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The German open-ended real estate funds (OIF) sector is in turmoil. Cash outflows are surging. Valuation issues are rampant. Management costs are sky-high. We've been reporting here in REFIRE on the deteriorating funds situation for months, and it's not improving.
Particularly alarming is the situation surrounding the Union Investment fund UniImmo: Wohnen ZBI, which has been heavily devalued amidst mounting challenges and increasing criticism of how Union Investment's managing team has been dealing with the media fallout in Germany about likely investor losses.
Firstly, the German OIF sector is indeed facing significant cash outflows, amounting to €2.6 billion in the first five months of 2024. According to Barkow Consulting, gross sales fell to just €165 million in May, the lowest figure since September 2013. Net outflows continued for the tenth consecutive month, highlighting a sustained lack of investor confidence. Barkow Consulting notes, “If savings plans and automatic reinvestments are deducted, gross sales could be close to zero.”
Valuation issues are compounding these challenges. Funds like KanAm and Union have realized double-digit value corrections. In an era where risk-free returns of 3% are achievable, the modest returns of OIFs, typically around 3%, are increasingly unattractive. The pressure on the market is evident, with double-digit performance once predicted for prime office investments now a distant memory.
The crisis of UniImmo: Wohnen ZBI
UniImmo: Wohnen ZBI, a major residential fund under Union Investment, epitomises the sector's struggles. In 2017, Union Investment launched UniImmo: Wohnen ZBI with great fanfare. Fast forward to 2024, and the reality is starkly different. Following a special valuation on June 23, 2024, the fund's share price plummeted by 16.7%, marking the steepest daily loss for a real estate fund since the 2008 financial crisis. The year-to-date performance fell by 21.8%.
Union Investment has attributed this decline to "exogenous factors" such as the pandemic, the Ukraine crisis, and rising inflation. However, this explanation rings hollow for many industry experts. The fund's rapid growth, driven by high inflows of investor money, led to the acquisition of numerous properties in less desirable locations such as Chemnitz, Zwickau, and Duisburg. The portfolio now consists of around 1,000 properties, many of which are small-scale and over 50 years old. The occupancy rate, touted by Union Investment as "stable" at 93.2%, is below the expected 97% for a healthy residential portfolio.
Stefan Loipfinger of Investmentcheck.de, a recognized funds expert, has been vocal about the issues plaguing UniImmo: Wohnen ZBI. He points out that the fund's valuation practices have been misleading, suggesting a degree of dishonesty. "The emphasis on the self-evident nature of 'correctly determined' capitalised earnings values alone shows that this should be called into question," Loipfinger asserted, in both print and at the recent half-yearly gathering of Germany's real estate journalists, - the Immpresseclub - in Düsseldorf. Loipfinger openly criticised the fund management for not making a complete adjustment to market realities, in effect misleading investors about the fund's true value.
The role of valuation and regulatory issues
The valuation methodologies employed by funds like UniImmo: Wohnen ZBI have come under intense scrutiny. The BIIS association of fund valuers distanced itself from the valuation conducted by CBRE, which devalued the UniImmo: Wohnen ZBI fund. Although the usual methodological criticism typically directed at German valuations does not apply here, the outcome has nonetheless been catastrophic.
Indeed, it almost looks as if the regulatory measures introduced post-financial crisis to protect investors are now acting to limit the attractiveness and flexibility of OIFs. The financial crisis-era regulations were designed to prevent a repeat of past liquidity issues by imposing strict rules on fund valuations and cash reserves. However, these regulations are now seen as a double-edged sword, as they restrict the ability of funds to adapt to changing market conditions.
Reputational damage and investor options
The reputational damage to Union Investment is significant. The lack of transparency and poor communication regarding the devaluation and future strategy of UniImmo: Wohnen ZBI have eroded investor trust. Trade journal Immobilien Zeitung commented on Union's poor communication strategy, noting that both Union Investment and its subsidiary ZBI have remained silent or evasive in response to media inquiries.
The brouhaha surrounding the Union fund devaluation leaves investors in a precarious position. Those seeking to exit the fund are faced with significant losses, as evidenced by the steep drop in the share price. For those who remain, the future is uncertain. The high management costs, low-quality portfolio, and ongoing valuation issues suggest that recovery will be challenging.
Scope, a leading rating agency, has downgraded numerous OIFs, including UniImmo: Wohnen ZBI. Sonja Knorr from Scope states, "The attractiveness of open-ended property funds as an investment has declined, as there are currently opportunities for higher returns with a similar risk profile, particularly in the bond sector." Scope's analysis shows that the average performance of OIFs in 2023 was a mere 1.2%, with some funds experiencing negative returns.
Market outlook and expert insights
Others have commented on how the future viability of the open-ended property fund model is increasingly in doubt. Björn Drescher of Drescher & Cie articulated these concerns at the recent BIIS conference, emphasizing the growing doubts about the model's sustainability. The high outflows and poor performance metrics indicate a tough road ahead for the sector.
Stefan Loipfinger suggests that the root cause of the current liquidity issues is dishonesty in valuation. He argues that a complete and honest adjustment to market values is necessary to restore investor confidence. "Union has taken some of the pressure off the ZBI residential property fund through the special devaluation. Unfortunately, the fund managers were not courageous enough to make a complete adjustment to the market," Loipfinger noted.
In conclusion, the German OIF sector is navigating a severe crisis, with UniImmo: Wohnen ZBI at the eye of the storm. The convergence of poor performance, massive outflows, and dubious valuation practices has shattered investor confidence. Union Investment's reputation is in tatters, underscoring the urgent need for transparency and regulatory overhaul. Investors now face a crucial decision: remain and weather the storm, or seek safer harbors. As Stefan Loipfinger aptly puts it, "Only a complete and honest adjustment to market values can restore trust." Moving forward, the sector must embrace these hard truths to regain stability and investor trust.
The insights provided by experts like Stefan Loipfinger and Sonja Knorr add extra weight to the urgency for honest valuation practices and strategic adjustments to regain stability and trust in the market. Long-time readers of REFIRE, and those with good memories of the OIF sector's travails in the financial crisis of 2008-09, won't be surprised to see those old valuation issues, and a deep German institutional fund aversion to even conceptually marking assets to market, raising their ugly heads again.
