Problem analysis on RELPs in the Netherlands : the use and abuse

Transcription

Problem analysis on RELPs in
the Netherlands: the use and abuse
R.J. Bakhuijsen
the UNIVERSITY of GREENWICH
MSc Real Estate dissertation
Colophon
By order of
The University of Greenwich (London)
School of Architecture and Construction
Avery Hill Campus
London
Programme
Master of Science in Real Estate Development & Investment (Europe)
Dissertation
Author
Robbert J. Bakhuijsen
000330314
rj@bakhuijsen.nl
Supervisor
David W.L. Isaac
Professor of Real Estate Management
Director of Research
Head of Property and Land Management
October 2005
Problem analysis on RELPs in the Netherlands: the use and abuse
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Preface
This paper is written as a dissertation by order of the University of Greenwich and is part of the
curriculum of the Post-graduate programme Master of Science in Real Estate Development &
Investment (Europe). The latter is a programme at the School for Architecture and Construction,
located in both Eltham and Greenwich in London, the United Kingdom.
Real Estate Limited Partnerships are very interesting investment vehicles, although there is not much
statistic information available and I was surprised by the current situation on the market. The opinions
of ‘market professionals’ on issues like possible abuse also surprised me. With this paper I hope to
make these investment vehicles understandable for a wider public and besides that I have tried to
encourage those involved to improve the market by terms of professionalism and transparency. If the
recommendations as provided by this paper are taken into account, the possible abuse of this specific
type of investment vehicle is reduced to an absolute minimum.
The underlying research was very interesting and I am convinced that this dissertation adds value in
regard to all information that is currently available about this topic.
With kind acknowledgements to those who have been very supportive in regard to this paper and its
underlying research. Particularly I would like to thank Mr. van Boom, Mr. Denkers and Mr. van
Rooijen for there willingness and offered time, which resulted in a lot of interesting material and
further resources for me and this dissertation. I am thankful to Mr. D. Isaac, my supervisor of the
University of Greenwich, for our discussions and the useful feed-back every time.
At last (but not least) I would like to thank my parents, family and friends for their moral support and
interesting discussions on all fields over the last months.
Amsterdam, October 2005
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Abstract
Real Estate Limited Partnerships (RELPs) are a popular investment method in the Netherlands,
however legislation around this investment vehicle is subject to change and critical responses from the
media are provided often. The Dutch Authority of Financial Markets (AFM) is the Supervisor for these
types of investments and showed her concerns by publishing their exploration of the RELP market.1
The report of the AFM is worrying and primarily negative about the RELP market. In some cases the
critique is justifiable, on the other hand there are some statements made which are not based on facts.
As a consequence of the statements as made by the AFM, the media is focused on the possible abuse of
this particular investment vehicle, although they are often not familiar with the use of it. Due to the fact
that this research is fact-based rather than desk-based, it must be seen as a sequel to the exploration as
conducted by the AFM. This problem analysis on RELPs in the Netherlands is conducted in order to
provide fact-based information about the current situation on this market. Besides that the issues as
clarified in this paper have been investigated to provide several recommendations for those involved
(i.e. the investors, the originators and the AFM). The RELP is discussed extensively preceding the
problem analysis and in order to make this complex material accessible for a wider public, the basics of
property investment are considered as well.
Prospectus analyses are part of the problem analysis of this paper and a number of contemporary
prospectuses have been analysed. Ten major issues have been found by the analysis, surrounded by
several problems which are interrelated. The ten issues are: Target group and originators; Structure of
a RELP; Initial value of the property; Additional costs; Exit value of the property; Supervision and
regulations; Incomparability of prospectuses; Imperfection of information; Sensitivity of variables and;
The risks. Each issue is described extensively in order to investigate the problems in regard to use and
abuse and based upon all research several recommendations have been made. The main conclusion is
that the RELP sector needs a sector association, which initiates a Code of Practice and aims to make
the market more transparent and professional. If the recommendations as provided by this paper are
taken into account, the possible abuse of a RELP is reduced to an absolute minimum.
1
Autoriteit Financiële Markten (2005), Vastgoed CV’s en maatschappen: Een verkennende analyse, April, Amsterdam. (NL)
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Contents
Colophon
i
Preface
iii
Abstract
v
1. Introduction
1
1.1 Introduction
1.2 Rationale
1.3 Aims
1.4 Objectives
1.5 Research methodology
1.6 Reading guide
1.7 Scope and limitations of the research
1.8 Declaration note and copyright
2. Property investment
1
1
2
2
3
4
5
5
6
2.1 Introduction
2.2 Quality of an investment
2.3 Characteristics of property
2.3.1 Direct versus indirect property investment
6
6
8
9
3. Real estate limited partnerships
12
3.1 Introduction
3.2 The history of RELPs
3.3 Formation of a RELP
3.3.1 Legal structure
3.3.2 Fiscal structure
3.3.3 Supervision
3.4 Financial characteristics
3.4.1 Leverage
3.4.2 Prognosticating returns
3.4.3 The use of debt
3.5 Advantages and disadvantages of a RELP investment
4. Problem analysis
12
12
13
13
15
16
19
19
21
23
25
26
4.1 Introduction
4.2 Target group and originators
4.3 Structure of a RELP
4.4 Initial value of the property
4.5 Additional costs
4.6 Exit value of the property
4.7 Supervision and regulations
4.8 Incomparability of prospectuses
4.9 Imperfection of information
4.10 Sensitivity of variables
4.11 The risks
5. Conclusions and recommendations
26
27
28
29
29
30
31
32
33
34
36
37
5.1 Conclusions
5.2 Recommendations
37
39
List of references
43
Appendices
I - VIII
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viii
viii
1. Introduction
1.1 Introduction
This chapter provides an overview of the dissertation as a whole. First the rationale is described, after
which the aims and objectives will be exposed. Besides that the research methodology is defined as
well as the scope and limitations of the study. A reading guide is provided as well and a brief
declaration note is made by the author.
1.2 Rationale
The market for alternative investment methods in general and for Real Estate Limited Partnerships
(RELPs) in particular is increasing. In the Netherlands the RELP market is increasing significantly
since the introduction of this investment vehicle for property investments in 1999. A RELP is often
referred to as a closed-end investment fund and must be seen as a way of indirect property investment,
although it has several characteristics of direct property investment.
As an answer to this increasing market the Authority Financial Markets (AFM) published their report
‘Real estate limited partnerships and partnerships: An explorative analysis’, which describes several
issues connected to this type of investment and even mentions possible abuse in the market.1 Even a
short comparison with the ‘Legio-lease affaire’2 is made. The AFM is the supervisor on the Dutch
financial markets, including this specific type of investments. An interesting fact is that the AFM3
acknowledged that their report does not offer enough foundation in order to make a deliberate
judgement about the exposed issues. Above that current legislation is subject to alteration, some parts
have recently been introduced and other parts are expected to become effective in 2006. The report as
conducted by the AFM became a guiding principle for the media and continuous negative publicity is
the consequence. However, no fact-based research has been conducted and therefore the report did not
have a warm reception from originators of RELPs.
1
The report is available at the office of the AFM in Amsterdam or on http://www.afm.nl
Around the year 2000 a popular investment method in the Netherlands turned out to be a disaster for those involved. The issue
here was the fact that people could invest in shares with high forecasted returns, however, they were not aware of the fact that
they were due to share in any loss. The investors pay interest to the company in order to participate and at the end of a fixed
period the shares will be sold and the profit (or loss) will be divided among the participants. This type of investment is known as
a so called ‘share leasing’ construction. Financial markets, and especially the stock markets, did not perform as forecasted and
significant losses were made by those involved, which meant the participants had to ‘invest’ extra money. Instead of the
forecasted profit, investors lost their money and were due to ‘invest’ even more, in simple words: They have lost more than they
have invested in the first place. Now in the year 2005 this disaster is still known as the ‘Legio-lease affaire’ and many
participants are still engaged in legal action, either individually or united in a foundation.
3
Personal communications
2
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r
In the meanwhile investors are still interested in these types of investments, primarily due to their
cy,
limited liability and tax-transparency characteristics. The market is known for its non-transparency,
ess
similar to the direct property investment market. However, investing in a RELP is possible with less
ekly.
capital and therefore accessible for a ‘new’ target-group, consequently ‘new’ originators arise weekly.
ue the
At the moment it is impossible for a ‘new’ investor to judge the reliability of those originators, due the
hat
fact of imperfect information. The available information is provided by the originators. Besides that
running RELPs are absolutely non-transparent, while it is impossible to gain information on their
press,
performance, unless for those participating. Often RELP propositions are widely evaluated in the press,
often negatively, where the facts are not always fundamental to their judgements.
d in
With this dissertation the first fact-based rather than desk-based research study has been provided in
ng
order to clarify all issues as involved in the RELP market, primarily towards the issues considering
illegitimacy and possible abuse.
1.3 Aims
This dissertation is undertaken in accordance to the following aims:
egard
(1).
Provision of a critical depth-analysis and evaluation of the current situation in regard
t-
to RELPs in the Netherlands (in order to expose the problems as a result of factbased research).
n
(2).
Provision of recommendations for those involved in the Dutch RELP market (in
ion of
order to assist in the creation of a stable market environment and the clarification of
possible abuse).
1.4 Objectives
e.
The objectives as under mentioned should be seen as an extension of the aims as mentioned above.
The objectives will be achieved by undertaken research as described in further detail later.
Some of the objectives could be seen as the direct consequence of the aims as described before.
(a).
Realisation of an extensive understanding about the working of Dutch RELPs,
including an evaluation of the upcoming changes in legislation.
d.
(b).
Clarification of the relation between problems connected to the issue ‘abuse’.
(c).
Encouragement to professionalize the Dutch RELP market by those involved.
(d).
Realisation of a sequel to the exploration as conducted by the AFM as an
encouragement to undertake further research where necessary by those involved.
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1.5 Research methodology
The research as undertaken for this dissertation is based on triangulation, hence it should be seen as a
qualitative as well as a quantitative method.
In order to develop an understanding on this specific matter an extensive literature review has been
conducted. This review has not been limited to books, but also included professional journals, several
dissertations on comparable subjects (by other then the author), research papers and other professional
publications. Besides that the review has not been limited to solely real estate as a subject, but includes
other relevant specialities (i.e. Law) and literature has been either written in the Dutch or English
language. Results from the literature review must be seen as quantitative data.
As a way to conduct qualitative data, several interviews have been held by the author. To avoid
subjectivity each group (i.e. investor, originator and AFM) has been questioned on similar issues.
Besides that several professionals have been questioned by email and telephone.
Another method which has been used in order to conduct quantitative data is the prospectus analyses.
A number of nine prospectuses have been analysed. All prospectuses are recent investment
propositions on Dutch RELPs. These analyses should be seen as a method to conduct quantitative data,
although the general knowledge established by these analyses must be seen as qualitative. The results
have been enclosed in the appendices.
Besides the techniques as mentioned above, ad-hoc field research has been conducted in co-operation
with specialists and investors whom are known by the author. Hence, relevant information on their
opinion could be taken into account as a form of qualitative as well as quantitative data.
The research methodology as described above provided a wide range of information which is used in
this dissertation. It is importance to notice that due to this research most data is fact-based rather than
desk-based.
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1.6 Reading guide
This dissertation exists of 5 chapters, including this chapter. General background knowledge on
ge on
financial investments is assumed as well as affinity with property investments. Specific knowledge on
RELPs is not required.
Chapter 1.
Introduction
(ca. 1500 words)
Exists of information on the dissertation as a whole.
Chapter 2.
market
Property investment
(ca. 1500 words)
Brief introduction to (property) investment and clarifies the position of RELPs in the investment market
in general in order to create an equal starting point.
Chapter 3.
l and
Real estate limited partnerships
(ca. 4500 words)
Extensive discussion on RELPs in order to understand all underlying issues, i.e. the history, legal and
fiscal structure, relevant legislation, financing structures and the prognostication of return.
Chapter 4.
nalysis
Problem analysis
(ca. 5000 words)
Extensive discussion about the problems in regard to RELPs in the Netherlands. Preceding the analysis
research has been conducted and this chapter must be seen as the result of all research.
Chapter 5.
Conclusions and recommendations
(ca. 2500 words)
Clear and extensive conclusions on all issues as described in this paper, followed by strong
recommendations for those involved.
