The financial world has been feeling the tension for many months with regard to open ended real estate funds. Once promoted as a very secure investment option for conservative investors, they are increasingly coming under scrutiny. This is not the first time. After the closures and winding-ups of numerous products about 15 years ago, the basic question is being asked once again. The question of whether real estate funds with daily pricing are a sensible structure as a retail investment product.

High interest rates, property value losses, and the changing real estate market are all putting significant pressure on these products. In the first nine months of 2024 alone, around 4 billion euros flowed out of real estate funds in Germany, as reported by the industry association BVI. Almost half of these outflows occurred in the third quarter. The transformation in the real estate market is leading to turbulence – investors and consumer advocates are raising the alarm.

A notable example of the current trends in real estate funds is Leading Cities Invest from Kanam Grund. The fund, which invests largely in office properties, had to accept a significant devaluation recently, after the main tenant of a property in the Paris suburb of Nanterre moved out. This caused the fund's share price to drop further. Over the past twelve months, the fund has posted a loss of 18%, according to Scope.

A common background to these developments is that investors are redeeming their shares, and the fund manager needs liquidity. Another example is the special evaluation of Unilmmo Wohnen ZBI in June of this year. The fund is now down 21% year-over-year. Such devaluations lead to significant capital outflows.

Consumer advocates have criticized the risk disclosures of open real estate funds. The Verbraucherzentrale Baden-Württemberg (Consumer Center of Baden-Württemberg) has filed a lawsuit against ZBI Fondsmanagement, a subsidiary of Union Investment. The reason for the lawsuit is the devaluation of Unilmmo Wohnen ZBI, which unexpectedly hit investors and led to a value loss of 1 billion euros.

According to the key investor document, the fund had been rated with a risk indicator of „2“ – a rating that consumer advocates deem misleading. „The fact that open real estate funds have the same or even a lower risk indicator than ETFs on short-term German government bonds is downright absurd“, says Niels Nauhauser from the Verbraucherzentrale.

Union Investment argues that the risk ratings are in line with current regulations. However, consumer advocates argue that a risk indicator of „6“ would be more realistic to warn against potential losses. According to Nauhauser, the current risk ratings obscure the actual uncertainty of these investments, and create a false sense of security.

The Schroders Immobilienwerte Deutschland fund, originally designed for both retail and institutional investors, has now suspended redemptions. The reason is the increased construction and financing costs, which, according to the provider, make the fund no longer viable for retail investors. A restructuring into a special fund is intended to secure the fund’s long-term viability, but this will limit the opportunities for retail investors to participate.

The development of open ended real estate funds remains a point of interest for many observers. For fund managers, the current market situation presents a challenge – if properties need to be sold to provide liquidity, valuations may come under pressure. Antje Schiffler from the analysis firm Morningstar describes the situation as „mixed“, and expects that the downward trend cannot be halted immediately.

The downward trends are also evident in fund ratings. Scope recently downgraded the rating of eleven out of 21 open real estate funds in Germany. Funds that purchased properties during the high-price phase from 2019 to 2022 are particularly affected by devaluations. „The recent devaluations are not likely to strengthen investor confidence“, comments fund expert Björn Drescher. He also emphasises that there are currently few incentives for investors to invest in such funds, given their returns. „When investors lock up their money for such a long period, they should expect an illiquidity premium. However, the return these funds have recently provided, and what seems likely in the foreseeable future, does not offer any additional incentive beyond the risk-free market return.“

Consumer advocates have expressed concerns that banks often recommend open ended real estate funds as a safe investment to risk-averse investors. An analysis from the consumer portal Finanztip explicitly advises investors to consider selling. „Recently, the risks have increased, and returns have decreased“, states a guide article.

The organisation Finanzwende also views this development critically, and emphasises that the original promise of the funds to be a secure investment is crumbling. Falling property prices and capital outflows are putting pressure on the funds, and further devaluations may follow.

For Finanzwende, the risk indicators of many funds also obscure the actual volatility, and make them seem more attractive to risk-averse investors than they really are. „Properties don’t sell like hot cakes“, it notes, pointing to the difficult real estate market. If funds are forced to sell, prices usually drop because there are few buyers for large real estate assets.

Open real estate funds are facing structural challenges, and there is increasing debate about improper advisory practices. This is evident in the case of the Goldenstein law firm, which filed a lawsuit against Volksbank Böblingen in September. An investor had been placed into a real estate fund by the bank, which, according to the law firm, was presented as a safe investment. „During the advisory meeting, the investor clearly communicated that she did not want to take any risks with her investment“, said the law firm. Such cases may occur more frequently in the future, as the transparency of risk information is increasingly called into question.

Some experts, like Sonja Knorr from Scope Fund Analysis, stand by the asset class regardless and continue to see open ended real estate funds as a useful component in a diversified portfolio. „Even though net capital outflows are noticeable right now, this is not the end of open real estate funds as an asset class“, Knorr says.

For Knorr, questioning the entire system does not arise. Rather, it is a dry spell, as investors are increasingly seeking alternatives, and it remains unclear whether the returns from the funds can compete with higher-yielding investment options.

Investors considering open ended real estate funds should carefully weigh their options, Knorr stresses. The illusion of a risk-free investment is long gone. Critics however maintain that fund companies are not sufficiently transparent about the risks, and are providing conservative investors with a false sense of security. The government had previously responded with holding and redemption periods, but the fundamental problem – illiquid assets in a volatile market – persists. Regardless, it seems certain: the much-touted security of open ended real estate funds is more under scrutiny than ever.