Historically, Luxembourg has been a popular jurisdiction for real estate funds – both for setting up new funds and for structuring their holdings. The prime drivers behind this have been Luxembourg's attractive tax regime, the pragmatic approach taken by the Luxembourg regulator and the emergence of a wide range of experienced service providers. In the absence of a pan-European Reit-type vehicle, Luxembourg structures have also proved to be some of the most effective single-vehicle structures where pan-European offerings are envisaged and/or where the assets of the fund are in a number of different jurisdictions.

At least five new regulated Luxembourg real estate investment funds (Reifs) were launched in 2004, bringing the total number of Reifs then established and operated out of Luxembourg to 49. (These figures include only Luxembourg funds regulated by the Luxembourg regulator, the Commission de Surveillance du Secteur Financier (CSSF). The inclusion of non-regulated funds would increase this total number of funds.) This number includes 18 funds categorized by the CSSF as investing directly in real estate, 29 funds investing in securities issued by real estate companies and two funds of real estate funds. The aggregate net asset value of the funds at December 31 2004 was $7.6 billion, a significant increase over the equivalent figure for the previous year. (No figures for aggregate commitments to such funds are available, but as most funds will not have invested their full commitment at any one time, the amount committed in aggregate to these funds is likely to be significantly higher.) Although the numbers for 2005 have not yet been officially released, this upward trend seems to be confirmed.

The mainstay of the Luxembourg Reifs market has been vehicles established as fonds commun de placement (FCPs), société d'investissement à capital variable (Sicavs) and société d'investissement à capital fixe (Sicafs). Out of the 49 Reifs, 17 are established as FCPs, 30 as Sicavs and 2 as Sicafs – although of the 18 Reifs categorized as investing in direct real estate investments, 14 have been established as FCPs.

In 2004 a new structure became available for making venture capital-type investments – the société d'investissement en capital à risque (Sicar). The CSSF did not envisage initially that this structure would be permitted to invest in real estate investments, but it has since relented and this structure may now be used for indirect investment in real estate assets, provided that the real estate assets have characteristics similar to venture capital (that is, there is an equivalent risk profile to venture-type investments). Although this is likely to mean that its use will tend to be limited to opportunity-type funds (such as those with substantial interests in development projects) rather than core funds investing in more established property investments, the CSSF has indicated that it will take a case-by-case approach to approving applications.

Choice of fund vehicle

The optimal choice of a fund vehicle will depend largely on the type of fund that is proposed to be raised, the proposed investor base (both in terms of the types of investors sought and their location), the tax implications and the type of investments.

As undertakings for collective investment, FCPs, Sicavs and Sicafs all fall within the remit of the Luxembourg law of December 20 2002 (the 2002 Law) and the rules issued by the CSSF in its circular letter dated January 21 1991 (Circular 91/75). Where such funds are promoted to institutional investors only, they are also subject to the terms of the Luxembourg law of July 19 1991 (the 1991 Law).

Public Reifs (that is, those not limited to institutional investors) may be promoted in Luxembourg to retail investors but, as they do not benefit from any passporting provisions (other than where they invest solely in listed real estate securities), they must be promoted in other jurisdictions under private placement exemptions. In practice, this is seen to provide only a marginal benefit to such funds and therefore the vast majority of existing Reifs are limited to institutional investors. Although institutional Reifs may not be promoted to retail investors, the definition of an institutional investor is quite wide and would include, for example, banks and other investment advisers who invest on behalf of their private clients under discretionary management mandates, as well as family offices and other funds of real estate funds marketed to non-institutional investors.

There are also significant advantages in limiting the fund to institutional investors, in terms of the investment and borrowing restrictions that will apply. While, as a matter of law, such restrictions will apply equally to public Reifs and institutional Reifs, the CSSF allows derogations on a case-by-case basis to institutional Reifs that are not extended to public Reifs. For example, it may permit more extensive leveraging of institutional Reifs (up to 75% of the fund's assets compared to 50% for a public fund) and the inclusion of the leverage in the value of a fund's assets for determining the 20% limit on investments in a single property.