In regard to references a superior number system is used. In the text a subscript number is found,
his
referring to a short reference in the footnote, including page numbers if necessary. At the end of this
inal
dissertation a list of full references is provided. If the addition ‘(NL)’ is made this means the original
d.
text is written in the Dutch language. Whenever necessary a free translation of the title is provided.
4
4
1.7 Scope and limitations of the research
This study is conducted on information about all types of RELPs (commercial and residential) open to
private investors in order to provide a complete overview on the market as a whole. Consequently data
(i.e. averages) could deviate from previous research as conducted by the market, focusing primarily on
offices or RELPs including non-limited partnerships. Whenever necessary a clarification is provided in
this paper.
This study is strictly limited to Dutch limited partnerships (LPs) (commanditaire vennootschappen i.D.)4
which must be seen as a closed-end investment vehicle for financial investments in existing real estate,
as meant by the Prospectus Guideline (de Prospectusrichtlijn i.D.). Nevertheless this study could be seen
as informative for other countries.
1.8 Declaration note and copyright
Except where stated otherwise, this dissertation is based entirely on author’s own work. This
dissertation is the intellectual property of the author (student), whereas the copyright is shared between
the author (student) and the University of Greenwich in London.
4
In order to improve the readability for those interested from the Netherlands, some particular words have been translated in the
text. The words written cursive and in parentheses with the addition ‘i.D.’ are ‘in Dutch’.
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2. Property investment
2.1 Introduction
shes
Investing in a (Dutch) RELP is one of many possible investments. The Dutch language distinguishes
financial investments (beleggen i.D.) and venture investments (investeren c.q. ondernemen i.D.), due to
due to
fiscal regulations. In this paper ‘investments’ should be read as ‘financial investments’ unless
neral
mentioned otherwise. This chapter clarifies the position of RELPs in the investment market in general
in order to create an equal starting point.
2.2 Quality of an investment
ome
As Isaac5 says, ‘an investment essentially involves an initial money outlay to recoup a future income
d
stream or future capital repayment’. This statement is supported by several authors, i.e. Bol,6 and
at is an
clarifies the underlying idea of any investment. The main issue in the approach to analysis of what is an
interesting and qualitative investment relies on the relation between risk and return. The latter is
illustrated in the following figure.
Figure 2.1: ‘Relation between risk and return’ (Adapted from Rust7 and Schütte8)
here
In the figure as shown before ‘A’, ‘B’, ‘C’ and ‘D’ should be seen as investment opportunities, where
n ‘B’
‘A’ is the best opportunity. Investments ‘B’ and ‘C’ are better than ‘D’, although ‘A’ is better than ‘B’
e the
and ‘C’. As clarification, ‘D’ involves more risk than ‘C’, although the return is equal. In that case the
return
demand for ‘D’ will be nil. As a respond on that the price of ‘D’ will decrease, consequently the return
increases and the demand will increase.
5
Isaac, D. (1998), p. 2
Bol, N. (2003), pp. 2-3
Rust, W. (1995), p. 160
8
Schütte, A. (2002), pp. 42-43
6
7
6
6
The simplistic illustration (figure 2.1) clarifies the relation between risk and return concerning demand
and supply. Apart from that it is extremely important to diversify investment portfolios in order to
create a positive effect on the relation between risk and return. It is not wise to lay a bet on one horse.
Diversification is important, as well in horizontal direction (different asset classes, i.e. stocks, bonds,
property) as in vertical direction (separate types of one asset class, i.e. property: Commercial and
residential). Besides an acceptable relation between risk and return an investor expects more from an
investment, for example the subjects pointed out by Isaac:9
(a).
Security of capital and also liquidity so that the interest can be disposed of easily;
(b).
Security of income from the capital invested;
(c).
Regularity of income;
(d).
Low cost of purchase and sale of the investment;
(e).
Ease of purchase and sale of the investment;
(f).
Divisibility of the investment: Is it possible to sell of parts of it?
(g).
The security of the investment in real terms: Is the value of the investment increasing
in line with inflation?
(h).
The opportunities for growth in value: Is this more than the rate of inflation?
The expectations of an investor rely on various subjects, i.e. depending on his10 current investment
portfolio, the available amount of capital and his attitude to risk. Apart from that, the decision to invest
in a certain opportunity should be based on judgements whereby diversification is kept in mind.
9
Isaac, D. (1998), p. 2
Wherever the masculine pronouns he, his, him are used in this paper where the feminine pronouns could equally well be used,
the reader should read these as she or her and vice versa, as appropriate.
10
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2.3 Characteristics of property
sets
Property investment is different from other types of investment in that ‘ownership of physical assets
al
like land and buildings is far more complex than the ownership of a share certificate’.11 The initial
difference in the mechanism and structure of the investment is often compared to other types of
investments, like shares as listed on the Stock Exchange.12
most
As the result of a (contemporary) literature search the following characteristics are stated as the most
important characteristics of (direct) property investment:13
ken
1.)
Property is not a standardised investment due to the uniqueness of each property.
2.)
The expectation of life of land is infinite and of buildings considerably long.
3.)
Property cannot easily be divided into smaller sizes (i.e. whereas shares can be broken
down into smaller sizes of ownership), hence property has high unit prices.
ations
4.)
The (re)development of property is a time-consuming process, mainly due to regulations
and the involvement of governments.
arce.
5.)
Property investment is considered to be a long-term investment, transactions are scarce.
n
6.)
Investments in property can be improved by active management. Apart from that an
investment often requires additional investments later on to maintain profitable.
n is
7.)
Property investment requires considerable knowledge and management skills.
8.)
The property market is characterized by its market imperfection. Market information is
often imperfect and the data surrounding transactions is often not available or kept
confidential.
ime-
9.)
There is no such thing as continual fixing of prices.
10.)
There is no single market, it is a localised market. Buying and selling properties is timeconsuming and costly.
11.)
An investment in property often offers protection against inflation, because rental
agreements are connected to the inflation-index.
12.)
the
Returns are partly reliable on government policy.
Apart from the characteristics 1. to 12. as mentioned, it is important to understand a principal of the
14
cle.
property cycle. The property cycle is two to four years delayed in regard to the capital market cycle.14
pared
Property investments therefore provide security against the tendency of the capital market. Compared
to types of investment which are sensitive for the tendency of the capital market, like shares, this
sifying
principal makes property investment a solid investment in general and an excellent way of diversifying
an investment portfolio in particular. In order to understand both issues, two types of property
investment are put against each other.
11
Isaac, D. (1998), p. 9
A clear comparison is made by: Brett, M. (1989), Characteristics of property, Estates Gazette, 21 January, p. 14
Brett, M. (1989), Isaac, D. (1998), Van Gool, P. a.o. (2001), Schütte, A. a.o. (2002) en Hendriks, C. a.o. (2003)
14
Schütte, A. a.o. (2002), p.19
12
13
8
8
2.3.1 Direct versus indirect property investment
Literature distinguishes several types of property investment, however the following distinction is often
provided and considered as the primary distinction: Direct and; indirect investment.
An investment in property is considered as direct if an investor has a majority interest as well as a say
on the management that is or is not provided by any subsidiaries. If an investor neither has a majority
interest or a say on the management the investment is considered to be indirect.15 Sometimes a
distinction is made between listed and non-listed indirect property investment. All this can be
summarized into the following figure, the ‘Capital Market Matrix’:
Figure 2.2: ‘Capital Market Matrix’ (Adapted from Bol, N. (2003), p. 5)
The capital market matrix is based on different types of financing and provides a clear view on the
possibilities. However, it should be seen as a simplistic reproduction of reality. In reality there are
many mixtures of financing using both equity and debt. Because property is an asset class requiring
high capital, debt is often used in order to realise diversification in an investment portfolio.
Diversification of investment portfolios is a subject on its own, including many theories.16 However,
for this paper it is only relevant to discuss diversification within the property portfolio. Property can be
divided in a number of sectors in regard to investments: Residential; Offices; Retail; Industrial; Parking
spaces; Agricultural land and; Others (i.e. hotels and advertising pillars). Diversification is possible by
investing in different sectors, locations, tenants, building types, ages of buildings and duration of rental
agreements.17 In practice diversification is hard to implement due to high prices per unit and the
required knowledge of specific types of buildings and regions. Among other reasons this is an
important reason why indirect property investment becomes more popular, especially under private
investors. For many ‘small’ investors indirect investments are the only possibility to realise
diversification in regard to property.
At this moment almost 20.00% of the private investors in the Netherlands invested indirect in property,
whereby this type of investment covers about 16.00% of their total property portfolio.18
15
Van Gool, P. a.o. (2001), pp. 45-46
For an extensive treatise on diversification in real estate portfolios see: Geltner, D. a.o. (2001)
Bol, N. (2003), p. 20
18
Troostwijk makelaars (2005), p.14
16
17
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rty
Indirect property investment has several advantages and disadvantages in regard to direct property
investment, including those as stated by Bol:19
of
ct.
Advantages
Disadvantages
Better opportunities for diversification;
Less say on management issues;
External (professional) management;
Other ratios in regard to the use of
Cost benefits due to size;
equity and debt;
Complete overview of expenditures and benefits.
Mismatching demand and product.
In addition to those mentioned above, Van Gool20 mentions a number of interesting issues, namely:
ely:
Stability of value; fiscal system; Expertise; Management; Discount and; Excitement.
These will be clarified later in figure 2.3.
t type of
An answer to the discussion of what is the best type of investment cannot be provided. The best type of
goals,
investment relies on many issues, like the availability of capital, the current portfolio, personal goals,
personal preferences, available expertise and available time.
o direct
The issues as mentioned above could be translated in advantages and disadvantages in regard to direct
this
property investment and closed-end investment funds, i.e. investments in RELPs. However, for this
o direct
paper it is more interesting to provide an overview of the characteristics of a RELP in relation to direct
as been
and indirect property investment. Therefore the figure 2.3 ‘Variations of property investment’ has been
structured with the use of the explanation of Van Boom21 as well as the issues as described by Van
Van
Gool.22 Figure 2.3 is presented on the next page.
19
Bol, N. (2003), pp. 18-19
Van Gool, P. (2001), pp. 104-105
Van Boom, G. (2005), p. 41
22
Van Gool, P. (2001), pp. 104-105
20
21
10
10
Figure 2.3: ‘Variations of property investment’, (By using explanations of Van Boom (2005), p. 41 and Van Gool (2001), pp. 104-105)
Figure 2.3 proves the fact that RELPs should be seen as a separate type of property investment, with a
number of unique characteristics in regard to other types of investment. Apart from that the relation
towards direct property investment is considerable, as shown above, although there is a strong relation
towards indirect property investment as well. In terms of the capital market matrix as shown before
(figure 2.2), a RELP uses a mixture of finance (equity and debt financing).
The position of RELPs has been considered as well as the basics of (property) investment. Therefore
this paper will now continue with the following chapter: Real estate limited partnerships.
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3. Real estate limited partnerships
3.1 Introduction
The
This chapter aims to realise an understanding about the working of RELPs in the Netherlands. The
be
method of financing these investment vehicles use as well as both legal and fiscal aspects will be
spect
described. Besides that legislation is an important issue throughout this chapter and the return aspect
will be clarified by explaining several valuation methods as used in prognostications.
To start some historical information on Dutch RELPs is given.
3.2 The history of RELPs
t Dutch
The limited partnership (LP) is a fairly common legal form for enterprises, nevertheless the first Dutch
, in the
RELP available for private investors is originated in May 1999 by ‘Roompot Recreatie Beheer’, in the
venture
form of the LP ‘Zeeland Kustgoed’, by idea of De Heij.23 Until then, LPs were associated with venture
lready
investments instead of financial investments. Although shipping LPs as well as film LPs were already
well-known under private investors in the Netherlands, due to their beneficial tax-transparency.
e
A similar investment vehicle used before the existence of the RELP and which is still used is the
normal (read: non-limited) partnership (maatschap i.D.).
r their
An important disadvantage in regard to partnerships is the fact that the participants are liable for their
on.
complete private capital, whereas a participator in a LP is liable up to the amount of participation.
ges.
