Until recently, one might say that investing in the European real estate market was a rather dull affair. Institutional investors - whether pension funds, insurers or foundations - would buy pieces of real estate and hold on to them for long periods.
For those without the expertise and/or the resources to invest in the asset class directly, domestic-focused funds were the answer, though, once again, these investors would buy and hold.
Of course, going long on real estate makes a great deal of sense for institutional investors, especially liability-driven pension funds and insurers. With several exceptions - like east Germany following the reunification-inspired construction boom in the early 1990s - real estate is a sound and steady source of returns.
But because of the way institutional investors use the asset class and the fact that many still invest domestically, words like ‘dynamic’ and ‘liquid’ hardly apply to Europe’s real estate market.
However, a new and exciting era may be dawning. Alongside a broadening of the real estate investment trust (REIT) market, the last few years have seen the arrival of another US export: the real estate fund of funds (REFFs).
By investing in whatever European open-ended real estate funds are available, REFFs seek to provide a high level of diversification, which, say industry experts, is attractive from both a risk and a performance perspective.
Andrew Baum, managing director of Oxford Property Consultants (OPC) said: “REFFs will typically have greater diversification at the asset level by a factor of ten. Single funds may be reasonably well-diversified, but there is a strong argument for investing in specialist managers only and bringing sectors and geographies together.”
To test this argument, in May the OPC, along with Portuguese asset manager Atrium, unveiled one of the first pan-European REFFs. The fund, which has tax-friendly Irish status, aims to deliver an annual return of between 8-10%, more than half of which will be paid out as dividends. OPC’s REFF has taken in some €75m of the €275m expected in assets in the fund’s first year.
Lisette van Doorn, chief executive of the European Association for Investors in Non-listed Real Estate Vehicles (INREV), observes that REFFs should do particularly well among smaller institutional investors which have neither the expertise nor resources to invest effectively in direct real estate.
She says: “Beyond the greater diversification opportunity, you could say that the fund of funds approach provides investors with active asset management. This means that underperforming managers can be replaced at any time. The approach also spares the investor the trouble of knowing a lot about bricks and mortar.”
Regarding the crucial issue of taxes and fees, OPC’s Baum notes that neither type of fund is a barrier to investment. “The underlying funds are usually domiciled in tax-free environments and the fund of funds vehicle will also be established in a tax-free zone,”
he says, adding, however, that “occasionally investors may have to obtain tax clearance from certain jurisdictions.”
On fees, Baum admits that investors in REFFs run the risk of paying two sets of charges – one for the underlying funds and one for the fund of funds. But he added that fees for REFFs can be set below those for the underlying funds “through aggregation of capital, seeding or expertise”.
Bart Coenraads, head of real estate at Fortis Investments in Amsterdam, also argues that the fees for REFFs are extremely low considering the high level of diversification they offer.
He says: “If an investor would like to build a team that has the capacity to select and manage the same number of funds as a fund of funds, it would cost much more. It’s not only the selection of the funds that the investor gets. He also gets active management in this quickly-changing marketplace, which is characterised by mergers, changes in strategies and challenging investment appetites.”
Convinced of the product’s promise, Fortis is launching a pan-European REFF as well as one for Asia. According to Coenraads, the European product should deliver a return of 12% per annum and take in around €300m from institutional investors in the short term. For the Asian product, Fortis is targeting a 14% annual return and expects to take in €200m from investors.

Adopting a fund of funds approach to an asset class - whether equities, hedge funds or latterly real estate - is not a new concept for institutional investors. While it may offer the advantages already discussed, it does not afford a lot of control over the investment process – something which big institutional investors, particularly in Germany, cherish.
Hence REFFs will, as van Doorn suggests, probably be more of an attractive prospect for smaller institutional investors in Europe. This is, at least, what Professor Dirk Lepelmeier, managing director of Nordrheinische Ärtzeversorgung (NAEV), a €7.5bn German medical pension fund, thinks. He says: “REFFs are more appropriate for smaller investors, because bigger investors like us prefer to directly invest in real estate or to have funds tailor-made to our needs.
If we go the latter route, we want to know precisely what is happening, which is difficult with the fund of funds approach.”
Real estate accounts for around €1bn of NAEV’s €7.5bn in assets. Its real estate funds are German Spezialfonds, which, in exchange for bigger volumes (ie, above €25m), provide a high-level of diversification, tax privileges and control over the investment process.
On the other hand, Robert La Fors, managing director of LaSalle Investment Management in Amsterdam, notes that REFFs can be tailored to meet the needs of bigger investors like NAEV. “The fact is a lot of our fund of funds business is for segregated discretionary mandates, or those which start at €50m,” he says.
For La Fors, the main hindrance to future growth of REFFs in Europe has less to do with institutional demand and more to do with supply. He says: “What we are forgetting here is the fact that there are not a lot of open-ended real estate funds to choose from in Europe. The situation is a bit better in the UK, but on the continent it is very, very difficult.”
Indeed, the dearth of open-ended real estate funds across Europe is the reason why DekaBank, Germany’s leading provider of such funds, has no current plans to launch a REFF. “The ability to diversify like one can with equities and bonds is, in our view, non-existent,” the Frankfurt-based provider says.
DekaBank, which has taken in €17bn with its three open-ended real estate funds, even claims that the products currently on offer in Europe have so much in common with each other that a fund of funds approach would add little value. As examples, it cited the funds’ considerable exposure to the European market generally and to office buildings in particular. DIFA, Germany’s second-largest provider of open-ended real estate funds, echoes DekaBank’s sentiments.
La Fors points out that unfortunately for REFFs, the advent of REITs in Europe might eclipse them. “I say this because REITs are the easiest way for investors to get into the real estate market. They provide the same high degree of diversification and tax privileges as funds of funds, but they go one better in providing immediate liquidity.”

What is a real estate fund of funds?
The concept behind a real estate fund of funds (REFF) is simple. REFF managers selectively invest in existing open-ended real estate funds. Current REFFs offer three basic investment strategies. In ascending order of risk they are: core, value-added and highly-leveraged.
It was just a matter of time before the fund of funds concept, which has long been used for other asset classes, would be applied to real estate in Europe.
The European Association for Investors in Non-listed Real Estate Vehicles (INREV) says that since 2003, between 10-15 pan-European REFFs have been launched. REFF providers are mostly based in the UK or Amsterdam. While there are no precise figures on their size, INREV’s estimate is several hundred million euros – a number which it calls “dramatic”.
REFF adherents say the main advantage is a high degree of diversification – which is important from a risk and performance perspective.
There are two important disadvantages, however. One is that there are not a lot of open-ended real estate funds to choose from in Europe. The growth of the REFF industry is being further held down by the reluctance of such big players as Germany’s DekaBank to unveil such a product.
The second disadvantage has to do with fees. While REFF adherents contend that they are not much of a problem, the fact is that investors will typically pay two sets of fees.