As we approach the second half of 2023 (doesn't time fly), what has happened so far this year for real estate fund investors and managers and what might happen in the rest of the year?

Review of Q1 2023

Increased disclosures for overseas entities owning UK real estate

The Register of Overseas Entities came into force on 1 August 2022, with the transition period expiring on 31 January 2023. The register requires overseas entities that own UK property to declare their beneficial owners or managing officers. Overseas entities cannot buy, sell, transfer or lease land, or create a charge against the land in the UK unless they have been registered with Companies House. Many were rightly impressed with the way the register was set up in the truncated period from when the Economic Crime (Transparency and Enforcement) Act was introduced to Parliament in Q1 2022 – 109 working days. But is it working? As at the start of March 2023, it was thought that of 32,400 overseas organisations, about 26,000 had registered. Their details are freely available to the public. There were more than 220,000 searches of the register up to March 2023, showing the scale of interest in transparency of UK land ownership. Those entities that have not declared their ultimate owners may now face fines and restriction on selling their land.

European Long-term Investment Funds (ELTIF) reboot

In 2015, the ELTIF Regulation was launched with the objective of raising and channelling capital towards European long-term investments in the real economy. There were high hopes, as the framework allowed ELTIFs to be marketed to retail investors by way of an EEA-wide passporting regime. 

What happened next was not in the plan. By January 2023, only 84 ELTIFs had been registered in the EEA, with more than half of those in Luxembourg. In late 2021, conscious of the low take-up, proposals were published for revisions to the regulations and these were approved by the European Council in February 2023. 

The initial rules were a compromise between an institutional and retail investor product, which did not seem to be embraced by either target group. This has been addressed by allowing for two forms of ELTIF, with the retail investor version coming with more extensive restrictions. 

The eligible investment rules have been relaxed and clarified. The original rules appeared to exclude commercial real estate – that was a cause for concern in the real estate sector. Eligible assets now include real assets generally and there is no longer a requirement for each asset to have a minimum value of €10 million. Other clarifications are that ELTIFs can invest outside Europe and can be a fund-of-funds. Also, the double-layer of authorisation (both at ELTIF and ELTIF manager level) is replaced by a system where only the ELTIF needs to be authorised. The new regulations, allowing for retailisation of funds, have been generally well received by funds professionals, whilst acknowledging that not everything is perfect, such as redemption limitations.

Fundraising is difficult (or is it?)

Fundraising in 2022 was undoubtedly difficult and for good reason - an ongoing war, political instability and interest rates on an upward trajectory, all in an environment where the denominator effect was curbing LPs' appetite for new capital commitments. So, how did things fare in the first part of 2023? The signs are that the challenging times are going to be with (certain) managers launching funds for a while yet, with investors capped out from real estate allocations. With the pace of transactions slowing and less capital being deployed, there are less distributions being made by existing funds and so less money to be invested in new funds. It could be there is a greater emphasis on infrastructure funds. However, Blackstone announced in April that it had raised US$30.4 billion for its latest global real estate fund, so some people are investing.

The price is REIT

Recent changes to the REITs regime have come into effect. Their aim is to make REITs easier to establish. The changes are:

• removal of the requirement for a REIT to hold a minimum of three properties where it holds a single commercial property worth at least £20 million;
• amendments to the rule which deems a disposal of property within three years of having undertaken "significant development" as being outside the property rental business – it is intended that the definition of "significant" will better reflect the increase in property values rather than be relative to expenditure; and
• amendments to the rules for deduction of tax from property income distributions paid to partnerships, to enable a property income distribution to be paid partly gross and partly with tax withheld.

Outlook for H2 2023

New fund structure incoming (RIF)

A consultation has recently opened in respect of a potential new fund structure – the Reserved Investor Fund (RIF). It has long been thought that there was a gap in the UK's existing funds range for a new UK contractual scheme that was open to professional and institutional investors, but not available to a broader retail investment market. Representations suggested that this new contractual scheme fund should be unauthorised and open to all asset classes, although it was expected to be particularly attractive to commercial real estate investors. A key part of the consultation is around whether a restricted RIF should be available for where there is no risk of a loss of tax from non-UK resident investors on disposals of UK property. A fund of this type would need a UK AIFM and a UK Depositary, but generally light touch from a regulatory perspective and quick to form. The consultation closes on 9 June 2023.

ESG, ESG, ESG

With ESG considerations now being firmly integrated in investment decisions made by real estate funds, how do those factors sit with potential changes to the value of real estate assets resulting from ESG factors, such as climate change? How do owners of assets that fail to hit minimum ESG standards go to market and are these properties simply "off the table" for investors with core strategies? Where the asset is a strong ESG performer, should there be a premium applied on acquisition, or is it considered "standard"? The market will drive the answers to these questions. In the meantime, the complexity over tracking and ranking ESG performance continues, all at a cost to managers (and investors). It is hoped that meaningful change continues and that ESG compliance does not drift towards a box-ticking exercise.

Get ready for disputes!

It has long been considered that an economic downturn leads to an increase in litigation. Businesses have had to deal with the pandemic, high interest rates, supply chain issues and a cost-of-living crisis in the past few years. With those pressures, it is not surprising that the legal terms of deals closed years ago are now being reviewed to see, for example, if there are ways to exit deals that have failed or claim recourse from counterparties who may not have performed as either expected or contracted. One area that could see heightened activity is ESG-related disputes (for example, concerning supply chain disputes around sustainability and modern-day slavery). It is important for managers to be aware that investors bringing these types of claims may be looking beyond the financial remedy – they want positive action, often as promised to them in the fund marketing material.