Where no special considerations apply, the FCP tends to be the most popular structure, as it is the most flexible, it does not require net asset value (NAV) calculations to be made when monies are drawn down for partly paid units and it allows investor control and voting rights to be tailored to meet particular circumstances. It is a contractual arrangement akin to a limited partnership and has no separate legal identity. Investors subscribe for units in the FCP, which is managed by an independent management company (société de gestion). FCPs are tax transparent and would typically invest through a corporate holding structure to enable tax treaty benefits to be obtained.

As Sicavs and Sicafs are both corporate structures, they have the advantage of being familiar with investors. Like FCPs, they also benefit from favourable tax treatment of their income and gains (effectively zero tax in Luxembourg on their income and gains) and do not have to set up subsidiary holding structures to obtain treaty benefits (for those countries with which Luxembourg has a tax treaty). However, as corporate structures, they are subject to statutory shareholder rights, making them less flexible than FCPs. They also require NAV calculations to be made whenever shares are issued outside the initial offer period. FCPs with fully paid-in units and Sicavs are particularly effective vehicles for German pension fund and insurance investors as they satisfy the technical reserve restrictions that apply to such investors through the requirement for their shares to be issued fully paid.

FCPs, Sicavs, and Sicafs are all subject to regulation by the CSSF. A Luxembourg undertaking for collective investment (UCI) must appoint an independent Luxembourg-based custodian and administrator.

A Luxembourg real estate investment fund must also appoint an independent appraiser for the valuation of the properties. The independent appraiser is an independent professional real estate valuer who is approved by the Luxembourg regulator. The independent appraiser cannot hold any interest either in the fund or in the promoter.

The independent appraisers examine the valuation of all properties owned by the fund or by its affiliated real estate companies. The independent appraisers must undertake a full valuation of the fund's properties at the end of the fiscal year. In addition, properties cannot be acquired or sold unless an independent appraiser has valued them, although a new valuation is unnecessary if the sale of the property takes place within six months after its last valuation. Acquisition prices may not be noticeably higher, nor sales prices noticeably lower, than the relevant valuation except in exceptional circumstances that are duly justified. In such case, the directors must justify its decision in the next financial report.

The investment strategy might require the fund to decide quickly to take advantage of market opportunities. In such circumstances, obtaining an independent valuation from the independent appraiser before an acquisition can be difficult. Therefore, institutional funds often apply to the CSSF for a derogation so the fund may acquire an individual property without obtaining an independent valuation before acquisition. An ex post independent valuation (that is, an independent valuation after the acquisition) will however be required as soon as reasonably practical after the acquisition. Such ex post valuation will be the exception, not the rule. If an ex post appraisal determines a price noticeably lower than the price paid or to be paid by the fund, a justification must be provided in the next financial report, outlining the reasons the fund believes that the price paid or to be paid is justified.

Ways to invest

A real estate fund promoter (that is, the person or entity who is at the origin, who gives the initial impetus and brings about the creation of the fund, who determines the policy of its activity and who profits of its realization) will often chose to accept investments by way of commitments and to issue fully paid-in shares. An investor commits a certain amount towards the fund that is then drawn down by the management company (in case of an FCP) or by the fund's board (in case of a Sicav/Sicaf) by way of a funding notice at the fund board's discretion. In consideration, the fund commits itself to issue shares fully paid-in to the investor to the extent that their commitment is called up and paid.

The fund's documents should indicate how the commitments are drawn. Indeed, one may chose to draw down commitments from investors in proportion to the amount of their commitments or on a first-committed, first-invested basis, or on the basis of any other objective rationale.

Another way to invest in an FCP or Sicaf is by issuing partly paid in shares. Upon entering the fund, the investor will need to pay in (liberate) a minimum amount and will be issued partly paid-in shares at a fixed price, which, at the discretion of the management company/board, are liberated over time. There is no objection to replicating a similar drawdown procedure as those indicated above.

