What is a real estate investment fund and is it a profitable option?

The majority of realtors (81%) believe that Russian-speaking investors rarely put their money into property funds, a 2017 Tranio.com survey has shown.

However, such a mode of investment is set to become more popular. “We expect Russian nationals to learn more about collective investment (crowd funding) and real estate funds, and to gradually begin moving in this direction in 2017–2018. This format is often more convenient than buying and then managing a property individually,” George Kachmazov, managing partner at Tranio.com, says.

This guide explains how to use an investment fund as a tool for investing in projects related to property and the construction of real estate.

The fund operates in the following manner:

1. the fund appoints a management company (fund managers);
2. investors make a capital contribution to the fund;
3. fund managers purchase properties with the money from investors;
4. fund managers generate profits and direct them to the fund;
5. profits from lease and/or resale of property are distributed among the investors in the fund proportionately to their share.

Fund investments have many advantages:

• low entry threshold: €1,000–30,000 (when compared to the minimum price of a liquid property, which is €100,000);
• shares are easy to buy and sell (on any working day in open-end funds);
• professional management (saves time);
• investment portfolio diversification;
• greater liquidity in comparison to direct property investment.

However, there is also a significant disadvantage: foreign funds are difficult for non-residents to invest in.

Tranio expert, Alexander Chernov, comments: “It is difficult for individuals to invest in the US for a number of reasons. Most investment platforms are organised as REITs (Real Estate Investment Trusts), exempt of taxation, which move the property investment income tax burden onto their shareholders (investors). Such a structure is favourable for US residents who often invest in these types of funds using the money from their retirement investment accounts that also have tax preferences for investment purposes. However, foreign investors who put their capital into similar American funds will have to pay a significant amount of income tax and submit a tax return in the US on their own, as the funds do not act as tax agents. In addition, tax returns are laborious and expensive to prepare.”

However, according to the Head of Financial Services at Tranio, Kirill Schmidt, it is possible to invest in REITs on the stock exchange, like in securities. “In this scenario, there’s no need to submit a tax return in the USA,” he says.

Types of funds

First, it is important to know what different types of real estate investment funds are out there before looking at profit accrual models.

1) By profit use

2) By trading on the stock exchange

3) By term of investment:

Funds financing construction projects are generally close-ended because capital is recouped during construction. Divestment is possible once the construction is finished and the building is sold. For instance, if a fund was established in 2015 and enough capital was invested in it to undertake a construction project lasting five years, it becomes close-ended. When the property is finished and sold in 2020, the profit made is paid out to the investors.

Investment strategies

There are four main real estate investment strategies: Core, Core Plus, Value Added and Opportunistic. An investor should know the strategy of the fund in order to assess the risks and returns.

Most funds adopt just one strategy but some choose to combine two or three concurrent strategies (e.g., pursuing Core, Core Plus and Value Added all at once). “In Europe and the US, Core and Core Plus funds prevail by capital volume, as they include a significant percentage of the largest and the most expensive institutional properties,” Alexander Chernov says.

Core funds usually choose established low-risk markets with steady demand, price growth and low rental yields (2–3%). The Core Plus funds generate higher returns (up to 7%) by investing in less central locations and using financial leverage (sometimes 75–80% of the project is leveraged). Value Added funds can earn yields of up to 10% by channelling investor capital into developing markets which are expected to gentrify and into purchasing real estate for renovation to later sell on it at a higher price.

Fund and strategies: case studies

“Objectives differ from investor to investor: some want to preserve their capital with minimum risks and returns; others have a good appetite for risk because they are looking for higher yields on their invested capital. The Western real estate fund market has a wide range of strategies, risk levels and returns for investors,” says George Kachmazov.

In a survey by the European Association for Investors in Non-Listed Real Estate Vehicles (INREV), most investors that responded chose Value Added or Core strategies in 2016. These strategies were more popular than in 2015 (rising from 82.2% of respondents in 2015 to 86.2% in 2016), compared to Opportunistic strategies (which declined from 17.8% to 13.8%), meaning that investors were more risk averse in this year. The survey also distinguishes low-risk countries (e.g., Germany, France and the UK) as the most attractive markets.

However, the Opportunistic strategy is more popular in certain markets. For instance, JLL reports that in Spain in 2015, 28% of investment strategies were Opportunistic whereas Core and Core Plus accounted for 35%. It is worth noting that Spain and its investors have a higher risk profile than the UK and Germany.

Mitigating risk and diversifying the portfolio

Real estate funds, as with any type of investment, entail risks: the higher the returns, the higher the risks. Return on investment (ROI) depends on: whether the fund asset value increases or decreases, rental demand; and rental rate dynamics. Returns are not guaranteed for investors.

“One of the key risks in fund investment is posed by dishonest managers. It is crucial to choose a company with a good background, reputation, transparent auditing and a clear strategy,” says George Kachmazov. Most of the funds do their best to mitigate risks by mixing various strategies and diversifying their portfolio.

Many funds diversify their investment portfolio, meaning they channel capital into real estate of various types in different countries using several investment strategies. Alongside real estate, funds can retain a minor part of the funds in cash or securities. There are also such funds that invest into other funds or into real estate companies abstaining from direct real estate investments.

Debunking profit myths on real estate and securities investments

How should I invest?

Core and Core Plus projects are the most secure, but the Value Added strategy allows you to earn more.

“There is no universal recommendation. the choice depends on the investment goals and where the client's portfolio has investments. For instance, if 80% of the capital has already been invested in reliable vehicles, and a vehicle to increase the yields is needed, another 20% can be directed to Value Added projects,” Alexander Chernov says.

According to George Kachmazov, those wishing to invest in Value Added strategies should choose understandable markets and reliable funds to minimise risks.

“It would be a good idea to select funds with promising strategies, for instance, investing in a class of property that will be popular within 10–20 years,” George Kachmazov says. “In our opinion, such properties are micro-apartments and senior care homes. It is also important to choose a developing area that is being gentrified and, therefore, somewhere with properties set to become more liquid in a decade or so. The funds that invest in promising and the latest strategies are more likely to generate profits than not.”

Annex: Specifics of European real estate funds

The material contained within this article is for informational purposes only. Real estate investments come with risk, which can extend to the loss of capital invested. Tranio strongly recommends discussing plans with a professional investment advisor before making any investment.

Yulia Kozhevnikova, Tranio