Are open-ended real estate funds still fit for the future?

Sebastian Lohmer is the owner and CEO of SHL Real Estate Consulting in Hamburg, which he established in 2022, after earlier positions as managing director of Patrizia Immobilien and TMW Pramerica Property Investment KAG, part of PGIM.

The crisis of open-ended real estate funds has reached its new peak with the suspension of the redemption of the shares of the Wertgrund fund. It is to be feared that smaller funds that do not have larger liquidity reserves will also be affected. The larger funds controlled by the banks still have sufficient liquidity to sit out the crisis.

Nevertheless, one must ask oneself whether the current structure and conditions of the funds are sustainable. Because, although the bank funds are large enough to manage themselves profitably, the scheme needs new inflows of funds. Without them, the funds would bleed dry in the long term.

To attract new funds, I believe that fundamental reform is needed. One only has to look at the criticisms of the recent crisis to define the necessary fields of action. The first thing to mention is certainly the risk classification. Here, the industry is hoping for a benevolent ruling from the European Court of Justice to be able to stick to the conservative classification of risk ratings 1-2. It would be more honest to voluntarily upgrade to risk classes 3-4.

It would not be the end of the world, as private investors also buy closed-end real estate funds with risk class 6. The current valuation method reflects volatile market movements in a delayed and smooth way. German investors have now accepted that the investment universe has become considerably more volatile, as evidenced by the increasing investment volume in the stock market. A monthly – albeit more volatile – valuation of the funds would certainly create more confidence.

However, this would then have to be based on current market values, i.e. "market to market", so to speak, instead of the usual "going concern". And finally, the management fees of open-ended real estate funds have been criticized for some time. These are particularly heavy in times of low returns. In my opinion, there is a lack of willingness on the part of fund management to structure fees more performance related. You could reduce the ongoing fees and agree on a higher, variable share of the sales profit when it is realized. This idea has been discussed in the fund industry for 25 years, but unfortunately no one has implemented it so far.

One should not underestimate the industry's perseverance, but it is time for a fundamental reform to make open-ended real estate funds fit for the future.

Summary

My comment analyses the current challenges of open-ended real estate funds, in particular the lack of liquidity of smaller funds and the criticism of their risk classification and valuation methods. It emphasizes that fundamental reforms are needed to ensure future viability, such as an honest risk rating, market-oriented valuation and more performance-based management fees. This is the only way to generate new inflows of funds and strengthen investor confidence.