Although liability is often limited by using a non-recourse mortgage, there are more disadvantages.
always
De Heij24 states that in regard to the management of partnerships the required knowledge is not always
available. On the contrary, in LPs there is always a professional Trustee entrusted with the
e LP,
management, as obliged legally. As De Heij continues, the partnership has no benefits above the LP,
ue to its
whereby the LP has several benefits above the partnership. The partnership is only still in use due to its
8)
direct association with property, a fact useful by marketing an investment proposition.25
23
Wiegerinck, E. (2005), pp. 28-29
Wiegerinck, E. (2005), p. 28
25
For an extensive (Dutch) treatise on the characteristics of partnerships and limited partnerships see: Mohr, A.L. (1998)
24
12
12
3.3 Formation of a RELP
Due to its characteristics, a RELP is an interesting and unique investment vehicle. The main
characteristics (limited liability and tax-transparency) are a consequence of its legal and fiscal
structure. Both will be explained in depth. It has to be noted that the current legislation in regard to
partnerships as a whole (including RELPs) is subject to alteration.26 Whenever necessary the
differences between current legislation and the alteration will be clarified.
3.3.1 Legal structure
As said before the limited liability aspect as well as the tax-transparency is crucial criteria for a RELP.
By realisation of a so called ‘Ltd. - LP construction’ (BV/CV i.D.) both criteria are complied with.
Titles 19 and 20 of the Book of Law for Commerce describe that a LP is an agreement between one or
more partners – the Trustee – liable for debts as a whole and one or more limited partners. The limited
partners (participants i.e. investors) are liable for the amount of their agreed contribution.
The Trustee (normally the originator) does not want to be liable for eventual losses of the LP, and is
therefore accommodated in a low capitalized Ltd., which performs the duties of the Trustee. Any
shareholder of the Ltd. is not liable for any losses of the Ltd. above the minimum required share capital
as obliged by the Civil Book of Law.27 Therefore every RELP originates a new Ltd. which performs
the duties of the Trustee to limit their liability. In total the liability for losses of that Ltd. is limited to
the share capital plus the agreed capital brought-in by limited partners.
In regard to the Ltd. - LP construction the property ownership is divided into two types, namely:
Legal ownership and; Economic ownership.
As obliged by Law28 a so called Guardian receives the legal ownership. On the other hand the RELP
receives the economic ownership. Both ownerships are liable to contractual agreements in order to
prevent conflicts between those involved and illegitimacy in regard to the assets. As a consequence of
the economic ownership all financial results are due to the LP as well as the risk of value attached to
the property, which could get lost by fire or vandalism. The latter are limited by insurances, as usual.
In order to clarify the legal structure the involved parties have been put into the following scheme.
26
Bill of the Law for settlement of title 7.13 of the Civil Book of Law (BW i.D.)
Title 2:175 ad. 1 (art. 2:175 lid 1 BW i.D.))
28
Act on the Supervision of collective investment funds (Wtb i.D.)
27
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Figure 3.1: ‘Scheme legal structure’
open-
The Dutch legislation distinguishes open-end LPs and closed-end LPs. The participations of an open-
nary
end LP are transferable, whereas those of a closed-end LP are only transferable under extraordinary
e.
circumstances with written permission of all limited partners, in practice this is often impossible.
A RELP is a closed-end investment fund as meant by the Dutch Law.
14
14
3.3.2 Fiscal structure
A LP is not an independent taxable legislative body, hence it is tax-transparent provided that the LP is
closed-end, as described before. 29 The Inland Revenue (Belastingdienst i.D.) ‘looks through’ the LP
construction and the results are taxable on the participators. The Dutch tax-system is often referred to
as the ‘Box-system’. In the Dutch tax system, the various types of income and deductible expenditure
are divided among three boxes.
Box 1
Taxable income from employment and home ownership in the Netherlands;
Box 1 contains income by labour, profit of ventures, social allowances, alimony, life-annuities and
income by main reside. Eventual particular costs like extraordinary expenses are deducted.
Taxation happens progressive up to 52.00%.
Box 2
Taxable income from a substantial interest in the Netherlands
Profit by substantial interest, which is an interest of at least 5.00% in for example one RELP.
Taxation by a fixed rate of 30.00%. As regards content not relevant for this paper.
Box 3
Taxable income from savings and investments in the Netherlands
Taxation on fictive return on capital by lump sum. The net capital, with a deduction of an exemption of
€ 19.952,00 per person,30 is assumed to conceive a lump sum return of 4.00%, which is taxed by a rate
of 30.00%. On balance this means an effective taxation of 1.20% on the average capital per annum,
after deduction of the exemption.31
In order to clarify the Dutch tax-system an overview is provided on the next page. This overview must
be seen as a general outline of the income and deductible expenditure pertaining to each box.
29
Act of Parliamentary Undersecretary of Finance 19th of December 2000. (Nr. CPP 2000/2157)
Inland Revenue (De Belastingdienst i.D.)
31
To illustrate: A private investor owns an average capital of €100.000,00 per annum. Therefore he needs to pay 1.20% over
€80.748,00 (€100.000,00 - €19.252,00) = € 969,00.
30
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Figure 3.2: Overview of the Dutch tax-system, (Adapted from De Belastingdienst 2005)
le –
If income falls into two or three different boxes, this income will be treated and – where possible –
,
taxed separately. This means that: Every type of income falls into one particular box. Therefore,
1, 2
income cannot be taxed twice. Different tax rates are applicable to the taxable income in Boxes 1, 2
ive
and 3 as described before. Any negative income (loss) in one box cannot be offset against positive
income in another box. A special facility applies to losses in Box 2.
ome in
Deductible expenditure that is directly related to revenue in a particular box will reduce the income in
that box.
on
Private investments in RELPs (closed-end) are taxed either in box 1 or box 3. The actual taxation
, while
depends on the type of investment. A financial investment as discussed before is taxed in box 3, while
this
the venture type of investment is taxed in box 1. Most RELPs or at least those as considered in this
paper are taxed in box 3, with an effective rate of 1.20% on the capital after exemption.
lled nil.
In practice and especially in comparison to the 52.00% of box 1 the tax rate of box 3 is often called nil.
3.3.3 Supervision
LPs) is
It has to be noted that the current legislation in regard to partnerships as a whole (including RELPs) is
subject to alteration.32 Whenever necessary the differences between current legislation and the
alteration will be clarified.
32
16
Bill of the Law for settlement of title 7:13 of the Civil Book of Law (BW. i.D.)
16
As known the AFM is the by Law appointed Supervisor on Dutch financial markets. In their report as
mentioned before, the current legislation is considered as well as the upcoming changes. However,
there is a lot of uncertainty around this issue. Under the then current regime there are several possible
situations whereby an LP is not under supervision. The alteration will change this in regard to venture
LPs, which are not the subject of this paper. In regard to RELPs as meant by this paper there are some
other upcoming changes which are worth mentioning.
A RELP as described in this paper is an investment fund by words of the Act on the Supervision of
collective investment funds (ASi) (Wtb i.D.). As obliged by Title 1.1. of the ASi it is forbidden to offer
participations in these funds outside an intimate circle, without a license as provided by the AFM.
Contravention of these regulations is seen as an economic offence and is liable to punishment.
The thread through the Supervision by the AFM is the quality of the provided information and the
integrity of the originators. In order to receive a license as meant by the ASi the directors of the
investment fund are tested on expertise and reliability. Besides that the investment fund needs to
provide a prospectus and a financial leaflet to the AFM for approval. If all conditions are satisfactory,
the AFM will provide a temporary license for the duration of initiating the investment fund by offering
participations to a wider public. After initiation (at full participation) the license is withdrawn and there
is no further supervision. This is changed since the 1st of September 2005: The license will no longer be
provided to the investment fund, but to the Trustee. Hence the investment fund and the Trustee are
under continuous supervision. However, the evaluation of the prospectus is still not satisfactory. The
AFM has no ability to check the actual content of the prospectus, all they can do is check whether all
obliged paragraphs are in it. The AFM recognises this as a problem and alteration is expected, however
this is still unsure.33 Since the 1st of July 2005 the prospectus needs to satisfy the conditions as stated by
the EU-Prospectus Guidelines as well.34 Above all that, there are more upcoming changes in the Dutch
financial legislation as a whole, however these are still uncertain and it is not relevant to discuss all
those in this paper.
The main issues are the changes in the provision of the license, which consequently mean continuous
supervision. In order to benefit from this change, it is obliged by the ASi (as relevant since the 1st of
September 2005) that the directors as well as the Trustee need to provide periodical results to the AFM
by using Total Expense Ratios.35 Besides that every Trustee has to provide an objective valuation of the
property, conducted by an external valuation expert. Both issues will improve the transparency of the
market from the Supervisor’s perspective. However, it is unsure if this information will become
available for investors whom are not a participant. Apart from that investment funds with an amount
per participation exceeding €50.000,00 or with less than 100 participators are exempt from all
conditions as mentioned before.36
It must be stated that the Supervision is improving, however it is still not satisfying at this moment
from an investor’s perspective. It is extremely important to avoid the existence of fictive security, a
33
AFM (2005), p. 5
Regulations (EU) Nr. 809/2004 by date 29th of April 2004
Already encouraged in 2004 by commission Winter, pp. 29-36
36
AFM (2005)
34
35
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ecially
thought supported by Hentenaar.37 Improving transparency is beneficial for the market and especially
r
for the investors, however the Prospectuses deserve more attention in regard to content and their
the
prognosticated returns. This is still not possible, not under current legislation but neither under the
alteration.
Self-regulation
es
Apart from supervision as obliged by Law, it is important to achieve self-regulation for all parties
involved. At this moment there is no self-regulation at all, although there are some initiatives.38
le for
The content of these initiatives is not accessible yet and it is not sure when this will be accessible for
be
the public. Self-regulation is extremely important in regard to improving transparency, as will be
d Belang
clarified in further detail later.
37
38
18
Hentenaar, R. a.o. (2005), pp. 35-78
Namely: Nederlandse Vereniging Institutionele Beleggers (IVBN), Raad van Onroerende Zaken (ROZ) and Vastgoed Belang
18
3.4 Financial characteristics
Figure 2.2 (Capital market matrix) already clarified the fact that there are a number of ways in which
an investment in property can be financed. A RELP uses a mixture, hence the total invested capital
exists of equity and debt.
The equity is the capital as brought-in by the partners of the RELP. Both the Trustee and the
participants must be seen as the partners. The Trustee does not always brings-in equity, although it
becomes more regular because it is seen as a mark of trust in the RELP. The prospectus analyses show
that the RELPs in the Netherlands use approximately 35.00% equity.39 In regard to RELPs it is not
unusual to increase the total invested capital by three to four times by using debt capital.40
Debt capital for a RELP is attracted in the form of a mortgage loan. The exceeding amount of capital is
attracted in the form of equity by (private) investors. This particular type of financing causes some sort
of lever in regard to the return on equity. In other words, the expected return is increasing by using debt
capital. The use of debt capital in property investments is very common, especially in regard to RELPs.
A study conducted by Troostwijk shows that half of the Dutch private investors approximately use
79.00% debt value for their investments, whereas three quarters of the Dutch private investors use at
least 59.00%.41
The effect of the existence of a lever is called ‘leverage’ or ‘gearing’ and is crucial for investments in
RELPs and their prognosticated returns. Originators of RELPs attract debt value in order to finance the
asset and to create leverage.42
3.4.1 Leverage
The proportion of equity value against debt value is called leverage and is expressible in a ratio, which
is called leverage ratio (LR). The LR is defined as ‘the total value of the underlying asset divided by
the value of the equity investment’,43 where the LR enables the investor to purchase an asset whose
value is LR times greater than the equity value invested. The lower the LR, the higher the equity and
vice versa. To calculate the LR the following formula must be used:
Leverage Ratio (LR) = V / E = (D + E) / E
In the formula ‘V’ is the asset value, ‘D’ is the debt value and ‘E’ is the equity. In order to clarify the
effect of the LR an example is provided whereby the variables are conducted from a prospectus.44
39
Prospectus analyses
Prospectus analyses and AFM (2005), p. 14
41
Troostwijk a.o. (2005), p. 23
42
Hoedjes, M. (2004), p. 27
43
Geltner (2001) p. 308
44
The prospectus of MPC Capital (MPC Holland 58 CV)
40
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Figure 3.3: ‘Leverage in practice’, interest rate is fictive.
ides
These simple calculations clarify the sensitivity of the return on changes in the interest rate. Besides
y testing
that it shows that the use of debt could gear the return, i.e. from 7.10% up to 10.30%. Sensitivity testing
costs of
as part of the research as conducted for this paper resulted in an interesting fact. As long as the costs of
the
debt expressed in a percentage is lower than the return in scenario 1. (asset value equals equity), the
leverage is positive. In the example as shown (figure 3.3) these costs cannot exceed 7.10%.
ory by
With an assumed interest rate of 8.00% the effect becomes negative. Geltner45 supports this theory by
e
stating that ‘whenever the return component is higher in the underlying property than it is in the
everage
mortgage loan, there will be positive leverage in that return component.’ As shown the use of leverage
l low
is extremely sensitive to interest rates and the effect is not always positive. The current historical low
interest rates in the Netherlands supports finance constructions using high debt values.46
As shown the effect could be positive as well as negative, however this is not always clear from
ffects
prognosticated returns in prospectuses. A small change in the interest rate can have significant effects
ecomes
on the return, as will be explained in further depth later in chapter 4. Apart from that vacancy becomes
a higher risk when the LR increases due to the fact the interest costs have to be paid including
redemption.
