A recent European Central Bank study calling for a regulatory framework to address instability in the market for Real Estate Investment Funds, known as Reifs, has been downplayed by a growing number of real estate specialists contacted by Investment Officer in Luxembourg and London.
A deteriorating outlook and declining valuations in the international real estate market, as we reported last week, has inspired researchers at the European Central Bank to take a closer look at real estate investment funds, especially the open-ended ones and their liquidity when subject to requests for redemption. Subject to any restrictions on redemptions imposed by the fund, these could pose liquidity challenges to the fund. Luxembourg, along with a handful of other EU countries, is considered a leading hub for these funds.
In the ECB report, the researchers suggested this framework would address issues including how to handle spikes in liquidity demands, internalising the cost of redemptions, while reducing the underlying liquidity mismatch.
Open-ended Reifs, the kind of vehicle that is concerning the ECB researchers, amounts to about 80 percent, or 835 billion euro, of the net asset values of all European real estate funds. This market has grown over the past 10 years. In Luxembourg alone the number of funds has risen nearly threefold, to 621, between 2012 and 2022. Asset values surged five-fold, to 127 billion euro.
Wide diversity
PwC Luxembourg director Alexandre Goossens, part of his firm’s Alternatives Valuation Services team, has joined other industry voices in opposing the policy framework recommended by the ECB researchers behind the study.
“These investment funds have such a wide diversity of underlying real estate that having a frame that covers all these real estate assets will be complicated,” said Goossens.
Goossens conceded that the real estate industry is in turmoil having to do with uncertainty and rising interest rates. However, he pointed out “we still see a lot of demand for space occupation.” This, he said means that “the income of these investments is more or less stable and secured.”
Structural vulnerability
He agreed that the Reifs pose a “structural vulnerability” to commercial real estate, but he said that most of this has to do with the cycle.
He emphasised that most of such funds put many constraints on investors applying for early redemption. “For 99% of the open-ended funds, it’s very complicated to get out. New investors know when they invest that they are taking on a certain level of risk.”
Other market commentators Investment Officer has spoken with said that this is not a problem for policy makers, as this is something that needs to be addressed by the market. Goossens said he agreed
Part of the game
The stock market itself is also very volatile, he said, adding that people invest in real estate mainly for diversification and you have some security in the long term. He emphasised that it was on a very long term. During that period, he said, you may see the indicators going down, but then back up again.
“We have had a booming real estate market worldwide for the last 10 years,” he pointed out. With all this growth, he said, it made sense that there would come a time where it went down.
Goossens was of the view that the decreases are “highly cyclical”. “We’ve experienced the same back in the global financial crisis in 2008.”
Crisis of uncertainty
There is not yet a crisis of liquidity, Goossens said, as was that crisis. He stated that it’s more of an energy crisis, linked to inflation, “but also linked to how the heck we’re going to use real estate in the future.”
“It’s more of a crisis of uncertainty rather than of liquidity,” he said. With uncertainty, “we can go back on track in one year or in five years or in three years.”
He argued that the fact that the risk is perceived to be higher, is driving, through the discount rate, the decrease in property market value. “If we have funds only allocated to real estate, of course, then the value of the fund, the Nav, will decrease.”
Generational change
However, this time, the variation in the values is being accompanied by a generational change in the way people are using corporate real estate. “The risk is indeed on how the property will be used,” he said. Instead of focussing on short-term price decreases, he said, “there should be more analysis of how a corporation will use real estate.”
He called for attention to what generation Z will accept to work in the future. “We see real estate being used more for experience.” He mentioned that part of this is making sure that office buildings have nice bars. “Spaces where people can rest, where they can have some entertainment.”
Parallel to this process, there is ESG. “There’s a lot of push for the investors to have some ESG aspects into the investments, real estate is a perfect example.” Goossens described a framework that would decrease the value of a property if the it doesn’t include sustainable criteria.
He also pointed out that the use of real estate accounts for 40% of the CO2 emissions in the world. “That’s where we should put some regulation.”