Real estate investments – Important building blocks in a portfolio context
Real Estate Assets
Real estate represents tangible assets and can therefore be defined as a physical, economic resource that creates direct consumption opportunities. Accordingly, tangible assets are to be distinguished from financial assets by this characteristic, since financial assets generate expected cash flows that can ultimately offer consumption opportunities for investors. Basically, real estate investments can be made directly (acquisition of real estate or real estate indices) and indirectly (investment instruments that acquire real estate). Real estate investments can be further divided into fixed-interest real estate investments and equity investments.
In addition, a distinction must be made between open and closed real estate investments. Within indirect real estate investments, real estate funds play the central role, as they provide access to fund managers with special knowledge and expertise. Conversely, however, investors lose direct control over portfolio decisions, including sales, use of credit facilities, leasing and strategic portfolio decisions.
The most important forms of real estate investments are described in detail below.
Private Equity Real Estate Funds (PERE Funds)
PERE funds invest pooled investor capital in unlisted or private real estate, including syndications and joint ventures. Investments can thus be made in equity and debt. Investment strategies include both development and investment in existing properties. The life of a PERE fund is typically 7 to 10 years with an investment period of 2 to 3 years.
They provide investors with access to private real estate, which is important both for smaller institutional investors who want to invest in real estate and for larger institutional investors who do not want to limit their exposure to the real estate-specific risks of a single property.
However, limited liquidity may be a potential risk as these investments are often bought and held until liquidation. As with a private equity fund, there may also be no detailed exit strategy before the fund is liquidated.
Fund performance may be difficult to measure due to the characteristics of the underlying assets. As a result, there may be valuation uncertainties and thus a situation where the prices from valuations cannot subsequently be realised in the market.
Open-ended real estate funds
Open-ended real estate investment funds sell share certificates to raise capital and then invest this capital in real estate assets. Investors gain access to real estate investments with limited investment amounts, similar to Real Estate Investment Trusts (REITs).
Generally, such funds issue or redeem units on demand, allowing investors to enter and exit the fund at will. This gives investors the opportunity to invest in the real estate asset class with more liquidity than is available from the underlying real estate assets.
However, open-ended real estate funds often reserve the right to defer investor redemptions in order to avoid liquidity problems, resulting in a potential liquidity shortage for investors, which often occurs when a significant percentage of investors wish to redeem units at one time. The underlying real estate investments may face liquidity problems at the same time, making it difficult for the fund to liquidate assets and generate cash for redemption of shares.
Calculated net asset values (NAVs) may lag the true market value of the underlying real estate assets. Selling prices that lag behind true market prices may cause existing investors to sell in falling markets and new investors to buy in rising markets. This could cause liquidity problems for the fund in falling markets, resulting in the sale of heavily discounted properties to generate liquidity.
Funds that invest in REITS should be mentioned in this category, but differ from this in some respects, as they only invest in REITS that must meet certain liquidity requirements (similar to an equity fund). The REITS to be invested in are regularly stress tested and managed like an equity portfolio.
Exchange-traded real estate funds
Closed-end retail real estate funds are exchange-traded investment funds. Unlike open-ended funds, they have a fixed number of units in circulation. The units are offered to the public - for the first time via an Initial Public Offering (IPO). A significant advantage of this form of investment is that a closed-end fund does not have to hold liquidity for the redemption of units, as is the case with an open-ended real estate fund. Closed-end retail real estate funds are also more liquid for investors, as they can sell units on the secondary market.
ETFs are tradable securities that, unlike a closed-end retail real estate fund, track a specific index. The ETF holds the assets contained in the index. These are subsequently traded on exchanges at approximately the NAV of the underlying assets.
In order to achieve a diversified portfolio, the often-high minimum investment sums and the associated risk can sometimes be too high for individual investors. Club deals, i.e. the formation of consortia or syndication of capital for the acquisition of real estate, take these points into account.
In a club deal, several investors join together to acquire a stake. The transaction is then executed for joint account. Thus, the participants in the transaction become mutually dependent or dependent on third parties for a certain period of time with respect to the investment, execution, valuation and divestment.
In the case of transactions involving unlisted companies, complex issues must be dealt with by means of unconventional solutions involving the necessary, far-reaching expertise, which fully meet the need for investor protection and equal treatment of the investors. The following issues are central to such a transaction:
- Liability and security
- Expertise and access to know-how
- Dealing with conflicts of interest
Strong reasons for co-investment are the potentially superior return/risk profiles that investors can achieve through co-investment. This is not only due to the typically lower management fees for co-investments for investments in the flagship fund, but also due to the possibility to tailor the investment to the investor's wishes. In addition, investors have direct access to the deal and can build knowledge and expertise for their own future direct investments. Significantly, co-investments usually result in stronger relationships to the benefit of the managers and the investors.
On the other hand, co-investment allows the manager to deal more efficiently with the underlying target investment, as risks can be split between the flagship fund and the co-investor. In addition, the manager is able to finance investments (including controlling positions) that would be beyond its capabilities without the contribution of the co-investors due to lack of capital, certain investment restrictions at the level of the flagship fund (e.g. diversification requirements) or possible redemptions by investors at the level of the flagship fund.
The concept of co-investments is therefore broadly diversified and covers many different situations.
In any case, co-investments must be structured in such a way that the interests of the co-investors are protected against the interests of the main fund. Normally, these interests are aligned. However, this is not necessarily the case at the beginning of each project. Therefore, the structure and corresponding impact of the co-investment will vary depending on the objectives (of the co-investors) and those of the other parties involved.
Co-investments come with certain challenges that need to be overcome. First, numerous operational issues need to be addressed, such as the allocation of costs and fees, the valuation of co-investments and the verification of co-investors' identities. Apart from this, conflicts of interest need to be clarified and equal treatment of investors in both structures needs to be ensured. In addition, disclosure requirements must be ensured in a balanced and efficient manner.
Summary and conclusion
Real estate investments represent attractive opportunities for investors, but they require a full understanding. It is important to consider tailor-made structures and asset class specific needs for such complex investments and to include lean configurations. It is also essential to have a flexible workbench to further strengthen the substance and stability of real estate investment funds. VP Fund Solutions is a strong partner with the necessary understanding and many years of expertise to take advantage of the opportunities offered by this asset class.
Real estate, also known as "concrete gold", is an integral part of any portfolio. For investors, funds are one of the most important forms of investment for a financially successful involvement in this asset class.Wolfdieter Schnee, Head of Fund Clients, Member of the Executive Management, VP Fund Solutions (Liechtenstein) AG, Vaduz