment. Of course, this is an issue and it has to be discussed in Brussels. Hopefully, this will be changed because real estate is not treated in a proper way by this new regulation."

The Alternative Investment Fund Managers (AIFM) Directive might well prove to have an impact on NAEV's real estate investments in the long run, but for the moment the pension fund can only monitor its developments. "It is very difficult to know today in what way it will be affected and by how much. So it is an open question," Aukamp says.

Germany itself has seen a number of recent changes to its Investment Act, bringing in new rules for the country's open-ended property fund sector, requiring withholding period, lower levels of leverage and more frequent valuations. However, Aukamp says that this will not affect NAEV since it operates through institutional-only Spezialfonds, which are exempt from the new regulations. "We never invested in open-ended retail funds," he says. "And most of the bigger pension funds didn't invest either."

Edwin Meysmans
Pensioenfonds KBC

*Not directly affected by new regulations
*Solvency II is having an impact on Belgium's capital raising market
*Lower appetite among Belgian insurers would have an impact on KBC indirectly


Edwin Meysmans, managing director at Pensioenfonds KBC, is not seeing any direct impact on the institution's real estate activities. That said, he has already experienced, first hand, the impact that Solvency II is having on the institutional capital-raising market in Belgium. The pension fund was interested in a real estate fund that was being marketed in the domestic market, but the relevant fund manager experienced difficulty in raising capital from Belgian insurance firms.

"If the Belgian insurance companies are no longer interested in investing in real estate, it would make life for Belgian - or maybe even other real estate fund managers - very difficult," Meysmans says. "Historically, Belgian insurance companies have always been very heavy investors in real estate. They always have quite a large allocation to real estate. If that is changed because of Solvency II, there is a problem, yes."

He says that this could pose a significant challenge in markets like Belgium and France where insurance companies are much larger than pension funds. "If they are not investing in real estate, I think there will be fewer funds that will be offered, because it is very difficult in Belgium and in France to set up a fund where the only investors
you have are pension funds. That's going to be very difficult because the market is not large enough."

Such a situation would be problematic for fund managers looking to raise capital but equally so for pension funds like KBC, since the ability of managers to attract other third-party capital is a prerequisite for committing capital to new funds. "It helps in the due diligence phase, when discussing with the board whether we should invest in this fund," Meysmans says. "One of the questions is always: who else is in the fund, and who else is committing money to the fund? It's comforting to know that some of the big names or other investors are also committing their money or trusting the
fund manager."

Jeroen Steenvoorden

*Regulation not an issue for the pension fund's real estate investments
*Unlisted real estate is reported the same as listed for solvability purposes
*Moves towards to inflation-linked contacts could increase appetite for property

Jeroen Steenvoorden, director at the €5.5bn occupational pension fund for Dutch medical consultants (SPMS), does not see any new regulations that are directly affecting the institution's real estate investments. The pension fund recently awarded a mandate to Aviva Investors to manage its existing global portfolio of unlisted real estate funds. It also has a small portfolio of listed real estate investments, but has no plans to increase its investments in the asset class in the near future.

Under current pension fund regulations, listed real estate and geared unlisted real estate investments require 25% capital reserves; direct property with no leverage is treated differently. SPMS reports its portfolio of unlisted real estate in line with listed investments for the purpose of solvability requirements. "There is always a question of what do you do with unlisted real estate - is it direct or indirect," Steenvoorden says. "We have always reported them the same as listed, with the same funding level requirements."

As far as he is aware, political debate over changes to Dutch pension fund contracts has not touched directly on real estate. However, it might have an indirect impact: if more pension funds move away from nominal contacts to those based on real values, taking into account indexation, there could be a greater demand for inflation-linked assets.
Although this hasn't been a major topic of debate, Steenvoorden says, real estate could, in theory, be one of the beneficiaries of this trend should it arise. "If some funds are opting for contacts which are more related to inflation-linked benefits, they may have more interest in real estate, because there is probably a better correlation between real estate and inflation. Of course that is not always true," he says.

"But If you are more interested in inflation protection, there are investment linked bonds, inflation swaps, and shares. Maybe real estate has a little bit of a higher correlation with inflation in the long term, so in that sense maybe it can make a difference. But I don't think pension funds are anticipating this."

Nick Duff
Aon Hewitt

*AIFM should not necessarily be viewed as unhelpful red tape
*Its principles reflect Aon Hewitt's core beliefs
*Pension funds will view real estate as a core asset class


Nick Duff, senior consultant at Aon Hewitt, does not see any regulation adversely affected his pension fund client real estate investments. In fact, he perceives the measure being proposed by the Alternative Investment Fund Managers (AIFM) Directive as being consistent with the investment consultancy's "core beliefs".