45
Geltner, D. a.o. (2001), p. 320
1 month Euribor rate on 1 September 2000 was 4,664 against 2,142 on 1 September 2005
Source: http://www.euribor.org/
46
20
20
It is important to note that the LR is not the same as the commonly known loan-to-value ratio (LTV),
although both are strongly connected to each other. An increase in the LR means an increase in the
LTV, however there is no linear relation. Besides that it is important to be aware of the debatable
filling-in of ‘V’, while normally for direct property investments ‘V’ is the value of the property.
However, in regard to RELPs this is not fair, because the additional costs are considerable in addition
to the value of the property. Whenever LTV is used is this paper, ‘V’ must be seen as solely the value
of the property. It is important to understand this difference in order to provide a clear comparison on
investment propositions in regard to RELPs.
3.4.2 Prognosticating returns
The return on an investment is extremely important and must be seen as a reward for the risk.
Each prospectus of RELPs shows a prognosticated return, however there are several ways to calculate
this and besides that different terms are used.
The total return component of a RELP investment can be divided into two parts, namely:
Direct return and;
Indirect return.
Direct return
The direct return must be seen as the return which arises due to operating the property (letting out and
use). It is the ‘..actual yield of a certain object over a certain period of time, divided by the average
invested capital over that period..’,47 whereby the actual yield must be seen as the total rental income
minus the operating costs of the property. Operating costs are for example: maintenance costs, taxes,
insurance costs, management fees and letting costs.
Indirect return
The indirect return arises due to changes in the value of property. It is the ‘..appreciation or
depreciation of the property over a certain period of time, divided by the total invested capital over the
period of measurement..’.48 This means that the sales result at the end of the duration of the RELP must
be seen as the indirect return. The indirect return is of great influence on the total return, especially if
there are high debt services. The LTV at the moment of sale is extremely important, because the yield
will firstly be used for total redemption, after which the remaining part must be seen as the sales result.
47
48
Hendriks, C. a.o. (2003), p. 394
Hendriks, C. a.o. (2003), p. 402
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Appraisal techniques
operty
There are many appraisal techniques in regard to property investment, however in the Dutch property
method
market the Gross Initial Yield (GIY) (BAR i.D.) method and the Discounted Cash Flow (DCF) method
y based
are the most commonly used techniques.49 The techniques as used in the prospectuses are mainly based
e of
on singular methods, although some exceptions use the DCF method by way of the Internal Rate of
ation of
Return (IRR). The singular method adds the total return of each year and divides that to the duration of
e value
the investment in years. Unlike the IRR (as explained later) the singular method ignores the time value
of money. However, it could be seen as a suitable way to compare several (equal) investment
propositions.
e
Another way used to compare several (equal) investment propositions is the GIY method. In the
Netherlands the GIY is used without rental correction instead of with as common in the UK.
The formula is denoted as:50
Gross Initial Yield = Market rental revenue year 1 / Total investment
year.
It is important to note that the market rental revenue is based on full occupation during the first year.
future
In regard to prognosticating returns in RELP prospectuses, the GIY is often used to forecast the future
value of the property by using a capitalization rate. These formulas are denoted as:
Capitalization rate = 1 / GIY year x
Future value = Capitalization rate * Market rental revenue year x
e.51
The prognostications as used in the prospectuses are often based on the initial capitalization rate.51
ables,
However, this method is unreliable due to fact that the market rent relies on many different variables,
erty are
which are extremely hard to forecast. The sales result and therefore the future value of the property are
rn,
of great influence on prognosticated returns. The indirect return is often 50.00% of the total return,
which is significant. 52
en
In regard to the far more complex DCF methods, the simplistic methods as shown above are often
mpared
criticised. However, recent research shows that the GIY method results in more unequivocal compared
to DCF methods, even though the same variables are used.53
ty at
DCF methods are based on ‘..all cash flows for a certain period and the exit value of the property at
ter
the end of that certain period..’, whereby all amounts are discounted to the initial date.54 The latter
y. The
results in the Net Present Value (NPV), which could be seen as the present value of the property. The
It is the
IRR is the discount factor of the cash flows, it is the actual return obtained from an investment. It is the
t as a
rate at which the NPV is ‘0’, the investment making neither a profit nor a loss.55 Rust refers to it as a
y
way to measure the yield on an investment, therefore it could be seen as a so called ‘profitability
49
Langens, E. (2003)
Rust, W. a.o. (1995), pp. 63-65
Prospectus analyses
52
Hoedjes, M. (2004), p. 31
53
Smit, W. (2003)
54
Hendriks a.o. (2003), p. 395
55
Butler, D. a.o. (1990)
50
51
22
22
indicator’.56 The DCF methods can be accurate, although this relies on the expertise of the appraiser.
As Isaac57 says, ‘the overriding advantage of DCF methods is the fact that they recognise the time
value of money’. Only a few of the originators as analysed showed the IRR in their prospectus.
Any investor who wishes to compare several return prognostications of RELPs must understand the
methods as described before.58 Each method will result in a different return and is based on many
variables. The sensitiveness of these variables and the assumptions made are extremely important in
regard to the expected return.
3.4.3 The use of debt
Originators of RELPs try to increase the return by using the finance construction as described before.
Therefore they attract debt (mortgage) using equity and the value of the underlying asset. As shown the
interest rate and redemption have great influence on the (prognosticated) return, hence they are often
controlled in order to reduce the risk. There are many different forms of mortgages differing from one
another in regard to interest payments and redemption. RELPs in general use a fixed rate or a collarconstruction, combined with increasing redemption (if possible none in the beginning).
A fixed interest rate for a certain period of time provides security, however it is not possible to benefit
from a decrease in interest rates. The collar-construction is based on a cap and a floor rate, which must
be seen as the maximum and minimum rate possible during a certain period of time. This construction
makes it possible to benefit from a decrease in interest rates. However, an increase in interest rates is
also possible and this would have a negative effect. Combinations are also possible. Both constructions
reduce the risk for a certain period of time. Interest costs and redemptions have great influence on the
actual return and are extremely important to analyse when considering an investment proposition.
The procurement of a mortgage is often done by professional and respected credit facilities with
knowledge about the property market.59 These facilities consider a number of aspects, however the
procurement of a mortgage is indissolubly connected to the provision of security. Besides that quality
must be seen as a key-factor from the perspective of credit facilities: Quality of the underlying asset;
quality of the debtor; quality of the tenant and the cash flow and; quality of the LTV ratio.60
56
Rust, W. a.o. (1995), p. 66
Isaac, D. (1998), p. 110
58
For more information on appraisal techniques see: Isaac, D. (1998) and Rust, W. a.o. (1995)
59
For example: Bouwfonds property finance, ING Real Estate and Rabo Vastgoed
60
Hoedjes, M. (2004), p. 29
57
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Quality of the underlying asset
Quality is a subjective judgement and in this perspective it is directed related to the property.
e
The quality of the location and the building are of extreme importance. The attainableness of the
the
location, among with the availability of services in that location are factors of quality related to the
ese are:
location. Baum61 suggests that the following define the components of quality in a building. These are:
);
Configuration (plan layout, floor to ceiling height); internal specification (services and finishes);
rnal and
external appearance (exterior and common parts); and durability of materials (resistance to external and
internal deterioration). The importance of location needs to be added to these factors.
Quality of the debtor
This issue needs to be defined in terms of financial wealth of the originator. The wealth of the
participants is not an issue, because of the limited liability characteristics of a LP.
Quality of the tenant and the cash flow
reports
In order to exam the quality of tenants their financial wealth is investigated. Often is referred to reports
provided by organisations like Dun & Bradstreet or Graydon.62 The quality of the cash flow is often
often
expressed in the Debt Service Coverage ratio (DCR). The DCR is the classical income-based
underwriting criterion and is calculated by using the following formula:63
Debt Service Coverage ratio (DCR) = NOI / DS
erest
‘NOI’ stands for net operating income and ‘DS’ for debt service. DS includes both periodic interest
the risk
payments and any redemption. The DCR should be at least ‘1.00’ at all times in order to reduce the risk
of a cash flow squeeze. 64 However, over 55.00% of the funds in undertaken analyses have an initial
nitial
due to
DCR of less than 1.00, because of a high DS combined with a low NOI.65 The latter is possible due to
ms of
the current interest rate on capital markets, i.e. the loan market is ‘hot’.66Apart from that the terms of
rental contracts should be considered as well as the spread of the tenants.
Quality of the LTV ratio
alue-
As the DCR is the basic income-based underwriting criterion, the LTV ratio is the basic asset-valuebased underwriting criterion. For an investment in RELPs it is important to realise that the
as a
implementation of ‘V’ is disputable, because of the required additional costs of the investment as a
ead of
whole. A credit facility will assess the value of the underlying property (land and building) instead of
ed on
the investment as a whole, because that is their security. They will procure a mortgage loan based on
debtor.
the execution value of the property in combination with additional securities as provided by the debtor.
oan.
In all cases the credit facility will hold the first mortgage on the property in order to secure its loan.
between
Therefore it is interesting to consider the initial LTV ratio in combination with the agreements between
the credit facility and the originator, in order to consider their opinion on the execution value.
61
Baum, A. (1989)
See: http://www.dnb.com/nl/ and http://www.graydon.nl/
63
Geltner, D. (2001), p. 451
64
Geltner, D. (2001), p. 452
65
Prospectus analyses
66
Geltner, D. (2001), p. 452
62
24
24
Apart from that the LTV ratio at the end is important. Imagine a construction with no redemption
during the full period: This will mean full redemption at the end, therefore the exit value has to be
considerable in order to realise the prognosticated indirect return.
3.5 Advantages and disadvantages of a RELP investment
Chapter 2. already provided a clarification of advantages and disadvantages in regard to direct and
indirect property investment. As shown, a RELP has a specific structure and its own characteristics.
These can be translated into several advantages and disadvantages compared to direct and indirect
property investment:
Advantages
Disadvantages
Property investment with characteristics of
Specific knowledge required;
direct as well as indirect property investment;
Low liquidity;
Investment in possibly interesting properties;
High additional costs;
Relatively stability of value;
Imperfection of information;
Accessible for ‘smaller’ investors;
No definitive regulations / supervision;
Limited liability;
Limited say on management issues;
Tax transparency (tax rate is nil);
Transferability (none or limited);
Possibility to diversify portfolios;
No diversification in one single RELP;
Economic ownership is obtained by investor;
Possibility of unreasonable performance
Average risk / return profile;
fees for originator;
Transparent cost structure;
Possible alliances;
Availability of professional management;
No historical data available.
Hedge against strong movements in inflation rate;
Average excitement rate.
A RELP investment is an interesting opportunity to invest in real estate because of the beneficial
similarities in regard to direct and indirect property investments. Although there are some important
disadvantages as showed above, these are mainly the same in regard to direct property investment.
Nevertheless they are considerable in regard to risk. The current popularity of RELPs is the
consequence of continual low returns on fixed-interest securities and shares, combined with an
enormous savings-balance.67 Considering the characteristics of a RELP (primarily limited liability and
tax-transparency combined with the accessibility), this type of investment becomes extremely
interesting. Continuous historical high returns in the property market as a whole strengthen the
demand.
67
AFM (2005), p. 4
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4. Problem analysis
4.1 Introduction
o
With reference to all previous chapters, under mentioned analysis has been conducted in order to
provide a clarification of problems. The analysis is focused on problems from an investor’s
perspective, however all concerned with this matter are taken into account, namely: Investors;
Originators; and the AFM.
