In the early 1990s, ABP, the Dutch civil servants pension scheme, and at €193.6bn Europe's largest, decided to move away from direct real estate in favour of indirect exposure through the listed and unlisted property markets. With roughly €22bn in real estate assets, the fund argues that direct exposure does not provide the diversification it needs, and also has too high a concentration of risk. Instead, it put 65% of its assets into listed funds, and the remaining 35% of assets in the unlisted market.

Many pension funds agree with ABP's logic, and for those that want exposure, which is as similar to owning direct investments as possible, the non-listed market has become increasingly important. "We have seen a great deal of institutional investor interest; investors are looking for any products which provide them with cash yield," explains Hans Op't Veld, head of property vehicles at the Investment Property Databank (IPD). He also points out that unlisted funds provide tax benefits and the structuring flexibility that investors need.

In the UK alone, 11 new institutional vehicles were launched during the period from January 2005 until now. They have brought in almost £4bn (€6bn) in assets, Op't Veld says. "That is quite substantial. My guess would be that it would have been more were there not such a dearth of products to invest in."

Demand for unlisted property is at an all-time high. A survey by the European Association for Investors in Non-Listed Real Estate Vehicles (INREV), entitled Investor Intentions 2006, reveals that an amazing 100% of investors expect to increase their allocation to non-listed real estate over the next two years. This becomes even more significant when you consider that 65% of investors already hold stakes in 10 or more non-listed real estate funds. The survey was conducted in early 2006, with questionnaires sent to 47 institutional investors and 92 fund managers. A total of 17 institutional investors responded, representing €32bn of real estate assets, as did 28 fund managers with a total of €117bn in European real estate assets under management.

Managers point out that demand is being fuelled by several important trends. Property has posted stellar growth over the past few years, and investors have hit their comfort zone with the asset class. More than 50% of investors in the survey mentioned enhanced returns as a key motive for putting capital into the non-listed sector.

The pooled property fund indices compiled by HSBC and The Association of Real Estate Funds (AREF) reveal that the net asset value total return for all balanced funds over the year to end June 2006 was 22%. This compares sharply with the FTSE All-Share Index return of 19.7% over the same period. All funds included in the index are collective investment schemes offering indirect exposure to the UK property market.

"Returns have been stellar, perhaps not so much when you compare it to the stock market, but comparatively very good," says Op't Veld.

Others point out that it is a diversification game. "Many of our clients come from the
Nordic regions, where the real estate market is quite small. You have big pension plans with very small domestic markets. Pension funds have a lot of competition when increasing allocations to real estate in domestic countries," explains Anders Åström, managing director of Aberdeen Indirect Property Partners, Europe's largest pooled property fund of funds. For smaller funds - those which cannot afford to buy direct holdings - unlisted funds offer diversification and a lower concentration of risk if invested outside the domestic market.

As a result, cross-border flows account for close to half of Europe's €80bn-a-year property investment market, according to figures from the Cass Business School. It is no surprise then, to see managers jump through hoops to build up truly pan-European businesses and offer cross-border offshore products, whether they are invested in European outlet malls or, more broadly, a European fund of property funds.

"There is a lot of money flowing into pan-European structures. Luxembourg has a big real estate funds market, and there are plenty of Dutch investment routes as well. In the UK more and more money is heading out and looking to diversify by jurisdiction," explains Richard Ross, partner at KPMG.


Listed or unlisted?

In the UK, for example, investors do not have the option of investing in REITs, and are looking for other opportunities. Still, there are benefits and disadvantages to both the listed and unlisted markets and managers say that REITs are complementary to unlisted fund investment, with institutional investors having allocations to both within their portfolios.

"I don't think there's an intellectual winner here about whether investors do it listed or unlisted," explains Neil Turner, head of international investment and research at Schroder Property Investment Management. "Advisers should sit down with their clients and really understand the objectives of that client.

