When the regulatory authority warns of risks in financial products, the industry pays close attention. "If the outflows are too strong, at some point, it may become impossible to generate sufficient liquidity," stated BaFin President Mark Branson on Tuesday regarding open real estate funds designed for private investors. He emphasized that the only remaining option in such a scenario would be to suspend the redemption of fund shares.

While Branson clarified that the funds currently have sufficient liquidity, the industry is experiencing a stressful phase. Real estate prices are declining, and after the interest rate turnaround, investors already have a secure and solid interest-bearing alternative with daily and fixed-term deposit offerings. After years of significant inflows into public real estate funds, the segment has been experiencing net outflows since August, increasing from month to month. In November, investors withdrew a net amount of 276 million euros.

Yields are also under pressure: Last year, real estate funds, according to the German Fund Association BVI, only delivered 0.6% in value growth, compared to an average annual return of 2.5% over a decade. Some funds are experiencing losses: DWS reports a 2.3% decline for its 8.2 billion euro "Grundbesitz Europa" in the retail share class over the past year, and the 3.8 billion euro "Grundbesitz Global" sister fund shows a minus of 2.7%.

The "Leading Cities Invest" by Kanam Grund even records a loss of 9.7% on an annual basis after a significant devaluation of properties in November. While this fund has built a portfolio in recent years and is a relatively small product with 872 million euros, some large funds continue to achieve respectable returns despite a challenging market phase and some property devaluations, such as "Hausinvest" by Commerz Real with a plus of 2.2%, "UniImmo: Deutschland" with 2.9%, and "Deka-Immobilien: Europa" with 3.1%. The segment thus exhibits heterogeneity.

A crisis of confidence remains theoretically possible. The interplay between an illiquid asset class on the one hand and a liquid product like an open fund on the other is fragile. Similar to banks that fear a run on deposits during a crisis, a sudden outflow can render a real estate fund immobile.

In October 2008, shortly after the collapse of the US investment bank Lehman Brothers, investors withdrew a total of 6.9 billion euros from open public real estate funds in Germany. Numerous products such as "CS Euroreal," "Kanam Grundinvest," and "SEB ImmoInvest" were frozen and later liquidated in the midst of investor panic. While then-Chancellor Angela Merkel emphasized the security of savings deposits, there was no comparable political promise for the funds.

Nonetheless, in 2013, the legislature introduced a minimum holding period of two years and a notice period of one year, applicable to all new investors. For existing fund investors, daily redemption was still possible, but limited to a maximum of 30,000 euros per calendar half-year. Although existing capital was partially spared from the new holding periods, all new investors have been subject to the new rules since then. Following that period, inflows and outflows have significantly decreased, resulting in increased stability for real estate funds.

The current BaFin Executive Director Thorsten Pötzsch, then Ministerial Director responsible for financial market regulation in the Federal Ministry of Finance, coordinated the reform. On Tuesday, BaFin President Branson praised the "braking effect" of these rules as "very positive."

The current fund segment, with a size of around 128 billion euros, is indeed largely protected by the holding periods. According to an estimation of the rating agency Scope in March 2023, only about one-third of all fund assets belong to old investors and could be withdrawn at any time. However, these savers, who have been on board for many years, are oriented towards the long term.

The funds also have financial cushions: In spring 2023, the liquidity ratio, based on the total fund assets, was 14.6%, as reported by Scope in another market study. Nevertheless, the degree varies by product, with most funds reaching double-digit percentages. The debt ratio of the products is also manageable, averaging 15.3%, according to the market study.

Even the "Leading Cities Invest," despite the devaluation in November, remains open – thus, Kanam Grund has overcome a critical moment. The liquidity ratio was 11.5% at the turn of the year. But the fund is selling some properties. The proceeds from the sale are used to fulfill existing redemption requests and manage the fund, the company wrote a few days ago regarding the sale of the Greenside office building in Edinburgh, Scotland. The purchase price is not disclosed.

The "Leading Cities Invest" was launched in 2013 and therefore exclusively caters to investors bound by minimum holding and notice periods. Managing Director Heiko Hartwig described the investors' rationale in a November video interview with the economic data service Drescher & Cie. He emphasized that those who choose to redeem now must also accept potential losses that may occur until the funds are disbursed. At the same time, he encouraged investors to be courageous, stating, "The scenario can also turn in the opposite direction."

High markdowns like in "Leading Cities Invest" are rare. The valuation usually provides stability. To capture the property values, fund houses commission appraisers who regularly estimate market values. The data obtained through this method undergoes less significant changes compared to various price indices. This makes the performance of the funds more stable.

The Federal Association of Real Estate Investment Experts (BIIS) defends a conservative valuation practice. Each property is unique, and market price developments are not a reliable indicator, says Managing Director Gernot Archner. It is important to recognize the long-term potential of a property. "The market value is not a single point value."

Moreover, not every property is a burden: Even in the current market phase, some property values occasionally rise. In "Hausinvest," a complex near the stock exchange in Frankfurt experienced an appreciation in the six months until the end of September. In "Grundbesitz Europa," the "Metris" office building in Munich gained value, as did the Hamburg Emporio in "UniImmo: Deutschland".

Even in the institutional investor segment, open real estate funds remain stable. In the special fund segment, money continues to flow into the products on a net basis. With 181 billion euros, open real estate special funds, as per the Bundesbank, have significantly more weight than public variants. The largest investors are insurers and pension funds, i.e. long-term oriented financial providers. Institutional investors understand the situation of real estate funds and show no interest in causing the products to fail, according to BaFin President Branson. A challenging market phase is not a reason for them to withdraw money. "They endure it," he notes.

Nevertheless, outflows from retail funds are ultimately low: In the past year, until the end of November, gross outflows from the funds amounted to only 3.7 billion euros – measured against the total assets at the beginning of the year, a moderate value of less than 3%. Even small investors, therefore, have plenty of staying power.