Unlike research as conducted by the AFM, this research is fact-based rather than desk-based.
etween
The problems have been divided into several main areas, however there is a strong connection between
as
all of them and where necessary this connection is clarified. The areas as a result of the division as
mentioned above are:
Target group and originators;
Structure of a RELP;
Initial value of the property;
Additional costs;
Exit value of the property;
Supervision and regulations;
Incomparability of prospectuses;
Imperfection of information;
Sensitivity of variables and;
The risks.
The results of the analysis are described for each area as mentioned above.
26
26
4.2 Target group and originators
As known the first RELP available for private investors is originated in 1999. Since then the market for
RELPs has grown significantly and the trend continues. At the moment there are over 60 originators68
active in the market and many investors are willing to invest in RELPs. Among others, the AFM
spotted this trend and showed her concerns on this evolvement, due to the non-transparency and the
lack of knowledge.69
Due to the non-transparent characteristics of the property market in general and the RELP market in
particular, it is not wishful to encourage accessibility for a wider public. Although RELPs are an
interesting way to diversify investment portfolios due to their lower required amount of capital and
specific characteristics, the property market becomes accessible for those with less capital. The latter
causes anxiety, because it is assumed that those with less capital have less knowledge about the
property market, especially in regard to direct property investments, whereby a RELP has strong
characteristics of direct property investments. In terms of the AFM, the knowledge-asymmetry70
between originators and participants is considerable. This is a serious problem due to the fact that the
potential participant relies on the information as provided by the originator. It requires specific
knowledge to see through bright looking forecasts. The latter is strengthened by the fact that the
prospectus is a marketing tool as well as a legal document, as will be explained in further detail later.
RELPs become available for a wider public, not in the last place due to the marketing-strategy of the
originators. Around 1999 RELPs were marketed by issuing houses and in most cases only available for
a select group of clients and institutional investors. Nowadays they are available for everybody with
little capital compared to the capital required for direct property investments. Due to advertisements in
general newspapers and on television it is assumable others then those with knowledge on property
investments are excited. This group needs to be protected, because it is impossible for them to make a
deliberate judgement based on the information provided by the originator (with little exception).
Like on any other market, demand creates supply. This is also the case for the RELP market. Many
investors are willing to invest in alternatives, for example RELPs, because of continual low returns on
fixed-interest securities and stocks, combined with an enormous savings-balance.71 Considering the
characteristics of a RELP (primarily limited liability and tax-transparency), this type of investment
becomes extremely interesting. Continuous high returns in the property market strengthen the demand.
The demand could easily be decreased by changing the tax-regulations on RELPs, with possible
taxation in Box 1 (up to 52.00% instead of 1.20%). However, this is strongly not recommended due to
the fact that the RELP is a very interesting investment vehicle, especially in regard to tax-transparency,
limited liability and diversification. The increasing demand is a great stimulator for professionalizing
the RELP market. As said before, demand creates supply. The RELP market is growing rapidly and so
is the supply. The experience of some originators is doubtful and often questioned due to the fact
68
Hentenaar, R. a.o. (2005), pp. 35-78 note: not all of them are originators of RELPs, some of them are originators of similar
real estate syndicates. More than half of them are originators of RELPs, however the increase in the market is also noticeable on
other products. Besides that a trend is seen by former originators of partnerships, who became originators of limited
partnerships. Therefore all of them are interesting as originators for the subject of this paper.
69
AFM (2005)
70
AFM (2005), p. 4
71
AFM (2005), p. 4
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thout
RELPs are seen as fee-driven products, whereby it is possible for an originator to gain profit without
e
further interest in the RELP or its results. This is a strong type of abuse and there are no reliable
e quality
indications if this is present, therefore this will not be assumed. On the contrary it is obvious the quality
uate the
of suppliers is diverse. This issue explains another problem, because of the impossibility to evaluate the
f an
quality of new originators without a track-record. It is extremely hard for an investor to decide if an
eds to
originator is trustworthy, based on information provided by the originator. On the contrary it needs to
eserve
be said that any investor focussed on prognosticated returns and neglecting the risks does not deserve
any compassion or self-pity.
up is a
Changes in numbers of originators and investors, combined with a broadening of the target group is a
fer to
sign of the improving maturity of the RELP market. Followed upon this, the market needs to refer to
f self-
this as a serious problem relating to further professionalization of the RELP market. The lack of self-
er.
regulation as well on the side of the investors as on the side of originators is crucial in this matter.
her
Although self-regulation by investors is wishful, it is not a priority. For the originators on the other
heat.
hand, it is crucial if they want possibilities to evaluate quality and separate the chaff from the wheat.
4.3 Structure of a RELP
gal and
A number of problems occur due to the decision to structure the investment as a RELP. Both legal and
as
fiscal regulations are important. Besides advantages, like limited liability and tax-transparency, as
o the
discussed in the previous chapter, there are several disadvantages (read: problems) connected to the
structure of a RELP.
In order to benefit from tax-transparency (Box 3 taxation), a RELP needs to be referred to as
ld be
transparent by the Dutch tax authority. In order to realise the latter, the investment vehicle should be
nd
structured as a closed-end investment fund, as meant by Dutch legislation. However, a closed-end
non-
investment fund implies illiquidity from an investor’s perspective due to the fact that shares are non-
known
transferable. The AFM refers to this as the so called lock-in risk:72 An investor invests for an unknown
s more
period of time, though with the thought of approximately seven to ten years. The lock-in risk has more
xed
in it than that, while it is also strongly connected to the credit facilities. Several RELPs use a fixed
ure the
interest rate for say five years. After this period a new credit facility is necessary in order to secure the
ould
existence of the RELP. Based on several reasons (i.e. decrease in rental income) any financier could
na
decide to no longer procure credit. In the worst case this results in a forced sale of all property in a
ulations
tense market with low demand. Besides that it is extremely important to agree with the exit-regulations
he sale
as held by the RELP. In general it can be stated that it is impossible to ‘exit’ the RELP before the sale
t.
of the property, due to strict regulations and the necessary written permission of each participant.
roperty.
In most cases the Trustee needs some sort of agreement by the participants in order to sell the property.
co-
For a participant this could mean that he does not agree with the sale, however he is obliged to co-
riorities
operate. At the end of a RELP conflict of interests arises and it is important to be aware of the priorities
and interests of the Trustee.
72
28
AFM (2005), p. 33
28
4.4 Initial value of the property
As mentioned before in this paper it is hard to valuate property, especially for private investors whom
not have the resources like institutional investors. Imperfection of information is subject to this issue,
as will be clarified later. Considering RELPs another problem occurs, while the so called ABCtransaction is often used in order to pre-finance the property. Pre-financier ‘B’ often receives
compensation which is exceedingly, resulting in ‘C’ paying a price which is not in accordance with the
market. The latter is strengthened if ‘B’ already paid ‘A’ a price which is not in accordance with the
market.
In regard to RELPs it is common that ‘B’ is the originator whereas ‘C’ is the RELP. In some cases ‘A’
is allied to ‘B’, which makes the whole transaction untrustworthy and doubtful. An investor has no
opportunity to investigate this matter in depth, while all information on transactions is kept confidential
and is non-transparent. It is possible to investigate transactions by cadastral research, however this
requires knowledge of the Register of real property (het Kadaster i.D.) and is not sufficient, while the
register ignores alliances.73 Originators do not recognise this problem, while their opinion is that the
mortgage provision can be seen as a second taxation on the value of the property. Besides that ‘the
margin is nil’.74 The latter is doubtable due to the existence of ABC-transactions and it can be stated
that the initial value is extremely important and sensitive for possible abuse.
4.5 Additional costs
Besides the fact that the valuation problem and the existence of ABC-transactions could increase the
price of the property, there are also several additional costs connected to initiate the investment.
Structuring an investment vehicle as an LP requires a higher investment as when there is a direct
investment. Research shows that RELPs add approximately 6.50% to the purchase price including
purchase costs which would also be relevant in case of a direct investment.75 These additional costs are
necessary in order to pay the structuring of the RELP and are used to pay for example registrations,
marketing, credit facility, consultants, a notary and a lawyer. The differences in additional costs per
originator are significant. Besides that almost every originator requires 3.00% of the amount of
participation as issuing costs, which goes to the originator as compensation instead of the RELP in
almost every case.
The real problem in regard to additional costs is directly related to the exit value of the property. These
additional costs need to be compensated, either by the direct- or indirect return. An increase of the
additional costs results in an increase of the time before the break-even point is reached. Another
problem here is the issue if the originator is or is not sharing in the risk. When an originator gains profit
at the moment of initiating the investment fund, there is no further financial stimulation. It is often said
that it is not fair to gain profit at the initiating phase, because the real work and the real risks have not
73
http://www.kadaster.nl
75
Prospectus analyses
74
29
ENWICH
started yet. Research shows that in some cases the compensation has no relation to the risk an
originator takes.76
y after
Besides the issue with the additional costs, there is an issue with the operational costs, especially after
ovide
completing the formation of the RELP. Upcoming (improved) legislation obliges Trustees to provide
will be
information on the operational costs during the total life-period of the RELP. This information will be
based on the calculation of total expense ratios.
to be in
Additional costs are reasonable due to the characteristic of the investment. However, they need to be in
he risk
correct proportion with the expected total return. Any fee need to be in correct proportion with the risk
s.
as taken by the receiver of that fee and expenditures and costs need to be transparent at all times.
larified.
Above all that any possible alliances between the originator and other fee-receivers need to be clarified.
4.6 Exit value of the property
al costs
Another major issue in RELP investments is the exit value. In order to compensate the additional costs
in which
investors make, a high exit value is important. It is possible the direct return is not satisfactory, in which
Previous
case the indirect return is extremely important in order to realise the prognosticated total return. Previous
research shows that the indirect return is often 50.00% of the total return, which is significant.77
sted
Prognosticating valuation schemes are used to estimate the operating result, based on the forecasted
mate the
rental income. The operating result and especially the forecasted rental income are used to estimate the
y
exit value. The latter is unreliable, while the operating result and the rental income rely on many
The
uncertain variables. Therefore the prognosticated exit value relies on many uncertain variables. The
he key
exit value is based on a simplistic formula, as explained in chapter 3., wherein the exit yield is the key
e,
factor. Several originators use three scenarios with different exit yields to estimate the exit value,
he
however they rely on their own prognosticated operating result. Besides that the exit yields for the
or
separate scenarios are not suitable, where the difference between optimistic and pessimistic is for
example 1.00 over a period of ten years.78
03
Net initial yields relating to offices in Amsterdam for example, fluctuated between 1990 and 2003
between 6.30% (1990) and 6.08% (2003), with the outliers 7.20% (1993) and 5.85% (1995).
e
Net initial yields in London West End ranged between 6.50% (1990) and 5.25% (2003), with the
n
outliers 6.50% (1993) and 4.75% (1997). 79 The difference in the approximate NIY for offices in
years.
Amsterdam over a period of thirteen years is highly 1.35% over a period of no longer than three years.
GIYs are related to NIYs, although the use of reliable variables is even more important in NIY
Ys.
appraisals.80 However, the fluctuation as shown above for NIYs could easily be the same for GIYs.
d the
Therefore it would be more appropriate to use a significant difference between the optimistic and the
regard
pessimistic yield. Over ten years of time a difference of say at least 2.00 is more appropriate in regard
76
Prospectus analyses
Hoedjes, M. (2004), p. 31
78
For example see the prospectuses of: Annexum invest, Schild Holland Fonds, Select Real Estate and SIG
79
Berkhout, T. a.o. (2004), p. 7
80
Rust, W. a.o. (1995), p. 176
77
30
30
to forecasting sale scenarios, while it is depending on the prognosticated and unsure rental income in
the future and the difference of 1.35% as mentioned above is appropriate as an overall average.
Another problem occurs in regard to the exit yield, because strangely several originators use the same
or even a higher exit yield compared to the initial yield. It is expected that the exit value of the property
is lower then the initial value, because of depreciation. Inflation can raise the absolute value of
property, however this is already taken into account due to indexation of rental income. In some cases
an originator uses even a pessimistic exit yield which is already higher then the initial yield.81 Besides
that it is important to be aware of the fact that the duration of the rental agreements are considerably
less and it is uncertain if the agreements will proceed. A building with a high vacancy rate is worth
less. The duration of rental agreements is often similar to the expected duration of the RELP.82
Due to all uncertainties around the exit yield and prognosticated indirect returns and their high
influence on the overall return, it would be better to use no (prognosticated) exit yield at all in
appraisals. In Germany this is already usual and it is recently introduced in The Netherlands by a from
origin German originator, MPC Capital.83 In this case only the direct return is mentioned and any
possible indirect return should be seen as a bonus. It can be expected this trend will continue, while
several professionals already mentioned this could seriously improve the quality and trustworthiness of
the market.84
Obviously, problems in regard to the exit value increase if problems in regard to the initial value occur.
