Stumbling project developments are becoming more common, but a construction halt on a high-rise is relatively rare. The half-finished Elbtower in Hamburg is a grim symbor for a deepening real estate crisis in Germany. Originally, it was intended to be the third-tallest skyscraper in Germany, rising between the Elbbrücken by 2025, as a “bold statement of the growing city of Hamburg.“ Reality paints a different picture. Construction on the skyscraper, which is to be realized by the crisis-hit real estate company Signa, has been at a standstill since late October.

The imbalance in project developments could eventually impact real estate savers, many of whom have bought shares in open-end public real estate funds with small sums. Typically, fund management companies invest in completed properties, particularly office real estate. However, a portion of the funds is also allocated to project developments, which carry higher risks.

"A significant share of project developments is certainly a risk, especially for companies that engaged in forward funding between 2018 and 2021," says Thomas Beyerle, Head of Group Research at the real estate company Catella. Forward funding operates on the principle that the investment company provides liquidity to the project developer, and the developer delivers the finished properties at a later date.

The planned Elbtower has been owned by one-fourth by the major real estate fund "Hausinvest" of Commerz Real since mid-2022. The fund acquired a 25% equity stake in the project. However, for a product with a total investment volume of 17.4 billion euros and over 150 properties, it's a relatively small investment. Commerz Real notes that the share of project developments in "Hausinvest" amounts to 3.2% in total.

Catella expert Beyerle, who has been in the market for over 20 years and has witnessed several crises, currently sees no risk of devaluation for the funds "as long as the asset management in the companies is functioning." However, a more significant problem for the industry is the interest rate development since the ECB has gradually increased interest rates to 4.5%.

Market developments have led to term deposits and savings bonds yielding significantly more, up to 4% depending on the maturity period. Many interest-bearing investments now offer higher returns than open real estate funds, whose returns typically change slowly. As of the end of September, these products averaged a performance of 1.6%. It's clear that the funds now look less attractive after years of near-zero interest rates. Additionally, falling property prices in the real estate market could gradually affect the valuation of the properties within the funds.

The figures for the net inflow of open real estate funds have been showing a declining trend since 2020, which continues in the current year. In August, according to the Bundesbank, a net outflow of 40 million euros was recorded from open public real estate funds. This is the first net outflow in years. In September, the outflow accelerated to a net 115 million euros. However, as the rating agency Scope notes in its analysis, more money has flowed into the funds overall in the course of the year.

Scope forecasts that the net inflow will remain positive for the entire year. However, the balance could turn negative for 2024, as the inflows are expected to continue to be low, while outflows may occur as fund shares are gradually returned due to various reasons, including withdrawals following the expiration of the required one-year holding period, according to Scope analysts' assessment. The minimum holding and redemption periods for open real estate funds were introduced with the 2013 reform.

Barkow Consulting is uncertain whether the initial net outflows already mark a turning point. "In light of numerous high-profile insolvencies of real estate developers, it must be closely monitored whether it's merely a seasonal weakness in August or the beginning of a sustained trend of outflows," writes company founder Peter Barkow in an analysis.

Real estate funds are not alone on the horizon; for the first time in years, they have to compete against other asset classes like bonds and savings accounts, according to Beyerle's assessment. "Most investors do not want stocks, which is why open real estate funds had no competition at the bank counter for a long time." Now, open real estate fund providers are required to offer higher returns than savings accounts. This may prove challenging in the short term.

In spite of the real estate market crisis and other attractive savings options Scope still views the role of open real estate funds positively. "Despite the challenges and the decreased attractiveness compared to interest-bearing investments due to the currently high interest rates, open real estate funds serve important functions in the portfolio as a long-term investment," according to the rating agency's assessment. In addition to diversifying the investment, these products offer solid returns and very low volatility over extended periods. "Therefore, they often serve as a stabilizing component in the portfolio."

Whether customers of open real estate funds remain relaxed and focus more on volatility than returns remains to be seen. It is essential to consider voices that strongly recommend selling. The consumer portal Finanztip, with a widely read newsletter, published its negative assessment in mid-October. The argument against open real estate funds is based on two points: "Due to high costs and low returns, they are now a less attractive asset class." The advice is to "opt for a combination of savings accounts, fixed-term deposits, and stock ETFs instead of real estate funds."

For the experts at Finanztip, it is clear that in the event of a real estate crisis, a decline in value would hit investors hard. Those with few other investments should "reduce the invested amount and, thus, dependence on the real estate market."

Selling shares in open real estate funds is subject to stricter limitations compared to other investment funds. Investors who purchased their fund shares after the 2023 reform must hold them for two years initially and then observe a notice period of twelve months for redemption. However, for existing investors, there is a tax-free threshold of 30,000 euros per half-year that they can withdraw at short notice.

Many investors cannot quickly redeem their shares at the official price from the fund management company. Therefore, in certain cases, Finanztip recommends selling through a stock exchange, where shares are traded at discounts of up to 10%. For example, the stock market price of "Hausinvest" in Hamburg is 39.32 euros, while the net asset value is 43.71 euros. To limit losses, Finanztip advises: "One strategy could be to sell a portion through the stock exchange and a portion through the management company to achieve an average."

However, Finanztip's recommendation is controversial in the industry. "In general, real estate funds are designed as long-term investments that are intended to generate stable returns. From this perspective, trading on the stock exchange does not make sense," says Beyerle, pointing out that trading the fund shares on the stock exchange has never really gained momentum.

"Finanztip calls for a run on open real estate funds," says Ali Masarwah, a fund expert at Envestor, with indignation. According to his warning, if hundreds of thousands of Finanztip readers were to redeem their fund shares, it could become a time bomb for open real estate funds. In that case, open real estate funds could implode just as they have twice in the past 20 years. Masarwah believes that Finanztip's selling recommendation could become a self-fulfilling prophecy.

Beyerle also warns, "One cannot exclude a mass rush or herd movement, and providers of open real estate funds should be aware that social media can unleash an entirely new dynamic among investors. Therefore, it is essential to provide investors with good reasons why they should not sell." The funds often serve as the airbag in the portfolio and can provide stability.

According to the industry, the legal reform of open real estate funds has significantly improved the product category's safety since 2013. Holding periods and notice periods were introduced after mass redemptions led to the closure and later liquidation of many funds in 2005 and 2008. In an illiquid segment like the real estate market, there should no longer be daily liquidity. Nevertheless, the rules, in principle, do not apply to long-term investors who purchased their shares before mid-2013. There are no figures on how large this old stock is.

When you add up the net inflows into open real estate funds from 2013 to 2023, the total is 62 billion euros. Relative to the total fund assets of 132 billion euros, the older share could still be quite significant today. If many old customers were to redeem their shares, it could become uncomfortable for the funds.