Nieruchomości C.H. Beck 11/2024
Alicja Slawinska
MECHANISMS OF OPERATION OF INVESTMENT FUNDS ON
THE POLISH REAL ESTATE MARKET
INTRODUCTION
In the investment and business community, committing funds to real estate is metaphorically referred to as investing in so-called concrete gold. The source of this statement is the security and relatively stable value of real estate. Investment in real estate also means long-term profitability, hedging against inflation and stable rental income. Interested parties most often commit their financial capital to acquiring a property in order to commercialize it or organize a so-called flip. Sometimes potential buyers do not have enough experience or budget to invest in the real estate sector on their own on a larger scale. An alternative is to invest together through an investment fund, which allows for a relatively secure portfolio of assets. In practice, this means that the fund’s assets are built by pooling the funds of all its participants. The primary goal of investment funds is to multiply the financial capital entrusted by investors and successively build a real estate portfolio. Investment funds are a practice often used in the real estate sector in Poland, especially with the involvement of foreign financial capital. This article is entirely devoted to the mechanisms of investment funds in the real estate market in Poland.
LEGAL SOURCE AND ESSENCE OF AN INVESTMENT FUND
In fact, the investment fund is managed by a professional manager, and participants deposit predetermined cash. Depending on the investment policy adopted and the nature of the fund, the fund’s portfolio may consist of Polish or foreign stocks, government bonds or other financial instruments or assets. Polish legislation regulates the creation and operation of investment funds in the Act of May 27, 2004 on Investment Funds and Management of Alternative Investment Funds (the “Act”). The Act is part of the capital market regulation and focuses on the rules for the organization, operation, transformation and dissolution of investment funds in the territory of the Republic of Poland. The said legal regulation distinguishes fund models into open-ended investment funds and alternative investment funds, which in turn include specialized open-ended investment funds and closed-ended investment funds. The law contains a number of nomenclatures that constitute legal definitions dedicated to the matter of investment funds, including legal definitions of an investment fund or an investment fund company.
According to Article 3(1) of the Law, an investment fund is a legal entity whose sole object is to invest money raised by offering to purchase participation units or investment certificates in securities, money market instruments and other property rights specified by the Law. In turn, according to Article 4(1) of the Law, the company establishes an investment fund, manages it and represents the fund in relations with third parties – “In this regard, therefore, the establishment of an TFI should be distinguished from the establishment of a fund by an TFI. For the former, for obvious reasons, must precede the creation of the fund. Thus, until the date on which the investment fund is entered in the register of investment funds, the TFI performs legal actions, aimed at the establishment of the fund, in its own name and for its own account (Article 31(1) u.f.i.). This is because it is only after the fund is entered in the register, and the fund thus obtains legal personality, that the TFI becomes the fund’s body (Article 15(6) of the u.f.i.).” In practice, real estate is most often invested in through closed-end and open-end funds, ETFs, REITs and by acquiring shares of real estate developers, which is discussed in more detail later in the article.
One of the key advantages of the mutual fund structure is the so-called diversification, i.e. the dispersion of risk and liability through multiple investments, such as in real estate, and the multiplicity of investing entities involved. It is clear that with a shorter time horizon for a given investment and a more aggressive investment policy, the risk increases. Investing in listed shares of real estate entities also remains an important element affecting the value of such shares and the associated benefits, i.e. exemption from paying taxes on operating profits to eliminate double taxation. In addition to the risks associated with investing in funds, participants must also expect to pay additional fees, including a management fee for a given fund. In practice, these fees oscillate around 2% of the value of the funds’ units (the aforementioned fee is a component of the investment result). Nowadays, investment funds are widely available to anyone interested, both through direct contact with an investment advisor and through relevant online platforms. Undoubtedly, those seriously interested in participating in real estate investment funds should be versed in the accompanying key trends shaping the current real estate market in Poland.