4.7 Supervision and regulations
One of the main issues as described in the report of the AFM is the current supervision and upcoming
changes in regulation. This paper has discussed the upcoming changes and will focus here on the
meaning of those and their possible effect.
The current investors market visualizes a wrong image on the role and responsibilities of the AFM. Not
every RELP is supervised by the AFM, and besides that not all prospectuses are controlled either.
Since the 1st of July 2005 the Prospectus Guideline (Prospectusrichtlijn i.D.) is active and obliges
closed-end investment funds to provide a prospectus, which is controlled by the AFM on
comprehensibility, consistency and completeness. However, the prognosticated returns are still
sensitive for window-dressing and this has not changed by the new Prospectus Guideline. Besides the
guideline, the overarched legislation is subordinate to changes and the content is still not clear.
However, recently (1st of September 2005) the so called Decree Supervision investment funds (DSi)
(Besluit Toezicht beleggingsinstellingen i.D.) has been put into operation. The most important change
is the fact that the AFM no longer provides a license to the RELP which is withdrawn after formation,
but to the Trustee with no withdrawal at all. The Trustee is under continued supervision by the AFM
81
For example: Select Real Estate
Prospectus analyses
http://www.gub-analyse.de and MPC Holland 58 CV
84
82
83
31
ENWICH
tal
and is obliged to provide an annual report as well as periodical results to the AFM, including total
er to
expense ratio’s. Apart from that the RELP is controlled each year by an extern controller in order to
he
evaluate the investment. As the regulation becomes more extensive, so are the exemptions. If the
amount of participation exceeds € 50.000,00 the RELP is exempt. If the number of available
vestment
participations is no more than 100, the RELP is exempt. Although legislation on closed-end investment
funds is improving, there is still space for creativeness of originators, which should be seen as
untrustworthy and this is of course not wishful.
on on
Recent research shows 67.00% of the Dutch private property investors wish for more supervision on
ency.
the RELP market. In their opinion there is too much uncontrolled growth and too little transparency.
eady
Besides that the quality of the property itself is often doubted. The other 33.00% thinks it is already
:
enough and an investment is the own responsibility of an investor.85 The latter is a crucial issue:
When does their own responsibility end?
At the moment the answer to that question is doubtful, due to the fact that the regulation is not
is still
described in full yet. Besides that the first RELP open to a wider public is initiated in 1999 and is still
port the
running. The AFM expects serious problems if the first RELPs will end with losses. In their report the
asons to
‘Legio-lease affaire’ is mentioned as a comparison, although this is overdone there are some reasons to
et.
expect problems. Not in the last place due to all the attention at the moment for the RELP market.
Besides that it is possible that some information could be seen as deceptive, especially in older
s at the
propositions where the regulation was less extensive. The AFM has not received any complaints at the
moment, however they cannot form an opinion about their expectations due to their task as
supervisor.86
vements
Current supervision is improving as well as legislation on this subject, however the final improvements
are still unsure and directly related to other legislation, which are changing as well.
ield of
Although legislation for RELPs as meant in this paper is changing, most changes occur on the field of
D.).
the closed-end investment funds operating as ventures rather than investments (Wte fondsen i.D.).
he
Expectations on running RELPs ending with losses are plausible, but not in all cases. Perhaps the
The
ending of an RELP with losses could support the reforming of legislation by way of a test-trial. The
nwanted.
latter could mean a spill-over effect on other parts of the property market, which of course is unwanted.
4.8 Incomparability of prospectuses
hen is
Firstly, originators use many different terms to present their product. It is hard to understand when is
anings.
meant direct return, for example. It is also common to use the same term, but with different meanings.
In one prospectus operating costs includes finance costs, but not in another prospectus.
he same
Secondly, different valuation methods are used by originators for their appraisals. Here again the same
hase
terms are used, but with different meanings. GIY for example; sometimes in regard to the purchase
make it
price, another time in regard to the total investment and yet another time as NIY. Both issues make it
is
extremely hard to compare several prospectuses. The latter is even harder if not all information is
85
86
32
Troostwijk (2005), p. 32
32
available in the prospectus. The second issue, differences in valuation methods, is the most important.
Investors are attracted by prognosticated returns, when two separate originators use the same term for
return and one is significantly higher, an investor is likely to prefer that type of investment. Hence it is
recommendable for an investor to see through forecasted returns and compare those returns by using a
self-made valuation scheme. However, this requires knowledge and time and therefore might be
disposed by investors.
Originators are capable in using several (complex) valuation methods and it does not need any
explanation that they will use the method which presents them the best. This does not mean they will
use the method with the highest return, hence it has to be seen in a wider perspective. The analyses
which have been conducted in regard to the prospectus analyses clarified that the chosen method is
often the one which camouflages those negative aspects which are not average and specific for the
RELP. Therefore the reliability is doubted again and besides that intentional use of such windowdressing practices could be described as abuse in some particular cases. It is hard to name a certain
RELP which could be accused of abuse, because all assumptions are based on subjective opinions. In
general it can be stated that the prospectus is sensitive for eventual abuse, especially in the form of
window-dressing. This issue is explained by the fact that the prospectus is a marketing tool as well as a
legal document. Combined with the imperfection of information this is a serious problem.
4.9 Imperfection of information
As mentioned before, the prospectus is a marketing tool as well as a legal document. Although the
Prospectus Guideline (Prospectusrichtlijn i.D.) obliges the insertion of a number of issues (i.e. a risk
paragraph), there is not much regulations on the actual implementation of those issues. Originators
have a lot of freedom on this actual implementation and layouts of, for example valuation schemes.
Apart from that it is obliged by Law to provide those whom are interested in the investment fund a so
called Financial Leaflet (Financiële Bijsluiter i.D.). The latter is often not more than two pages which
describe the investment and its risks in general.
The property market in general is known for its imperfection of information and for those involved in
this market it is nothing new. However, an investment fund like a RELP makes the market accessible
for a new type of investors. Due to the lower required amount of participation the property market is no
longer restricted to investors with a large amount of capital. The market is open for a new target group,
as described before.
Another issue in regard to the imperfection of information is the fact that it is not possible to access
information on running RELPs, except for participators in that specific RELP.87 In other words, there is
no historical data available in order to compare. Information on ended RELPs is available in the form
of a track-record, which is provided by the originator. The RELP market is as transparent as the general
property market, with the distinction that the RELP market is accessible with less capital. The latter is
87
Own research: By purpose of this paper information has been requested by 8 different originators. 6 of them replied that this
kind of information is only provided to participators in that fund, 2 did not reply at all.
33
ENWICH
o
the reason for the importance of information, preferably by others then the originators in order to
are two
realise some sort of knowledge database, based on objective information. At the moment there are two
initiatives, namely:
Fundview (Idem i.D.) and;
Property Profit Meter (PPM) (VastgoedrendementsMeter i.D.).88
or of
The first is sometimes called subjective in the market, while it is an initiative of a former director of
ndview
MPC, an originator of RELPs. However there is no direct connection anymore and therefore Fundview
of
should be seen as an interesting method to compare several RELPs. The second is an initiative of
ective,
‘Adviesgroep Reyersen van Buuren’, an issuing house for investment funds. PPM is partly subjective,
005) it
but mostly objective and has great potential, however due to its short existence (since January 2005) it
judge
is not suitable as a benchmark yet. It is worth mentioning that it is a helpful tool for investors to judge
ke
several RELP propositions with the possibility to change variables and measure the effect. Unlike
and
Fundview, the PPM is free and easy to use. Besides that the PPM is mainly focused on RELPs and
ment
responds quickly on new supply, while Fundview is focused on all closed-end real estate investment
d that
funds, whereby the amount of available fund reviews cannot be called extensive. It can be stated that
ated
there is still need for a solely objective benchmark in the form of a tool to re-valuate prognosticated
se this
returns, supported by a database filled with general and specific historical data. In order to realise this
ing
investors should have access to information on the results of running and ended RELPs. Upcoming
ults to
changes in legislation might support this, while RELPs will be obliged to provide periodical results to
d the
the AFM. If investors will be able to benefit from this change is unknown. An originator89 stated the
ovided
provided information is ‘already more than enough,’ especially compared to the information provided
sparent,
by any company listed on the Stock Exchange. Therefore RELPs could be characterised as transparent,
ed, not
especially in regard to the clarification of expenditures and costs. These statements can be argued, not
es that
at least due to the fact that the prospectus is a marketing tool as well as a legal document. Besides that
fair,
the results of a listed company are easily accessible. The AFM90 adds that the comparison is not fair,
many
because the market for listed shares is extremely transparent in regard to information. There is many
sary to
objective (analyses) as well as subjective (opinions) information available. Therefore it is necessary to
e latter
provide more information about the RELP market and not about the market for listed shares. The latter
at the
is probably necessary due to the fact that the RELP market is relatively young. It can be said that the
ard to
structure itself of a RELP is more transparent than those of any listed company, however in regard to
information (especially after the closure of participation) this is not the fact.
4.10 Sensitivity of variables
ough
Prognosticated returns are based on many underlying variables. Each variable is forecasted, although
d.
not clarified in every prospectus. Besides that some interrelated variables are not always clarified.
y the
An investor needs to be aware of the sensitivity of those variables and their reliability. To clarify the
ch has
sensitivity of variables used in valuation schemes it is interesting to see the results of a test which has
rest
been conducted primarily for this paper: The effect of the LR on the return by changing the interest
rate. The results are shown in the following figure.
88
http://www.vastgoedrendementsmeter.nl , http://www.fundview.nl
90
89
34
34
Figure 4.1: Effect of LR and interest rates
The results are shown above are reduced to a formula, namely:
Effect on return = ( 1 – LR ) * ic
‘LR’ is the leverage ratio, as described in chapter 3., whereas ‘ic’ is the change in the interest rate. The
LR level and the interest rate are just one of many interrelated variables which are used in valuation
schemes. Valuation schemes as used to prognosticate returns in prospectuses are mainly relying on the
following variables:
Initial value; rental income; occupation (vacancy); indexation of rental
income and expenditure; interest rate and redemption; operational costs;
fund costs; management fee; exit yield; performance fee; liquidity reserve;
issuing costs and; taxation.
Because the effect of each variable on the prognosticated return it is wise to change those variables to
exam their effect on the return (i.e. by using the PPM). Investors need to be aware of the importance of
each variable and the reliability of the assumption as used in the valuation scheme.
In order to assist the investors it is wise to mention this fact and to provide sensitivity analysis in the
prospectus. Resistance from originators is expected, because this will affect their prognosticated return
significantly. The benchmark tool to re-valuate as discussed before could be useful in order to solve
this problem as well. Assuming such a tool will be developed soon it would be helpful if the variables
(initial value; rental income; etc.) were stated separately in prospectuses, for example in an appendix.
An investor could easily use these variables for his own appraisal and valuation. The clearness of
variables is important, because as they are clearer the investor is more able to compare and evaluate
those variables.
35
ENWICH
nal
The consciousness of an originator in using unreliable assumptions, combined with the intentional
provision of unclear variables is a possible way of abuse.
4.11 The risks
ated to
Every investment consists of several risks. As explained in chapter 2. those risks have to be related to
the possible return. Risk is not a problem, on the contrary; it should be seen as a positive issue.
