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The growing role of investment funds in the euro area real estate markets: risks and policy considerations

By September 21, 2023No Comments

In the past decade, the REIF sector has witnessed significant growth within the Eurozone, currently accounting for 40% of the European CRE market. This presents a challenge for European authorities as potential instability in the REIF sector could pose a systemic risk to the entire European CRE market, which is valued at €1 billion. Regulators are particularly concerned about this due to the structural liquidity mismatch within REIFs. This arises when they offer frequent redemptions to investors while holding illiquid real estate assets, potentially leading to insolvency. Moreover, the high leverage within the REIF sector, makes it highly susceptible to fluctuations in real estate prices.

This regulatory concern is further fuelled by unfavourable macroeconomic prospects in the Eurozone, characterized by rising inflation, a slowdown in the economies of major countries, and high interest rates reminiscent of 2001, with no short-term prospects of decline. Consequently, uncertainty has materialized, resulting in a sharp decline in transaction volumes and falling prices. Additionally, the post-pandemic scenario for European CRE was challenging. While the industrial segment of CRE rebounded swiftly, both the retail and office segments failed to regain pre-pandemic levels and now face significant deterioration.
European regulators have several options to mitigate the systemic risk that could arise from instability in the European REIF sector, which could potentially escalate to systemic risk in the CRE market in the event of a market shock. Among these options is the enhancement of REIFs’ ability to manage their liquidity during times of market stress, imposing limits on leverage to bolster the resilience of REIFs, and implementing more targeted LMTs such as redemption fees and redemption gates. Expanding the range of tools available to fund managers would improve their capacity to effectively oversee the liquidity of the fund. Furthermore, authorities could enforce a regulation requiring REIFs to maintain a portion of their assets in a more liquid form than the rest, enabling them to better navigate periods of liquidity shocks in the market.

Addressing these concerns is essential to prevent potential market instability from triggering an economic crisis. Regulatory measures are necessary to ensure stability in the REIF sector and safeguard the broader CRE market. Proactive action is crucial to mitigate systemic risks and maintain economic resilience.