TRENDS IN THE REAL ESTATE MARKET IN POLAND
It is clear that interest in investment funds managing real estate portfolios depends largely on current trends in the real estate market in Poland. The market for analyzed investment assets is of particular interest to foreign clients, especially commercial real estate – “EUR income-based investments have undoubtedly attracted foreign capital, mainly Western European and American. Polish capital accounts for less than 10% of the transaction volume.” “Foreign entities are most interested in office properties, warehouses and shopping centers as so-called ‘prime’ properties. In the case of the residential market, we can see a reduction in the dispersion of smaller developers among developers in favor of consolidation of entities, including the example of Echo Investment’s purchase of Archicom – “Echo Investment will acquire a majority stake in Wroclaw-based Archicom from its founders. Once the transaction is finalized, the Echo-Archicom group will be the largest residential developer in Poland (…)” . The subject of commercial real estate in Poland is dominated by the following investment model: construction of a property and its commercialization with the ultimate intention of selling the project. Transactions operate through the sale of real estate or a portfolio of real estate; there are also transactions whose subject is a development operating company. An example of this type of real estate operation in Poland is, for example, the purchase by the Hungarian private equity fund, Optima, of a majority stake in the listed developer GTC. The above-described venture should be assessed enthusiastically, as it develops international expansion and creates new opportunities for the development of the real estate sector in Poland.
Undoubtedly, the Polish real estate market can still be described as dynamic, and the above-mentioned examples of real estate transactions confirm the potential of the Polish real estate sector. This does not change the fact that the situation in the real estate industry can be volatile and often depends on external circumstances such as economic or political. In a broader perspective, the condition in the real estate market is summarized by the following comparative statement – “After several years of intensive development, the Polish real estate market recorded a large decline, caused mainly by unfavorable economic and geopolitical factors. In 2023, the total investment volume reached EUR 2.1 billion, compared to EUR 5.8 billion a year earlier. “ Of course, depending on the real estate area, different factors affect the condition of the investment market and determine its current situation. The institution of the so-called “2% Safe Loan”, introduced by the government, determined the number of mortgage applications, which in turn directly translated into an increase in housing prices. The booming PRS market is also noticeable in comparison with the Western market, where institutional rental has long been well established – “… has increased the volume of rental units, with more than 63,000 units expected to be in institutional rental by 2028. “ Poland is emerging as a leader in the warehouse market right after German or French developers. In addition, the development of the warehouse sector is strengthened by the global strategy of so-called friendshoring and nearshoring , which oscillate around locating investments in the area of countries with a similar value system or closer to the home country.
In the case of the office sector, well-adapted and modern, high-quality office spaces are most desirable. Developers, investors or others interested in participating in investment funds with real estate portfolios should also pay attention to trends shaping the market, including environmental, social and corporate aspects, the so-called “ESG” factor (“Environmental, Social and Governance”). Commercial real estate interests must take into account ESG strategies manifested in, among other things, reducing operating costs and pursuing energy-saving policies. In conclusion, engaging cash capital in investment funds has great potential for growth and profit, but requires vigilance and careful analysis of real estate market trends by asset managers.
TYPES OF INVESTMENT FUNDS ON THE POLISH REAL ESTATE MARKET
Undoubtedly, investment funds are a safe and cost-effective investment tool for interested parties who do not have the necessary time, experience or “know-how” to invest and build a real estate portfolio on their own. There are several types of funds successfully operating on the Polish real estate market, including closed-end investment funds (“FIZ”), Exchange Trade Funds (“ETF”), Real Estate Investment Trust (“REIT”) or investment crowdfunding . The most clear and transparent division is the distinction between closed-end (“FIZ”) and open-end (“CIF”) investment funds.) First of all, it is noted that both funds are subject to rationing and supervision by the Financial Supervision Commission (“FSC”), which is the body that oversees the proper functioning of the financial market in Poland. The two fund models also differ in the title of participation and other elements indicated below.