However, many people relate risk to negative results and danger.
rty
A RELP investment knows a certain number of risks, of which some are similar to direct property
not a
investments and some are specific for RELPs. Both risks (as discussed in chapter 2. and 3.) are not a
t on the
problem, as long as the investor is aware of those risks and able to make a deliberate judgement on the
hensive,
investment proposition. Hence the information as provided by the originator should be comprehensive,
ave
consistent and complete (in terms of the Prospectus Guideline). Therefore an investor should have
other
considerable knowledge about property investments and be able to understand the risks. On the other
ph’ in
hand the originator is obliged by the Prospectus Guideline to include an extensive ‘risk paragraph’ in
the prospectus in order to clarify the risks involved with the investment. The reliability of the
nable
prospectus is relying on the intention of the originator. Therefore it is questionable if it is reasonable
o
that the prospectus is a legal document as well as a marketing-tool. Perhaps it would be better to
e a lot of
distinguish both, although an originator would resist this while consequently there would not be a lot of
space to distinguish his proposition from one another. The current lay-outs of prospectuses (as
efore the
analysed) are not satisfactory, due to their incomparability as discussed before. As addressed before the
matter.
issue ‘own responsibility’ in regard to an investor is extremely important and sensitive to this matter.
of the
The Financial Leaflet could be more extensive to provide the information as necessary, instead of the
prospectuses which could sometimes be seen as a maze and act deterrent.91 On the other hand,
ce to
upcoming legislation supervises the prospectus to a greater extent, possibly with the consequence to
o make a
become more understandable and objective. The main issue is that an investor should be able to make a
deliberate judgement under any circumstances. Based on all problem issues as described in this
chapter, the next chapter will provide clear conclusions and strong recommendations.
91
36
Prospectus analyses
36
5. Conclusions and recommendations
This chapter will provide clear conclusions based on the information as provided by all preceding
chapters, especially in regard to the problem analysis (chapter 4.). Besides that several strong
recommendations towards the investors, the originators and the AFM will be given at the end of this
chapter.
5.1 Conclusions
A number of five main conclusions can be drawn due to this paper, namely:
1.) Property investment is complex and requires considerable knowledge.
As shown by this paper property investment is not simple. Market imperfection, the scarce of data
available and the several local markets are only a few characteristics of the property market which must
be seen as the reasons for this fact. An investor needs considerable knowledge, in general and in
particular, in order to be able to make a deliberate judgement on investment propositions in the
property market. Therefore it is important to recognise that investing in RELPs is not suitable for any
investor with capital available that equals the amount of participation in a specific RELP.
2.) A RELP is an interesting investment in order to diversify an investment portfolio on the
understanding that is used in the right way.
Investments are basically concerned with risk and return, related to demand and supply. In order to
effect the relation between risk and return in an investment portfolio positively, it is necessary to apply
diversification; it is not wise to lay a bet on one horse. Compared to other investments, like shares as
listed on the Stock Exchange, property is an excellent hedge against inflation and other fluctuating
movements on the capital markets. Therefore property is often seen as an excellent way to diversify
investment portfolios. However, the characteristics of property as discussed (chapter 2.) require
considerable knowledge and direct property investments require a high amount of capital, due to their
high prices per unit. On the contrary there are indirect property investments, which require far less
capital but these behave more like regular shares. As shown (chapter 2. and 3.) a RELP could be seen
as a mixture of direct and indirect property investment, whereby an investor could benefit from the
characteristics of a direct investment (i.e. hedge against inflation) as well as from those of an indirect
investment (i.e. less capital required). However, a RELP is a specific type of investment which
requires specific knowledge. Due to the imperfection of information it is extremely hard to make a
deliberate judgement, especially for investors whom are not familiar with property investment. This
specific group has access to the property market by way of investing in a RELP and it is important to
protect those against possible abuse and issues like window-dressing (chapter 4.). An investor should
never base his decision solely on information as provided by the originator, due to the subjectivity of
that information.
37
ENWICH
cle,
3.) The specific (legal and fiscal) structure make the RELP an interesting investment vehicle,
or new
however the property market becomes accessible for a new target group and interesting for new
originators. At this moment this is worrying.
ed
A RELP must be seen as a closed-end investment fund as meant by the Dutch Law. The invested
capital exists of equity and debt, hence there is leverage (chapter 3.). Due to the legal and fiscal
es an
structure of a RELP the investors have limited liability, whereby the tax-transparency guarantees an
ual low
effective tax-rate of 1.20% (nil). The current popularity of RELPs is the consequence of continual low
d
returns on fixed-interest securities and shares, combined with an enormous savings-balance and
s
strengthened by the historical returns of property investments. As on any market demand creates
ntrary,
supply. Considering the size of the RELP market it can be said this market is mature. On the contrary,
he
considering the current situation on the market and legislation, the market is far from mature. The
e and
market is non-transparent, there is no historical data and the availability of information is scarce and
etween
often subjective. In regard to the originators there are many signals that there is a lot of chaff between
separate
the wheat (chapter 4.). From an investors perspective it is extremely hard (if not impossible) to separate
kes it
the chaff from the wheat, i.e. recognise illegitimate use and possible abuse. New legislation makes it
he
possible for the AFM to supervise the market in a better way, although it is necessary to avoid the
g
existence of fictive security. Therefore it is time for self-regulation, as described later as a strong
recommendation.
the
4.) The market is increasing. In relation to size it becomes mature, however in relation to the
professionalism of the market it is far from mature.
m all
The problem analysis (chapter 4.) as conducted for this paper explored the market in depth, from all
es show
perspectives. As a result, there are found ten major issues. The problems surrounding these issues show
ive
that the market is far from mature and that it is possible that the market will suffer from a negative
ues are
image as a result of its non-transparency and connections to possible illegitimate use. These issues are
ve
all sensitive for possible abuse and every doubt should be taken away in order to create a positive
ying,
image and a stable market environment. The change in the target group and originators is worrying,
non-
especially because of the knowledge-asymmetry between the originators and the investors. The nontransparent character of the RELP market in specific and the property market in general are not
beneficial in this case. New initiatives in regard to self-regulation are expected, however recent
us on the
initiatives are not sufficient because they do not recognise the issues as a whole, but solely focus on the
etween
information provision in regard to valuation data. It is important to recognise the interrelation between
all issues, as clarified by this paper (chapter 4.).
5.) The problem analysis clarified ten major issues, surrounded by several problems.
These problems are interrelated to each other and there are several (too much) possibilities to
es to
abuse the RELP.
e
The ten major issues are: Target group and originators; Structure of a RELP; Initial value of the
bility of
property; Additional costs; Exit value of the property; Supervision and regulations; Incomparability of
prospectuses; Imperfection of information; Sensitivity of variables and; The risks.
38
38
These issues are not described again in regard to content, because this is done extensively in chapter 4.
In this section it is more useful to conclude the fact that they are there and focus on a possible solution.
It is important that the market focuses on a complete solution instead of improving small parts of the
market, i.e. a new online valuation tool. Therefore those involved in the market need to co-operate in
order to solve all ten issues as described in this paper.
Therefore a number of strong and realistic recommendations will be provided now.
5.2 Recommendations
A starting point for all groups involved (investors, originators and the AFM) should be:
‘Improving the RELP market in order to create a professional sub-market. This sub-market must exist
and operate in a stable and trustworthy environment. Therefore it must be made easy to distinguish
between the use and abuse of a RELP. Consequently, there will no longer be place for abuse.’
In order to realise this, all issues as discussed in chapter 4. need to be recognised and be improved.
Therefore the market (investors, originators and the AFM) is strongly recommended to:
Initiate a sector association which aims to improve and guarantee the professionalism of the
RELP market. In regard to the association, objectivity is extremely important. Therefore there
may not be any alliances between the association and originators of RELPs. It is preferred that
the initiators are private and / or professional investors whom have proven their selves in the
property market. The IVBN, ROZ and Vastgoed Belang are three possible organisations for
the implementation of this idea, supported by the fact that they are already involved in the
market and acknowledge the fact that self-regulation is absolutely necessary.
The association has to initiate a Code of Practice (CoP) for RELP originators as well as a
control mark for certification. The latter should be provided to the understanding that an
originator works by the regulations as set in the CoP. The control mark is not provided to a
RELP, but to an originator and hence, indirectly to the RELP itself. By this way the
originators have the necessary freedom to originate new funds and initiatives. Hence,
periodical testing is necessary. In order to avoid resistance from the originators or the AFM
the CoP should be designed in close co-operation with the originators and the AFM. Besides
that, the investor needs to recognise the association, otherwise it has no sense for an originator
to work by the CoP. Therefore the association needs to convince the investor of its importance
in close co-operation with the AFM, especially in regard to the new target group as described
in this paper, because they cannot make a deliberate judgement on their own.
39
ENWICH
The CoP should contain regulations on all fields, including especially the problem issues as
sues as
a result of the research as conducted for this paper. The main idea should be that the
originators will use the same terminology and a standardized appraisal method with
all
recognition of the time value of money. Apart from that the originators should provide all
.
assumptions and variables (as discussed in chapter 4.) in an appendix of the prospectus.
egard to
The association could advise the AFM about the quality and realism of the content in regard to
he
the provision of a license. Above all, the indirect return should no longer be shown in the
prospectus and must be seen as a bonus (if the sales result is positive).
st
If possible, the CoP should contain limitations in regard to the additional costs and must
ver.
clarify that any fee needs to be in correct proportion with the risk as taken by the receiver.
o
Regulations on all fields mean that the CoP must act as an overarching guide in order to
erefore
guarantee the trustworthiness of the RELP market instead of ad-hoc improvements. Therefore
but to
it is important not to focus on the basic and known issues, i.e. prognosticating returns, but to
n tool
see the problems in a wider perspective, as discussed by this paper. Just a new valuation tool
on and a
or a form of certification is not the solution, whereas the initiation of a sector association and a
CoP is the long-term solution
The CoP should also focus on the realisation of more transparency, especially in regard to
ard to
running RELPs. The latter is possible due to new legislation in regard to the AFM as
ary
discussed in chapter 3 of this paper. In this way the association has access to all necessary
e should
data, which need to be stored in a database in order to obtain knowledge. This database should
ries if
be (partly) accessible for the investors either directly or through specialised intermediaries if
out the
necessary. Besides that it is important that the originators provide more information about the
e less
purchase of the property. By making this process transparent ABC-transactions become less
t the
possible and the investor has more possibilities to control the taxation. In order to assist the
omes,
latter it is wise to provide information on one or more similar properties and rental incomes,
by which the investor can make a comparison.
tinction
The originators need to standardize their prospectuses, in order to provide a clear distinction
to the
between a legal document and a marketing tool. Standardization becomes possible due to the
he
CoP and it is advised (especially to the AFM) to undertake further research to clarify the
meant
possibilities of an extension of the Financial Leaflet in order to help the distinction as meant
ll
before. An ideal situation would be a Financial Leaflet as a legal document, and a small
prospectus as a marketing tool.
tly with
As a direct result of the sector association and the CoP the transparency will improve significantly with
sible
the consequence that the market becomes more trustworthy: All possible issues in regard to possible
be
abuse are reduced to an absolute minimum. A professional and stable market environment will be
created for an interesting investment vehicle, the RELP.
cated
Therefore it is important not to focus on the basic and known issues, i.e. deception in prognosticated
luation
returns, but to see the problems in a wider perspective, as discussed by this paper. Just a new valuation
40
40
tool or a form of certification is not the solution. This paper discovered the ten major issues and
showed the interrelation of these issues and the related problems. Therefore these ten issues should be
taken into account as a whole instead of one by one. There is one way to realise this, namely the
initiation of a sector association and a CoP as recommended by this paper.
Because the initiation of a sector association and a useful CoP are time-consuming processes, five
recommendations have been made towards each group, which should (could) be taken into account
immediately. These recommendations for the short-term are described next.
The investors should:
(a) Realise that investing in RELPs requires specific knowledge and be aware of the specific risks
as described in this paper. If necessary they need to consult a specialist and use analyses as
provided by the PPM or FundView in order to make a deliberate judgement;
(b) Analyse the assumptions in order to become aware of the specific risks of each investment
proposition;
(c) Use the variables as mentioned in chapter 4. in their own analysis and pay specific attention to
the initial value, the LR and the interest rates;
(d) Realise that the exit value is uncertain, therefore they need to see the indirect return as
a bonus and focus on the direct return;
(e) Never invest in one single RELP in regard to diversification;
The originators should:
(a) No longer provide prognostications on the exit value and indirect return in their prospectus;
(b) Provide access to all available information about the purchase, including information on
similar properties;
(c) Provide access to information on running RELPs, at least to the AFM although it is preferred
this data becomes accessible for the investors;
(d) Provide all assumptions and variables as used in their prognoses in an appendix of their
prospectus;
(e) Recognise the fact that it is time to change in order to avoid serious problems in regard to the
trustworthiness and professionalism of the RELP market.
