Plata o plomo? The exit from special real estate funds

The experiences from the last cycle continue to have an effect. Institutional investors are already reviewing the contractual structures of a fund more critically than before before – also with regard to exit options. Because only when these are taken into account is the investment case complete.

The basic scenario presumably sought by all investors in a special real estate fund is clear: investors agree to end the fund investment as price-maximised as possible as soon as the strategic or commercial goals have been achieved.

For open-ended real estate special funds, maturities of ten, sometimes twelve years are common – often supplemented by one or two extension options. The logic is understandable: the fund invests, develops assets and sells them at the end of the term. It is not without reason that open-ended special real estate funds are also referred to as term funds in this form.

In practice, however, this plan is not always straightforward. Real estate cannot be liquidated at will – at least not at a price maximization. They can only be sold sensibly if the market allows it.

It is precisely at this point in the cycle that institutional investors are increasingly encountering a well-known phenomenon again: fund extensions.

The mechanism is formally clearly regulated. Investors will vote on whether the fund will continue beyond the originally planned term. What seems like a simple decision in theory, however, is often less clear in practice.

Basically, the exit logic – especially for core properties – is highly market-dependent. Price levels, market cycles and the absorption capacity for individual properties or entire portfolios play a decisive role. If the market seems unfavorable for a sell-off, a temporary extension of the term is often a completely rational decision.

The situation becomes less clear if a capex requirement becomes apparent towards the end of the fund term that was not foreseen in the original logic of expectations. In this case, the exit logic shifts from a pure market decision to an investment decision.

The dilemma for investors is then obvious:
Should technical measures be introduced to restore the value and letting situation before a sale? Or should – in the case of more extensive investments – even a further capital commitment beyond the original commitment be accepted?

If the extension is not decided and the fund is sent into liquidation, the properties must be sold – regardless of whether the market is particularly receptive at the moment or whether the properties structurally meet the requirements for a price-maximised sale.

As a result, the decision is often reduced to a sober consideration because of the adverse consequences.

A sale can create liquidity, but it can also potentially realize an unfavorable price. An extension can buy time, but it postpones the originally planned return on capital.

Especially in the case of open-ended real estate special funds, it is therefore evident that real (!) Liquidity is a function of portfolio composition and market phase. Illiquid investments cannot be entered and exited at will. The determination of an expected fund term is therefore at best an attempt to structure economic reality by means of a reference value.

Whether the fund will reach the end of its term at a time when a sale actually seems to make sense is usually not foreseeable at the time of entry.

The decision on an extension of the term is therefore reduced in the end to a rather sober question:

Plata o plomo?