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What is a real estate investment fund and is it a good option

REITs provide investors with profits from property market activity

A real estate fund is a means for investors to preserve capital without having to deal with the duties of asset management. This guide explains how to make the right choices when investing your capital using these special-purpose funds.

Advantages of real estate investment funds

  • low entry threshold: €1,000–30,000 (compared to the price of one property)
  • shares and units are easy to buy and sell (any business day in open-end funds)
  • professional management (saves time — no skills required)
  • diversifying an investment portfolio mitigates risk
  • easier to sell on than direct property investments

The fund operates in the following manner:

  1. An investor makes a capital contribution to the fund.
  2. Trust managers purchase a property with the money from investors.
  3. A company is hired to oversee the project (costs 1–2% of total assets per annum).
  4. The project earns profits that are distributed among the investors.
  5. Earnings come from two main sources: rental income and/or capital gains.

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

  Accumulation (Acc.) fund Income (Inc.) fund
Ways profits are used Profits are reinvested into the fund to buy other properties or shares. Profits are deposited on the investor's bank account.
Purpose of fund Boost and increase the property base to generate incremental income. To earn income only.
Most real estate investment funds combine expansion and income generation.

2) By trading on the stock exchange

  Listed Non-listed
Share issuance Issuing shares Not issuing shares
Legal status — REITs
— private equity real estate companies
— unit trusts or mutual funds
— pension schemes
— limited partnerships
Information on listed funds is readily available for investors.

3) By term of investment:

  Open-end Close-end
Terms of sale and purchase An investor can buy units or call on a management company to purchase units on any business day. Established for a term (5–10 years). An investor may not withdraw money from the fund over that term. Units are repaid when the fund is liquidated.
Liquidity High Low
Most funds with development projects are close-ended but investors can sell their units to another person.

Funds financing construction projects are generally close-ended because capital is recouped during construction. Divestment is possible once the construction is over and the building is sold. For instance, if a fund was established in 2015 and got the capital to undertake a construction project lasting five years, it becomes close-ended. When the property is finished and sold in 2020, the income is used to pay off 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.

Investment strategies

Strategy Other names Meaning Risks Return
Core Buy and Hold Real estate acquisition for rental purposes without leverage Low Low
(2–3%)
Core Plus Real estate acquisition for rental purposes with leverage Medium Medium
(5–7%)
Value Added Value Added
(incremental value)
Redevelopment (real estate acquisition for renovation, future repairs and resale at a higher price) Medium–high Medium–high
(7–10%)
Opportunistic Construction, purchase of undeveloped land, encumbered properties High High
(over 10%)
Data by Tranio

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). Many European funds opt for Core and Core Plus, as well as Value Added, whereas the US funds prefer Value Added and Opportunistic.

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% with leverage) by using financial leverage to boost returns on investment (sometimes 75–80% of the project is leveraged). Value Added funds can earn yields up to 10% by channelling investor capital into the developing markets with expected gentrification, purchasing real estate for renovation to sell on it at a higher price.

Fund and strategies: case studies

“Before deciding on a strategy, a fund looks at the needs of its target audience because 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, managing partner at Tranio.

Foreign real estate funds and strategies

Fund Aberdeen Property Trust Henderson Legal & General PropFund US Masters Residential Property Fund
Type of fund Open-end, listed Open-end, listed Open-end, listed Close-end, non-listed Open-end, listed
Jurisdiction UK UK UK Germany Australia
Strategy Core Core Core Core Plus Value Added
Minimum budget £5,000 £1,000 (Acc.),
£3,000,000 (Inc.)
£500 €30,000 N/A
Geography
of properties
UK (London) UK (South-East England) UK Germany (Berlin and suburbs, cities with over 50,000 inhabitants) USA (New York, New Jersey, undervalued locations)
Types of properties 50% retail
20% office
Retail and office property 22% industrial
Rest: shops, offices, retail parks, warehouses
Apartments Affordable housing for 1–4 households
Blocks of flats with 20–100 units
Return,
% annual
2.0–2.5 3.1 2.8 7.0–10.0 N/A
Leveraged capital
(LTV, %)
- - - 75–80 N/A
Sources: Aberdeen Property Trust, Henderson, Legal & General, PropFund, US Masters Residential Property Fund

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

The Opportunistic strategy is more popular in certain markets. For instance, JLL reports that, in 2015, 28% of investment strategies are Opportunistic whereas Core and Core Plus accounted for 35%. This country 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 investments, entail risks: the higher the returns, the higher the risks. ROI depends on whether the fund asset value increases or decreases, rental demand and rental rate dynamics and is not guaranteed for investors.

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

Key risks and mitigation

Risks How funds insure risks
Macroeconomic risks
(crisis, inflation, etc.)
Choice of stable markets (e.g. investments in Germany's “Big Seven”) and diversification (e.g. 80% of the capital can be channelled into retail or offices and 20% into logistic hubs and senior care homes)
Market risk
(real estate price decrease, lower rentals)
Forex risk
(e.g. an Australian fund investing into the US faces exchange rate risks if the US dollar weakens)
Regulatory risk
(legal developments)
Price risk
(buyer offer lower than the asking price)
Buying in neighbourhoods with expected or ongoing gentrification or regeneration
Credit risk
(the fund cannot get beneficial lending terms in the future)
Fixed-rate loans, LTV of 50% max
Default of tenants Reliable tenants with a good credit history (major companies such as Sainsbury's, public companies), several tenants
Idle capacity risk Choice of leased properties with minimum occupancy of 80–95% in neighbourhoods with a mature transport network, long-term and strict lease contracts
Maintenance cost risk Choice of quality properties (not requiring renovation, green Class A office buildings etc.)