The choice will mainly depend on the profile of the targeted investors, accounting issues, and on the corporate governance structure the promoter wants to reflect in the fund. In case of partly paid-in shares, the shareholder rights are independent of whether the shares are already fully liberated, whereas only the commitments drawn in consideration of fully paid-in shares will give rise to shareholder rights.

Recent developments

Most of the initial real estate investment funds were institutional funds with a limited lifetime and no redemption possibility (that is, closed-ended). This allowed the promoter to build up a portfolio, account taken of the commitments the fund got during the offering period, and to forecast an attractive return within a tax-efficient investment structure using a combination of Luxembourg intermediary companies and local property companies. The retail market was not unaffected by this boom and more retail clients were eager to take part in that development.

Allowing retail clients in a real estate fund was however quite different from institutional investors. Mostly investing lower amounts and requiring a possibility to redeem were features difficult to match with a durable investment in real estate.

The saturation of the market, the multiplication of real estate funds, the availability of money and the interest shown by retail investors helped nourish the idea of creating real estate funds of funds that give higher flexibility.

Funds vs funds of funds

In outlining the main differences between real estate funds and real estate funds of funds, one must start with stating the obvious: the investment policy of finding and acquiring or financing properties, typical for real estate funds, is quite different from analysing and investing in funds that invest in real estate, necessitating a different kind of expertise for the promoters who want to set up a fund of funds.

Another difference is that most countries impose other investment restrictions to funds of real estate funds than those applicable to real estate funds; which are to be applied at the top fund's level (prohibiting a look-through, which would take into account the diversification of assets held by an underlying fund). For instance, the leverage that can be taken by a real estate fund is up to three times higher than the leverage funds of funds can take up (abstraction made of the fact that the underlying funds may have maximum leverage).

In Luxembourg, real estate funds may, to achieve a minimum spread of risks, not invest more than 20% of their net assets in a single property.

Luxembourg funds of real estate funds may invest in foreign undertakings for collective investment of the open-ended type, provided they will in principle not: (i) acquire more than 20% of the units or shares issued by the same undertaking for collective investment; (ii) invest more than 20% of the net assets in units or shares of the same UCI. The Luxembourg regulator, CSSF, may grant derogations from these rules.

The liquidity of the portfolio is also quite different. Whereas the real estate fund is mostly illiquid and needs to dispose of properties to satisfy redemptions (which are mostly staggered over a long period of time), the fund of funds can transfer shares in the underlying funds on the secondary market.

Commitments in real estate funds are drawn down to finance an investment during a predetermined acquisition period. The fund of funds structure is however confronted with an aberration caused by the need to synchronize drawing down the fund of funds' investors with the capital calls of the underlying funds and so managing a commitment period in view of the commitment periods towards underlying funds. This ongoing and unpredictable commitment period is often compensated by an unlimited lifetime of the fund and a redemption possibility for investors (staggered to avoid the sale of parts of the portfolio, by searching new investors to replace the money dip).

Change poses opportunities

The market for Luxembourg real estate investment vehicles is constantly mutating and poses interesting opportunities to launch innovative investment vehicles with a capacity to satisfy a maximum of investors, focussed on open-ended funds of an undetermined lifetime, allowing new investors to join the fund structure.

Author biographies

Joëlle Hauser Kremer Associés & Clifford Chance Joëlle Hauser has been a partner in the Luxembourg office of Clifford Chance since 2001 and practises mainly in the area of investment funds, advising banks, financial services institutions and asset managers. She specializes in regulated retail and institutional investment funds (securities, derivatives, real estate, private equity), asset management work, as well as in advice on custody and administration for the financial services industry. She is a graduate in law from the Université Catholique de Louvain-la-Neuve, Belgium (magna cum laude) and is admitted to the Luxembourg Bar. Olivier Lambertyn Kremer Associés & Clifford Chance Olivier Lambertyn has been an associate in the Luxembourg office of Clifford Chance since 2003 and practises mainly in the area of investment funds and corporate law. He is a graduate in law from the Katholieke Universiteit Leuven, Belgium (magna cum laude) and is admitted to the Brussels bar.