Real estate investment funds have grown both in volume and share of the EU real estate market over the last decade. With this growth, the share of risk has also increased due to its intrinsic illiquid nature and the systemic risk it poses if investment sentiment sours. Photo: Shutterstock

Real estate investment funds have grown both in volume and share of the EU real estate market over the last decade. With this growth, the share of risk has also increased due to its intrinsic illiquid nature and the systemic risk it poses if investment sentiment sours. Photo: Shutterstock

Investment funds that directly invest in physical real estate properties or indirectly through purchasing shares or debt of property companies have experienced substantial growth over the last decade. However, this increased investment also poses higher risks. In response, the European Central Bank has called for a policy framework and risk assessment for these funds.

Luxembourg-domiciled real estate investment funds (Reifs) have grown more than tenfold since 2010, rising from €22.41bn in January 2010 to €253.74bn by December 2022. This represents 22.4% of the total value of euro area Reifs, ranking just behind Germany’s share of 33.5%, according to recently released European Central Bank data. The euro area as a whole has seen its Reifs surpass the €1trn mark as of April 2022, with these funds now comprising 40% of the total commercial real estate (CRE) markets.

While Reifs provide financing and investment in the CRE markets, thereby reducing reliance on bank financing and diversifying the investor base, their significant market share means that instability in the Reif sector could have direct implications on the CRE markets. This, in turn, could lead to broader implications for the financial system and real economy. It is worth noting that in case of Luxembourg, a significant proportion of its CRE holdings are cross-border investments, making them vulnerable to market forces in other EU member states. According to the latest annual Reif survey by the Association of the Luxembourg Fund Industry (Alfi), 66% of the Reifs were EU focused.

In addition, Reifs that offer frequent redemptions (open-ended funds) have an inherent structural liquidity mismatch because they hold illiquid real estate assets. This means that any pullout by investors due to unfavourable market conditions would lead the open-ended Reifs to sell assets at discount, further deteriorating real estate market sentiments. At present, open-ended Reifs constitute €835bn or 80% of the net asset value (NAV) of all Reifs in the eurozone. However, in Luxembourg, they only account for 36%.

In light of this increased interdependence, as well as the deterioration in the outlook for CRE markets in recent months in some euro area member states, the ECB has emphasised the need for a policy framework. “Reifs should therefore be subject to a common and comprehensive policy framework to reduce the liquidity mismatch and risks to financial stability,” .

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