Many funds diversify their investment portfolio, meaning they channel capital into real estate of various types in different countries using several investment strategies and directions. Alongside with 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 real estate companies abstaining from direct real estate investments.

-> Debunking profit myths on real estate and securities investments

Sample fund structure with diversified portfolio

Tranio recommends Core and Core Plus strategies

Tranio recommends Core and Core Plus project investments as they present the least risk and are the most reliable, as are the funds pursuing these strategies. It is advisable choosing mid- to long-term investments (i.e. for at least five years). Long-term is preferable as a property market cycle lasts for several years and risks can be mitigated by holding the investment for longer.

'Why don’t we recommend the Value Added strategy? I believe there is no straightforward answer. It all depends on the investor's objective and risk profile. The Value Added strategy can be chosen by someone looking for high returns but then, the investment should be made into transparent markets and reliable funds,' says George Kachmazov.

Annex: Specifics of European real estate funds

Country Legal status Requirements for fund Pros Cons
Austria Immobilien-Sondervermögenare open-ended funds, not legal entities, managed by an Austrian management company Kapitalanlagegesellschaft, KAG, that is either an LLC (GmbH) or a JSC (AG). At least 10 investments in four years. – For any investor.
– No taxes at fund level.
– Well-regulated.
– The fund buys units if investors want to.
– Restrictions on types of real estate.
– Capital gains are taxed whether the property is sold or not.
Immobilien-Spezialsondervermögen are close-ended funds, not legal entities, managed by an Austrian management company (KAG), that is either a company with LLC (GmbH) or a JSC (AG). At least 5 investments in four years. – Flexible tool for institutional investors. – Restrictions on certain types of real estate.
– Only accepts investments from legal entities.
– Usually long-term investments.
– Capital gains are taxed whether the property is sold or not.
UK Limited Partnership (LP) None – No taxes at fund level.
– Lower tax rates for non-resident investors.
– The structure is more suited to close-end funds.
Tax Transparent Funds, TTFs: authorised and regulated limited partnership vehicle (ALP) and contractual co-ownership arrangement (CCA) None – No taxes at fund level.
– Lower tax rates for non-resident investors.
Non-residents can be exempt from the capital gains tax.
– TTF is a new functional type of a real estate fund.
– Uncertainty in terms of recognition by international organisations.
Property Authorised Investment Fund (PAIF), Open-Ended Investment Company (OEIC) – Conditions are determined on a case-by-case basis. – Most of the fund's income is not subject to the corporate tax (yet investor’s income is taxed). – Strict regulation of the fund's activities (Financial Conduct Authority).
Germany Immobilien-Sondervermögen is an open-end fund, not a legal entity; managed by a German management company (KAG): either an LLC (GmbH), a JSC (AG), or a limited liability company and a kommandit partnership (GmbH & Co. KG) – Bank leverage of no more than 30% of the total real estate value – Common and reliable tool for any investor.
– No taxes at fund level.
– Minimum two-year holding term and one-year notice on withdrawal before unit repayment.
Spezial-Sondervermögen is a special open-end fund, managed by a German management company (KAG): either an LLC (GmbH), a JSC (AG), or a limited liability company and a kommandit partnership (GmbH & Co. KG) – Bank leverage of no more than 50% of the total real estate value. – No taxes at fund level. – Only for professional or semi-professional investors.
Geschlossene Investmentkommanditgesellschaft, Investment-KG is a limited liability partnership.
The principal partner is usually a GmbH. Investors are partners with limited property liability.
– Bank leverage of no more than 60% of the total real estate value. – No tax on profit distribution for any investor. – Double tax treaties and EU directives not applicable.
– The fund can be subject to German trade tax.
Spezial-Investment-KG, Investmentaktiengesellschaft or a limited liability partnership.
The principal partner is usually a GmbH. Investors are partners with limited property liability.
None No taxes at fund level. – Double tax treaties and EU directives not applicable.
– Only for professional or semi-professional investors.
Luxembourg Undertakings for Collective Investments, UCIs:

Fonds Commun de Placement, FCP
Société d’Investissement à Capital Variable, SICAV
Société d’Investissement à Capital Fixe, SICAF

Managed by a Luxembourg management company (Alternative Investment Fund Manager, AIFM)
– Maximum 20% can be invested into one investment property.
– Bank leverage no more than 50% of the total real estate value
– Minimum asset value €1.25M
– Flexible investment tool.
– Popular among foreign investors.
– No taxes at fund level.
– Taxation of investors depends on their country of residence.
Specialised Investment Funds, SIF
(FCP, SICAV, SICAF)
– Maximum 30% invested into one property.
– Minimum asset value is €1.25M.
– No taxes at fund level. – Investors can only be companies, professional investors or individuals investing at least €125,000 or willing to provide the documentary proof of investment experience.
– Taxation of investors depends on the country of residence.
Société d’Investissement en Capital à Risque, SICAR, can be in various legal organisation forms (LLC, LLP, etc.). None (Opportunisitc investment strategy) – No taxes at fund level. – Only for professional investors.
– Taxation of investors depends on the country of residence.
France Fonds de Placement Immobilier, FPI

Société de Placement à Prépondérance Immobilière, SPPICAV

Managed by a French management company or a company registered in another EU country
– €500,000 capital during the first three years after establishment.
– Minimum 60% should be property.
– Minimum 85% of rental income and (for SPPICAV) 100% capital gains are distributed among investors
– No taxes at fund level.
– Public funds can be exempt from the 3% tax.
– Double tax treaties not applicable.
– Few FPIs
Data by PwC

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

Yulia Kozhevnikova, Tranio