In the case of FIZ, we are talking about so-called collective investing, which serves to multiply capital. A prerequisite for participation in FIZ-type funds is the possession of an investment certificate, which is a security (bearer or registered) – “The investor purchases shares, stocks or bonds of special-purpose companies set up to carry out investment projects, such as renovating a tenement house and selling it, building an office building, a shopping center, etc.,” he said. “ According to Article 117 para. 7 of the Law, the FIZ’s charter specifies the entities that can be participants in the fund and the conditions that such participants must meet. In practice, FIZs may issue public or non-public investment certificates. According to the common view, closed-end investment funds are dedicated to more serious investors with a more affluent portfolio or budget. However, the genesis of mutual funds shows that it is such a dynamic and developing matter that there is no room for any stereotypes: “As specialists prove, FIZs are currently accumulating more funds than CIFs. They are becoming more and more popular among investors every year. One reason is that FIZs can pursue a more flexible investment policy, and that’s because they target a narrower audience, and TFIs can borrow and lend up to 75% of a closed-end fund’s net asset value. This allows them to take slightly more investment risk than open-ended funds. “ Open-ended funds, on the other hand, are characterized by a lack of restrictions on the ability to join and to withdraw from participation.
ETF AND REIT INVESTMENT INSTRUMENTS
The aforementioned Exchange Traded Fund is an open-ended investment fund listed on an exchange, just like stocks. In essence, an ETF is part of a portfolio of securities to track a specific market index – “ETFs replicate Polish stock market indexes: WIG20, mWIG40, sWIG80 and American ones: S&P 500 and Nasdaq. In Poland, the only provider of such solutions is BETA ETF, which today offers 9 ETFs. “ ETF funds are a relatively convenient investment tool, structured to diversify a portfolio of assets through a single investment fund. The main advantages of the fund are (i) diversification in the form of acquiring assets through a single vehicle (ii) transparency in tracking the mechanisms of the fund (iii) low cost of operation due to the passive management model (iv) simplicity and ease of use of the fund. Example risks: i) Investing directly in a mutual fund may be a cheaper alternative if you plan to invest frequently and small amounts (ii) Funds may lose value if the market or sector they track falls.
Real Estate Investment Trust, as an institution for the collective investment of real estate funds, can have the status of a joint stock company or investment fund. REITs, as entities that generate income through the creation and management of a real estate portfolio, can be publicly listed on the stock market. “Unlike other real estate companies, REITs do not own real estate for resale. The REIT owns or rents the properties, and thus pays rental income to investors. This is called dividend-based income. These properties can vary and can include everything from office buildings, hotels, shopping centers and homes to data centers and cell towers. “ REITs are a relatively safe and easy-to-use investment vehicle usually managed by one or more trustees or directors. At least a percentage of assets should be invested in the real estate sector; in practice, this is usually 75% of the funds raised. REIT-type investment vehicles have been structured so that 90% of income passes on to taxable shareholders. Each investor, before deciding to invest money in the type of investment fund of his choice, should diligently consider all the advantages and risks associated with the choice of a particular investment model. It is prudent to pay attention to such factors as market, political and credit risks. The circumstance of putting money into foreign investment funds requires a common-sense consideration of currency risk.
Currently, the real estate sector is awaiting the implementation of REIT fund regulations into Polish legislation – “Experts estimate that the introduction of REITs into the Polish market should be preceded by a transition period, similar to those used in other countries, such as the UK, among others. (…) legislation on REITs should allow investment in all segments of the income-producing real estate market, with the proviso that the invested assets must be of high quality.”
SUMMARY
In conclusion, the real estate investment market still holds a lot of promise, including high returns, tax advantages or the possibility of leverage. However, those interested in investing in the real estate sector must expect rising costs of acquiring and maintaining assets, including the need to make expenditures and lock up cash capital over the long term. Despite the volatile economy, investing in the real estate sector is still one of the safest or most popular methods of capital multiplication. That is why knowing the mechanisms of operation and choosing the right investment instrument is such an important task for an entity with a serious interest in the real estate market.
