Luxembourg real estate funds recently reduced their eurozone equity exposure while keeping debt securities largely similar, potentially as a measure to reduce risk associated with equity due to tightening fiscal policies. Archive photo: Maison Moderne

Luxembourg real estate funds recently reduced their eurozone equity exposure while keeping debt securities largely similar, potentially as a measure to reduce risk associated with equity due to tightening fiscal policies. Archive photo: Maison Moderne

Real estate funds domiciled in Luxembourg are currently undergoing some key portfolio changes, most likely in anticipation of perceived risk mitigation, as evident from reduction in equity exposure in the euro area.

Based on the most recent data from the Luxembourg Central Bank (BCL), real estate funds domiciled in Luxembourg have made adjustments to their portfolios in recent months, suggesting a shift in their outlook, likely influenced by the aimed at curbing inflation, as well as geopolitical uncertainties.

Equity exposure

Real estate funds based in Luxembourg have decreased their equity holdings in the euro area by €6bn in January and February combined, representing an 8% drop and marking the largest decrease in value. Conversely, after experiencing a decline from October to December 2022, equity holdings in the rest of the world have increased by €4.7bn, reaching their highest level ever at €29.8bn.

Notably, equity holdings in the United States have declined by 60%, from €7.2bn in September 2022 to €2.9bn in February 2023, even before the and smaller Signature Bank in March 2023.

Debt securities

For real estate funds, debt securities are not particularly attractive as real estate projects, under normal conditions can easily avail credit from monetary institutions, like banks and credit institutions. For Luxembourg-based real estate funds, euro area debt securities increased by €340m in January and February, compared to a decrease of €268m for rest of world.

Changing hands

Traditionally, real estate, as an asset class, has the potential to appreciate in value over time, making equity investments in real estate attractive for funds seeking to participate in the potential capital appreciation of underlying properties.

Equity holders bear more risk as they are exposed to the company’s performance and potential losses, but they also have the potential for higher returns through dividends and capital gains.

In contrast, debt securities carry a lower risk as their repayment is usually prioritised over equity holders, but their returns are limited to interest payments.

This is one of the main reasons why, under normal economic conditions, real estate funds favour risk-over-return and typically have lower exposure to debt compared to equity. In Luxembourg-based funds, debt securities typically constitute one-fifth of that of equity holdings, data from the BCL shows.

However, it is important to note that debt holders are considered creditors and have priority over equity holders in case of company liquidation or bankruptcy. Therefore, as a risk management measure during periods of perceived increased risk, real estate funds may reduce their equity exposure, especially for real estate projects which are underperforming, underscoring a repositioning of the funds to mitigate potential risk exposure.

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