The discontinuation of tax breaks with closed-end real estate funds, the crisis with open real estate funds, and the upcoming introduction of REITs in Germany — there are many reasons for the funds sector to come up with new strategies.

Even though politicians still do not currently agree on their legal and fiscal design, almost everyone agrees with introducing REITs (Real Estate Investment Trusts) in Germany. Thus, a new vehicle for Germany will be created whereby investors will receive another option for investing their money in the real estate sector. However, this new asset class is not the sole thing that is making initiators of open and closed-end funds come up with alternatives to their current product offering. With the closedend fund, this includes omitted tax breaks and increasing competition. The crisis of the open real estate funds has made it clear to the makers of this type of fund at the turn of the year that they need to implement long-overdue reforms in their product offerings in order to win back investor confidence.

Photo: Today, investors can no longer be lured to investing their money in classic office real estate in a typical office location such as Frankfurt am Main. Meanwhile, fund initiators must come up with new products and go down new paths.

New ideas for closed-end funds
“As a mid-sized issuing house, we have decided to become active in the areas where the large companies will not go,” explains Angelika Kunath, Managing Partner at the Fondshaus Hamburg GmbH, a main pillar of her company. This year a closed-end Germany fund will be put on the market that is directly focused on the economically hopeful region Baden-Württemberg. The Hamburg company has already acquired three objects—two in Heidelberg and one in Freiburg—for the funds. Angelika Kunath and her colleagues have Stuttgart as a fourth location on their list of candidates.

As a long-term expert in the real estate sector, Angelika Kunath knows that a regional fund Baden-Württemberg will not make all investor groups happy. That is why they have submitted the prospectus for their new “FHH Real Estate Fund 1”. “We, of course, also see that new innovative fund models have been showing up in the market lately,” explains Angelika Kunath. The same goes for foreign funds, since the purchase prices for traditional and fully rented “Class A office real estate” in the international markets have risen so strongly that traditional fund concepts no longer offer attractive returns.

The new funds from Hamburg are based on a fund-in-fund concept, whereby a German closed fund, with the capital of its draughter, has a share in a significantly larger international fund that is otherwise only accessible to institutional investors with a minimum share of multi-million Dollars. “That way, private investors with moderate sums of money can also profit from the opportunities that such a broad real estate investment offers,” says Angelika Kunath.

Draughters of the FHH fund have shares in a LaSalle Investment Management private equity real estate fund, LaSalle UK Ventures L.P. The fund invests in a mix of rented real estate, as well as project developments in the areas retail, office and logistics, and its goal, among others, is to upgrade non-core properties through modernisation, restructuring or repositioning, in order to resell them to core investors. A period of six years is planned for the LaSalle fund, with three years to purchase and three years to sell the properties.

Changing conditions with open funds
But the initiators from the open real estate funds also need to do something to make their product attractive again to investors. The “short-term money for long-term real estate” strategy that some investors follow is now outdated.

“With the ‘DEGI Global Business’ fund, especially created for institutional investors in November of last year, I think we have shown where the road is leading us also in terms of mutual funds,” explains Malcolm Morgan, Managing Director of the Allianz Group’s DEGI Deutsche Gesellschaft für Immobilienfonds mbH. The facts are as follows: the fund does not demand an issue surcharge. When giving back shares the investor pays a so-called redemption fee, which is dependent upon his holding period of the fund. If the investor wants to sell back his shares in the first year, he will then pay a fee based on four percent of the share value; in the second year, this fee is reduced to three percent. If the investor had shares in the fund for more than two years, he only pays a two-percent redemption fee when he sells back his shares. After a three-year period, a redemption fee is no longer charged.

Besides, investors in DEGI Global Business fund have to announce the selling of a significant amount of shares ahead of time in order to allow for effective fund management. Share refunds starting at 500,000 Euros have to be announced six months in advance, and twelve months starting at ten million Euros.

Malcolm Morgan also considers his company’s existing mutual funds and their legal conditions suitable for such measures, but notes that it is not so easy to encroach upon existing funds in such a drastic way.

Photo: Infrastructure projects, such as streets, bridges, tunnels, as well as supply and waste lines, could become a new asset class for real estate funds. Fund initiators are also considering specialty funds in Public Private Partnership.

Infrastructure projects as alternative assets          
Deutsche Bank Corporation is currently promoting a completely different topic. Through the company RREEF Infrastructure, a subsidiary of Deutsche Asset Management, which deals with the entire Real Estate and Infrastructure Investment Division, the German bankers are offering the Pan-European Infrastructure Fund, which so far has only been marketed to institutional investors. John McCarthy, Head of Europe at RREEF Infrastructure, considers the entire “infrastructure” area an asset class that represents a very good addition to traditional real estate investments. “The topic of infrastructure can be used very well towards the immunisation of portfolios, since investments in this area have a much lower volatility than traditional real estate investments,” says John McCarthy. A gas pipeline, as opposed to an office building, has a certain eternally unique position. “Because of its very constant income, this asset class is very suitable to the requirements of institutional investors, such as pension funds or insurances,” explains the RREEF specialist. “These are looking for long-term and particularly constant income.” John McCarthy assumes yearly returns on the invested capital, which are between 5.5 and eight percent depending on the project. The total return could very likely reach eight to twelve percent.

While the funding of infrastructure projects in countries such as Australia, Canada and Great Britain are already very advanced, Europe, and in particular Germany, is still in the beginning stages. “However, the examples of privatisation of the DFS Deutschen Flugsicherung GmbH and the increasing emergence of Public Private Partnerships in Germany prove that this topic is definitely up and coming, even in Germany,” believes John McCarthy.

Public Private Partnership funds
Hans-Georg Napp, Director at Landesbank Hessen- Thüringen in Frankfurt am Main, is convinced that investments in infrastructure projects will have a big future. Hans-Georg Napp has had this topic on his agenda for new fund products for a while now, whereby he has particularly dealt with the offering of special funds of Public Private Partnerships. “We have already brought the first PPP funds in private placement to the market,” explains Hans-Georg Napp. An annual return of at least five percent with a manageable risk is a combination that is interesting particularly to large investors, in order to hedge their respective liabilities, which, for example, serve the pension plan sector.

Thus, Hans-Georg Napp has high expectations for the lawmaker. “With the PPP Acceleration Act, the foundation for PPP has already been laid. Now, many of the points in the PPP Simplification Act must be ascertained.” This is the second step of the PPP Acceleration Act, whereby the existing financing barriers are removed. According to Hans- Georg Napp, adjustments will follow that enable the use of the topic PPP through duns. Considerations for an infrastructure fund, which can approach a broad group of investors, are already in the pipeline.

The Topic at EXPO REAL 2006 Tuesday, 24 October 2006 EXPO REAL FORUM Hall C3 10.00 am – 10.50 am New fund products: Changing concepts For detailed information click here.

By Hans Heuser
Hans Heuser is Deputy Editor in Chief of the Magazine “Fonds professionell”, Cologne.