Personal Finance

Post-Covid reflection on real estate funds



  • Fund managers of real estate funds have continued to operate at tight liquidity and forced to consider asset-mixing.
  • Capital investors form a critical arm of the limited partnership of a real estate fund.
  • In Kenya, the establishment of the Kenya Mortgage Refinancing Company (KMRC) supports affordable housing as a pillar of the government’s Big 4 Agenda.

Establishing an investment in a strong and long-term growth industry such as real estate is imperative in intergenerational wealth creation. World over, the investor appetite for real estate as an asset class has remained strong over the years.

This can be attributed to real estate offering attractive absolute returns, portfolio diversification and low correlation to bond and equity markets.

There are a number of ways in which individuals can invest in real estate. The common ways include; direct property ownership, investing in listed property companies and Real Estate Investment Trusts (REITs) or investing in Real Estate Funds.

Most often, real estate is largely practised in the private markets away from regulation. However, some of the financing vehicles used such as real estate funds and Real Estate Investment Trusts (REITs) can be offered either under regulation or through private placements. These funds have at least 70 percent of the assets allocated directly in property or property securities.

While real estate has been considered as a stable and appreciating asset, in the wake of the Covid 19 crisis, investment returns witnessed increased volatility that led to investor losses and liquidity issues in real estate funds as a result of reduced cash inflows, outflow pressures and difficulty in property valuations.

Fund managers of real estate funds have continued to operate at tight liquidity and forced to consider asset-mixing in order to achieve a diverse portfolio for the much-needed flexibility in the changing property market. Save for those that received government bail-outs, other real estate funds suspended redemptions, while others froze their assets in a bid to seek moratoriums to regain liquidity and avert defaults.

Whereas real estate fund managers may not be humanly able to predict occurrences of black swans such as Covid 19, they can certainly prepare for these unprecedented events by expecting the unexpected in future. There is a need to adopt a framework centered on strict and strategic execution of the fund’s objectives in adverse environments.

Real estate fund managers must be judicious in the use of leverage and ensure the availability of cash buffers and credit lines to serve as a disaster preparedness plan to offer the much-needed liquidity interventions to the funds.

As the general partner, a real estate fund manager must appreciate the importance of their staff’s agility during these times. Staff must remain motivated and made to understand the importance of critical tasks assigned in such events. Their quick adaptation will ensure brand resilience as staff accepts the new roles assigned and other departmental changes if any.

Capital investors on the other hand form a critical arm of the limited partnership of a real estate fund. Fund managers occupy a fiduciary position to act in the best interest of their capital investors. In cases where funds are faced by liquidity pressures, moratoriums, redemption gates, asset freezes and looming defaults, there’s a need for proper and timely communication to investors through all possible channels of communication on these eventualities.

Market regulators owe the real estate players a fair, efficient and supportive market. They therefore should play a major role at the policy level in ensuring investor protection, fostering market confidence to avoid panics and unnecessary runs.

In the UK, in response to the illiquidity crisis faced by real estate funds, the Financial Conduct Authority (FCA) published CP20/15 Consultation paper in August 2020 that proposed a 180 day notice period be given to real estate fund managers by the investors prior to redemption.

In China, real estate contributes to about 30percent of its nominal GDP. The regulators imposed the ‘Three red lines’ rule, as guidance on property developers against a backdrop of growing debt levels and a property price bubble.

The ‘Three red lines’ criteria included;

Liability-to-asset ratio of less than 70percent (excluding advance receipts) Net gearing ratio of less than 100percent Cash-to-short-term debt ratio of more than 100percent.

The regulations further categorise property developers who fail to meet either of the ‘Three red lines’ by use of colour codes bearing limits on the extent to which the developers can further grow their debt levels. Green, for developers with no breach, qualifying for up to 15percent annual debt growth.

Yellow, for developers in breach of one of the ‘Three red lines’, qualifying for up to 10 percent annual debt growth. Orange for developers in breach of two, with a 5 percent annual debt growth allowance and finally red for developers in breach of all the ‘Three red lines’ with no allowable annual growth in debt.

Whereas these regulations have been viewed as tad stringent, they have somewhat stabilised the sector and controlled the rising house prices in China. With the forceful deleveraging of the sector and serving as a credit rating to developers, these regulations have further created a more predictable and stable future of the property market through access to finance and increasingly safer opportunities for real estate fund and bond investors.

In Kenya, the establishment of the Kenya Mortgage Refinancing Company (KMRC) supports affordable housing as a pillar of the government’s Big 4 Agenda. KMRC will offer long-term fixed-rate loans at a concessionary rate to selected financial institutions who will in return increase mortgage penetration through affordable mortgages to Kenyans.

On regulation, the regulator published draft regulations with an aim of obtaining feedback from the sector stakeholders. The draft sought to update the Collective Investment Scheme (CIS) regulation and other emerging issues in the sector, in order to create a regulatory environment for privately pooled funds, real estate funds included.

The proposed regulations on Alternative Investment Funds (AIFs) included among others; proposal to cap the minimum entry investment at one million shillings in order to attract professional investors with higher risk tolerance and capacity, capping the number of investors in these funds at twenty, a proposal likely to be disputed by market players since investor capping is likely to limit the funds' uptake and reduce investor confidence in the Alternative Investment Funds.

In conclusion, the Covid crisis has indeed exposed the vulnerable underbelly of the real estate sector financing models. Observably so through the glaring defaults, volatilities and illiquidity. In particular, the stability challenges as a result of maturity mismatches between the underlying assets and the investment vehicles used to raise capital.

However, these financing vehicles that include; bonds, REITs, notes and high-yields, hold a lot of growth potential if and only if they are accorded support from the government at policy level.

With local banks citing high risks and seemingly noncommittal in financing real estate and other greenfield ventures, open-ended funds or Alternative Investment Funds (AIFs), remain viable financing vehicles to be used to secure capital in financing capital intensive and illiquid assets such as real estate.