Alkis Hajittofis, Executive Director and Head of Portfolio Management at Resolute Investment Management (Cyprus) Ltd, outlines the benefits of investing in real estate through a Fund.
When speaking to prospective investors looking to invest in an Alternative Investment Fund (‘Fund’) with a diversified real estate strategy, we are often asked “why invest through a fund rather than a company?”. It is a valid question, and one which has multiple answers which I will try to address below.
Pooled Investment in Multiple Assets
When entering a pooled investment, whether with friends and family or complete strangers, it is important to consider who will have control and how will any disputes be resolved.
Through a company, minority shareholders are subject to little or no representation on the board and thus have little control over the investment. On the contrary majority shareholders have control and may steer the investment in the direction that they wish.
Disputes may arise between the best of friends or business partners, and the resolution can be costly and time consuming for all parties, with the outcome always subject to the decision of the court.
A Fund is controlled by a professional Alternative Investment Fund Manager (‘AIFM’), who will manage investments in line with the investment strategy set out in the prospectus, a document to which all investors agree upon subscription. Furthermore, all shareholders in a Fund are subject to the same level of protection regardless of their percentage stake.
A common problem for most investors is where to allocate capital which they have earmarked for real estate investment.
Individual real estate investors tend to invest in areas they know well, such as their home country, due to accessibility or understanding of the specific market’s dynamics.
In addition to the above, whilst they may be interested in investing in different types of real estate, the individual ticket sizes may be beyond their appetite. This leads to a lack of diversification both geographically and across asset type.
Investment in real estate through a Fund provides a solution to the above problems.
AIFMs employ seasoned professionals who have the know-how and experience in the countries they invest in. These professionals provide the Portfolio Management Function of the AIFM with information used to decide capital allocation, subsequent monitoring and ultimately disposal of investments in multiple countries, and across asset type. This allows investors in Funds to maximise their real estate diversification both geographically and across asset type.
Furthermore, as a pooled investment Funds have access to premium or large properties such as shopping malls or hotels, which most individual investors cannot invest in on their own (unless they are very wealthy).
Professional and Transparent Management
Funds are professionally managed by AIFMs, who perform due diligence on prospective transactions on behalf of the individual investors employing professional advisors such as valuers, lawyers and accountants as required.
Furthermore, Funds are transparent, with AIFMs providing regular information on performance, major transactions, and other important matters to investors through periodic reports, financial statements, and management accounts. This information allows investors to make informed decisions on whether to subscribe to or redeem units.
Taxes and transaction costs
Taxation on both companies and Funds depends greatly on the jurisdiction in which they are registered.
Cyprus Funds are subject to the same tax framework as companies and are therefore very tax efficient. However, a major benefit of Funds over direct real estate investment is that professional management fees charged by Cyprus AIFMs are not subject to VAT (a significant cost saving).
Taxes at the investor level are dependent on each investor’s specific circumstances, as is the case with direct property ownership. However, as Funds share transaction costs and taxation of the underlying assets across their investor base, this results in the burden of these expenses/taxes being less for individuals on an absolute basis, than in the case of a direct investment.
Regulatory Oversight and Alignment of Interests
As in any transaction, real estate investors’ interests may not be aligned with those of their advisors or counterparties. In a direct transaction, many of the advisors and counterparties may not be regulated or subject to any third-party oversight.
A major benefit to Fund investors is that an AIFM’s interest are aligned with those of the investors through execution of the agreed upon strategy. AIFMs owe a fiduciary duty to their investors and will therefore ensure that investments are made in accordance with the approved strategy.
Investor interests are additionally safeguarded by oversight from the Regulator and the involvement of professionals such as Non-Executive Directors, the depository, fund administrator, internal and external auditors, all of which give comfort to the investor by monitoring transactions and performance of the Fund.
A Fund investor will have their liability limited to the amount of the initial investment. In the case of a leveraged Fund, investors are not required to give personal guarantees to secure any debt undertaken by the Fund.
Through direct ownership the owner has a higher level of liability, whereby a default may lead to properties being repossessed along with other assets used as collateral and personal guarantees being called. Furthermore, in case of an outlier event such as an injury/death on site, there may be civil lawsuits against the owner. Thus, in some circumstances, liability under direct ownership may outweigh investment.
Liquidity is an important consideration when making an investment, therefore the ability to monetise a real estate investment is of key importance.
Direct real estate is relatively illiquid and requires significant time and effort from the owner to find a buyer, especially in the case of larger value or more specialised properties. Agents may assist in the process but will ultimately take a cut of the sales price.
Units in Funds which allow periodic redemptions or Funds that are listed on a regulated exchange are significantly more liquid than a direct real estate investment. Investors can redeem some or all of their units at the prevailing Net Asset Value Per Share (‘NAVPS’) or sell them to a third party on the exchange.
By contrast, units in closed-ended Funds or during a lock up period in an open-ended Fund are less liquid than direct real estate. However, there is always the option to sell units to a third party, although it may be at a price lower than the prevailing NAVPS but that is also the case when trying to sell direct real estate for which there may not be much demand.
Investment in real estate is an essential part of a diversified portfolio. Both direct and indirect investment have their merits, however Funds allow more diversification, transparency, and access to professional management with competitive costs. Investors should consider options available, and make the choice which is most suitable to their personal circumstances.