"Robust governance; transparency; disclosure; independent valuations; the right design of remuneration structure, so that managers aren't taking excessive risks; safekeeping of assets; transparency on leverage and how leverage is used. That is all best practice," Duff says. "That is what we would have looked at anyway, but it is being formalised. Clearly, it might have an impact on some of the smaller managers, but if they want to stay in the game they are going to have stay up to speed on it."

He recognises some of common complaints with the directive from the real estate industry, especially since it seems primarily concerned with other asset classes. "You can argue it is going to be more relevant to other types of asset managers than real estate ones," he says. "I think it is trying to address some of the issues in hedge funds and private equity."

But he says the directive should not necessarily be seen as unhelpful red tape, since it addresses some valid concerns and is moving in the right general direction. "It's all about best practice and risk management. I don't have any material concerns," he says. "I am broadly sympathetic with what it is trying achieve."

He adds: "I still think our clients will continue to look at real estate as a core asset class. Alternatives are growing anyway, whether it's real estate, infrastructure, private equity or hedge funds. There is going to be a lot more focus generally on that opportunity set. Investors are moving away from equities and to some extent bonds; they want to diversify."

Bill Hughes
Legal & General Property

*Solvency II could make real estate lending more attractive
*It will not necessarily render direct property less attractive
*Welcomes moves to avoid treating all unlisted funds as equities

Bill Hughes, managing director of Legal & General Property, says Solvency II will affect insurance companies' real estate investments in three main ways. One potential consequence is that it makes commercial real estate lending more attractive. The latest quantitative impact study (QIS 5) is proposing that insurance companies would need to hold capital reserves of between 0% and 8% for these types of investments, compared with 25% for direct property. "This is one reason why insurers are being encouraged towards lending to real estate," he says.

However, Hughes does not believe this necessarily makes investing in direct real estate less attractive. "For some organisations that are looking for solvency capital requirements (SCR) as being the most important determinant in what they are doing, it might make direct real estate less favourable under current arrangements," he says. "But as part of Solvency II there is an expectation that correlation is a very important part of the equation. For those organisations that end up with the right numbers for correlations between property and other asset classes, they will continue to look pretty favourably upon direct property investment."

For example, the 25% SCR for direct real estate is higher than gilts and bonds, but is comparable with medium-dated, triple-B bonds and has lower correlation characteristics. "So I think it is wrong to say that property is a loser in that space."

The third issue concerns unlisted real estate funds, which under earlier proposals would have been treated by Solvency II as being more in line with equities due to levels of leverage that can be found in some vehicles. Gearing levels vary greatly throughout the unlisted funds sector. "It is very important for Solvency II to recognise the actual level of gearing in property funds rather than make a blanket assumption about gearing in unlisted funds," he says.

Hughes therefore welcomes more recent proposals that unlisted funds with no gearing be treated the same as direct property. "There is a possibility of factoring in an additional level of solvency capital requirements for funds that do carry gearing," he says.

Willem-Jan Pelle
Composition Capital Partners

*AIFM Directive is unlikely to alter the way business operates
* But there are concerns over depository and valuation requirements
*Non-EU managers may also be dissuaded from marketing funds in the EU

Composition Capital Partners is monitoring various regulatory developments, with the Alternative Investment Fund Managers (AIFM) Directive being of first and foremost concern. Although the fund of funds manager is unregulated itself (it serves professional investors only), managing director Willem-Jan Pelle does not believe that the directive would require any significant changes to the way in which the company operates, although it is likely to raise costs.

"We think some degree of regulation could be beneficial for our industry as a whole, even though the introduction appears not directed at private equity real estate in the first place, but more so to hedge funds," he says. "The way we have operated our business, in terms of detail of reporting, checks and balances, transparency towards investors, we feel that AIFMD, once implemented in local legislation, will not change the way we operate a lot."

That said, Pelle does harbour concerns over some areas of the proposed legislation. "Some elements show a lack of understanding by the legislators of unworkable practical consequences for closed-end private equity real estate funds," he says. Pelle cites depository and valuation requirements as examples, which do not really appear to serve a purpose for private real estate fund investments. "I hope these ‘wrinkles' can be ironed out in the level-two process," he says.

Another concern is that AIFM will cause a disincentive for non-EU private real estate fund managers to offer their products in the EU because of the greater complexity and costs entailed. "It will be easier for them to market their product in their home market or elsewhere in the world," he says, citing the US and Asia as examples. "There is a saying: ‘good deals don't travel far'. And AIFMD could have a magnifying effect in that respect."