"If liquidity is important, and if they want to go higher up the risk-return profile, then listed is something they should consider, because of the liquidity that conduit offers. If liquidity isn't an issue, and they are happy to invest in closed-end funds, but are interested in getting direct property exposure, then the non-listed route will be very attractive."

For investors that are interested in gearing, listed vehicles like REITS make little sense. "There will be all sorts of regulatory parameters on REITs which won't be what everybody wants, such as limits to gearing," explains KPMG's Ross. "A REIT is not going to be an attractive vehicle in which to hold non-UK property, and it's not certain yet whether a REIT will be a proxy for real estate return or for equity return," he adds.

Others are clearer about the differences of returns. "The big advantage of a listed product like REITs for investors is that they offer liquidity and can be sold at any time," explains Michael Englisch, director responsible for business development at Henderson Global Investors. "The disadvantage is that short-term property companies that are listed, whether they have REITs status or not, behave like listed companies rather than like property. Their volatility goes with the volatility of the financial markets, which is much greater in the short term."

He also points out that prices can trade below net asset value and that listed vehicles have to put that on their balance sheets at the end of the year. However, competition between REIT structures and unlisted funds isn't an issue right now. "Raising capital is not a big concern. The big issue is finding investment opportunities," he argues.

Åström at Aberdeen believes liquidity is also not a big concern for investors. "Most of our clients don't mind that unlisted funds have a lack of liquidity, because they have high liquidity in their equity and bond portfolios, and the level of exposure to the closed-end funds are very limited. A lot have up to 10% in alternative investments, and they see unlisted real estate as an alternative exposure. As long as it's not a big exposure they don't mind."

At the same time though, managers are trying to develop a secondary market for unlisted vehicles. "You're allowed to sell your units, but there is not a marketplace in which to sell. Still, you can hire someone to sell it, so there is some turnover."

It might get easier in the future though. Op't Veld points out that roughly 60% of unlisted vehicles are closed ended, and have a limited life span of seven to 10 years. "Because a lot of capital was raised during the period where the stock market had a bad patch, in one or two years you'll start to see funding start to unwind. That capital will converge in some shape or form. The question will be: will that flow into the listed market, or remain in the unlisted market?" Capital in the funds is estimated to stand at £20bn. "That's a lot of money to unwind," says Op't Veld.


Location, location

The INREV survey reveals that a shortage of suitable product is a major impediment to investment in non-listed funds, meaning that capital might have nowhere to go in the future.

The association does not separate its analysis of offshore funds from onshore funds, arguing that the decision to go offshore is driven by tax restructuring and so is simply a tool that helps the fund in implementing its investment strategy. But while a decision is typically based on where the investor is domiciled (UK investors tend to go with funds based in Jersey and Guernsey for example), there are more compelling reasons to choose one location over another. Some countries are more relaxed about regulation than others.

"From an investor point of view, 99% of the time the investor doesn't care what the form of the fund is, as long as its tax efficient," explains David Brown, head of the international funds team within the real estate group at Deloitte & Touche.

However, leading the group is Luxembourg, with its FCP, SICAV, and, more recently, SICAR structures. The SICAR was introduced in May 2004, designed mostly for private equity funds. It is, say managers, suitable for opportunistic property funds. Other centres, like Ireland, have lost out. Brown points out that Ireland has a very good tax regime for funds, but not a very good regime for holding companies. You need both, he argues, to make it work.

As a result, Ireland is now shut out of the competition. The usual suspects, such as Jersey, Guernsey, the Cayman Islands and Bermuda, are all attractive domiciles for the funds but other, less known, jurisdictions are also vying for attention. Henderson's Englisch points out that for Turkish or Israeli investors, Malta is a popular location, while Cyprus is also picking up some interest. Still, he believes that larger domiciles like Luxembourg will continue to dominate. "Big investors in many countries have some experience with FCPs and SICAVs. It may not be the first choice but it is the second best for all of them," he says.

But investors would argue that without anywhere to put their capital, choosing a jurisdiction is a moot point.