41
ENWICH
The AFM should:
(a) Encourage the recommendations as suggested in this paper in the market;
sector
(b) Undertake further research or encourage further research in regard to the initiation of a sector
association and a Code of Practice;
al
(c) Undertake further research in regard to the possibilities of distinguishing between a legal
document and a marketing tool in regard to prospectus, by a possible extension of the
Financial Leaflet;
(d) Inform and communicate towards the originators in regard to the upcoming changes in
legislation and use these chances to actually improve the market in co-operation;
o
(e) Be more involved in the market and listen more to the originators, because they have to
implement all possible changes.
d be
The recommendations as described on the previous page are solely for the short-term and should be
taken into account immediately. However, the overall solution as recommended by this paper is
focused on the long-term. In regard to the aims and objectives as stated in chapter 1.:
he
A clear and critical dept-analysis and evaluation of the current situation in regard to RELPs in the
been
Netherlands is provided by this paper. The problems as a result of the conducted research have been
rket is
exposed and upon that several recommendations could and have been made. By this way the market is
on this
encouraged to create a professional and stable market environment. An extensive understanding on this
upon
subject is realised by this paper and the relation between problems and abuse is clarified. Based upon
this paper further research can be conducted by those involved, especially in regard to the AFM.
As a concluding remark:
issue
A number of ten major issues have been found by this problem analysis. Each issue
e
consists of several problems, which are interrelated to each other and therefore
tor
cannot be seen as individual in regard to their solution. The initiation of a sector
a
association and a Code of Practice is the only way to solve these problems as a
o
whole, in an effective and professional way. Due to this solution it is possible to
make a clear distinction between the use and abuse of Real Estate Limited
lution
Partnerships in the Netherlands. Hence a realistic, practical and long-term solution
is provided by this paper.
khuijsen
42
42
List of references
as referred to in this dissertation
(free translation of titles between parentheses)
Autoriteit Financiële Markten, AFM (2005), Vastgoed CV’s en maatschappen: Een verkennende
analyse, April, Amsterdam. (NL)
(Real estate limited partnerships and partnerships: An explorative analysis)
Baum, A.E. (1989), An Analysis of Property Investment Depreciation and Obsolescence, published
PhD thesis, University of Reading, Reading.
Berkhout, T.M., Wouwe, M. van and Tansens, P.R. (2004), Risk premiums in cap rates of investment
property, Research paper in co-operation with MeesPierson Center for Real Estate Investments.
Bol, N.J.T. (2003), Vastgoed als beleggingscategorie. In: Hendriks, C.J.G.M. (2003),
Vastgoedbeleggingen, Kluwer, Deventer. (NL)
(Real estate as an investment category) In: (Real estate investments)
Boom, G. van and Brink, S. van den (2005), Beleggen in vastgoed: Alles over vastgoedfondsen,
Verbum, Laren. (NL)
(Investing in real estate: Everything about real estate funds)
Brett, M. (1989), Characteristics of property, Estates Gazette, 21 January, p. 14.
Butler, D. and Richmond, D. (1990), Advanced valuation, Macmillan Press, London.
Geltner, D. and Miller, N.G. (2001), Commercial real estate analysis and investments, South-Western
publishing, Ohio.
Gool, P. van, Jager, P. and Weisz, R.M. (2001), Onroerend goed als belegging, 3rd edition, WoltersNoordhoff, Groningen. (NL)
(Property as an investment)
Hendriks, C.J.G.M. (2003), Vastgoedbeleggingen, Kluwer, Deventer. (NL)
(Real estate investments)
Hentenaar, R. and Enk, W. van (2005), Onderzoek vastgoedmaatschappen en –CV’s, PropertyNL,
Nr. 7, April. (NL)
(Investigation on real estate partnerships and –limited partnerships)
43
ENWICH
Hoedjes, M.C.H. (2004), Vastgoedmaatschappen en CV’s in Nederlands vastgoed, een
kwaliteitsonderzoek, Dissertation for the Amsterdam School of Real Estate, Amsterdam. (NL)
(Real estate partnerships and limited partnerships in Dutch real estate, a quality research)
Isaac, D. (1998), Property investment, Macmillan Press, London.
Langens, E. (2003), Het aanvangsrendement benaderd vanuit drie verschillende invalshoeken:
NL)
rapportages, theorie en praktijk, Dissertation for the University of Amsterdam, Amsterdam. (NL)
ships in
In: Rooijen, M.A. van and Geertzema, N. (2004), A return analysis of Dutch (limited) partnerships in
real estate, Dissertation for University Nyenrode, Breukelen. (NL)
(The initial yield from three perspectives: reports, theory and practice)
,
Mohr, A.L. (1998), Van maatschap vennootschap onder firma en commanditaire vennootschap,
5th edition, Arnhem. (NL)
(About partnership, firm and limited partnership)
Rust, W.N.J., Seyffert, F., Heijer, A.C. den and Soeter, J.P. (1995), Vastgoed financieel, 2nd edition,
ition,
Vlaardingen, Management studiecentrum. (NL)
(Real estate financial)
Schütte, A., Schoonhoven, P. and Dolmans-Budé, I. (2002), Commercieel vastgoed, Elsevier
bedrijfsinformatie, Berenschot Osborne. (NL)
(Commercial real estate)
ode,
Smit, W. (2003), BAR/NAR methode leidt bij taxaties tot eenduidiger resultaten dan DCF methode,
Vastgoedmarkt, May. (NL)
(GIY/NIY method is more precise in taxations compared to DCF method)
eleggers
Troostwijk makelaars (2005), Het vastgoedbeleggingsbeleid van de Nederlandse particuliere beleggers
2005, in co-operation with the Technische Universiteit Eindhoven. (NL)
(The real estate investment policy of Dutch private investors 2005)
Wiegerinck, E. (2005), Toezicht AFM mag best een stuk strenger, Vastgoedmarkt, February. (NL)
NL)
(Supervision AFM could be closer)
Winter, J. (2004), Rapport commissie modernisering beleggingsinstellingen, December,
Amsterdam. (NL)
(Report commission modernization investment funds)
44
44
Relevant Law
Act of Parliamentary Undersecretary of Finance 19th of December 2000 (Nr. CPP 2000/2157)
Act on the Supervision of collective investment funds (Wtb i.D.)
Bill of the Law for settlement of title 7.13 of the Civil Book of Law (BW i.D.)
Financial Leaflet (Financiële Bijsluiter i.D.)
Prospectus Guideline (Prospectusrichtlijn i.D.)
Regulations (EU) Nr. 809/2004 by date 29th of April 2004
Title 2:175 ad. 1 of the Civil Book of Law (art. 2:175 lid 1 BW i.D.))
All relevant Law can be found by the Government’s database on http://www.wetten.nl or
http://www.minfin.nl (Ministry of Finance)
Websites
Bouwfonds Property Finance
http://www.bouwfonds.nl
Central Bureau of Statistics
http://www.cbs.nl
Dun & Bradstreet
http://www.dnb.com/nl
Euribor rates
http://www.euribor.org
FundView
http://www.fundview.nl
Graydon
http://www.graydon.nl
Güb Analyse (Germany)
http://www.gub-analyse.de
ING Real Estate
http://www.ingrealestate.nl
Inland Revenue (De belastingdienst i.D.)
http://www.belastingdienst.nl
Nederlandse Vereniging Institutionele Beleggers
http://www.ivbn.nl
Property Profit Meter
http://www.vastgoedrendementsmeter.nl
Raad voor Onroerende Zaken
http://www.roz.nl
Rabo Vastgoed
http://www.rabovastgoed.nl
Registry of real property
http://www.kadaster.nl
Vastgoed Belang
http://www.vastgoedbelang.nl
Mr. Drs. G. van Boom
Van Boom & Slettenhaar Real Estate Funds
Mr. Drs. F.L.R. Berends
Youngstreet Residential Funds
Mrs. LLM A. Kaya
Authority of Financial Markets
Mr. M. Denkers
Authority of Financial Markets
Mr. M.A. van Rooijen
Consultancy Reyersen van Buuren and Property Profit Meter
Mr. M. Thissen MSc MRICS
DTZ Corporate Finance (London)
Director
Director
Jurist
Strategic analysis officer
Project manager
Associate
45
ENWICH
46
46
Appendices
I
ENWICH
used
alyses
Appendix I
II
Description of variables used
in the prospectus analyses
II
Fund originator
Name of the organisation which originates the RELP.
Name of the fund
Official name of the RELP.
Sector
Clarifies in which sector is invested.
Date
Month in which the prospectus became available.
Number of objects
The number of separate objects in the fund.
Participation from
Minimum required amount of participation.
Number of participations
The number of available participations.
Expected duration
The expected duration of the fund.
Legal body
The legal body of the fund.
Auditor’s report
Is the auditor’s report included in the prospectus?
Yes or No.
Financial Leaflet
Is the Financial Leaflet included in the prospectus?
Yes or No.
Experience originator
Based on the number of funds the originator already originated in a
RELP structure. From ‘very poor’ to ‘very good’.
Lettable floor space
The net lettable floor space in square meters.
Number of tenants
The number of different tenants. This is important to understand the risk
of possible vacancy at the expiration date of the rental agreements or
possible bankruptcy of a tenant.
Average duration rental agreements
The actual average duration of current rental agreements.
This is important to understand the risk of vacancy as described before.
Besides that it is important to see if there are tenants at the sales moment.
Indexation of rent
The assumed indexation of rental income each year. In most rental
agreements it is agreed that this equals the consumer’s price index (CPI).
Initial vacancy
Percentage of vacancy at the start of the fund. If a rent guarantee is
provided this is mentioned, because that means there is no loss of income
for the period of the guarantee.
Additional costs in total
Percentage of costs in regard to a ‘normal’ direct investment. Based on
the purchase price including additional costs of purchase.
Issuing costs
A percentage of fees which the originator requires for offering
participation in the fund. In a percentage of the amount of participation
Operating costs
All periodical operating costs, excluding management fees. Based on the
first year, in a percentage of the rental income.
Management fees
Fixed percentage of the rental income, which is designated for the
Trustee of the fund (the originator).
Reservation rental income loss
Reservation for possible income loss in the future, for example by
vacancy.
Initial capitalization rate
1 divided by the GIY (see GIY).
III
EENWICH
ator.
Profit-sharing by originator
Percentage of the sales result which goes directly to the originator.
Total fund investment
Equals equity plus debt.
Equity
The amount of capital as brought in by participants.
Debt
The amount of capital as procured by a (mortgage) loan.
Loan to value ratio (LTV)
Debt divided to the purchase value excluding additional purchase costs.
Leverage ratio (LR)
Total fund investment divided by the amount of equity.
Debt service coverage ratio (DCR)
Net operating income divided by debt services. Net operating income
ase costs.
income
before
equals the actual operating income after interest payments but before
mption.
redemption. Debt services include interest payments and redemption.
e in the
Interest on mortgage
Details on the interest rates of the (mortgage) loan.
Duration debt finance (agreement)
Duration in years in regard to the agreed interest rates.
Prognosticated interest rate
Interest rate as used in calculations for prognostications.
Redemption
Amount(s) of redemption based on the (mortgage) loan.
Gross initial yield (GIY)
Based on the purchase of the property. The gross rental income in the
of the
year of purchase at no vacancy, divided by the purchase price of the
that the
property excluding additional costs of purchase. It is assumed that the
actual rental income equals the market rental.
Average operating result
calculated
The prognosticated gross operating result (before taxation) as calculated
in the prospectus.
Expected sales result
e per
Based on assumptions in the prospectus, showed as an average per
annum, after ‘profit-sharing by originator’.
Total return and (IRR)
shown).
Based on the net operating result and expected sales result (in shown).
Where available the IRR is given between the parentheses.
Exit yield
ental
The expected exit-value of the property, divided by the gross rental
income in the year of sale.
e the sales
Capitalization rate at sale
1 divided by the exit yield (see exit yield).
Profit preference of participants
If the actual gross operating result is lower than this percentage the sales
mount as
result will be used in order to guarantee the participants the amount as
ts profit.
prognosticated, if possible. After that the originator will take its profit.
the
ood’.
Participation of originator
Own participation of the originator as part of the equity.
Information from prospectus
Clearness, completeness and consistency of the information in the
prospectus, based on subjectivity. From ‘very poor’ to ‘very good’.
IV
IV
Appendix II
The prospectus analyses
V
EENWICH
VI
VI
VII
REENWICH
VIII
VIII

Problem analysis on RELPs in the Netherlands : the use and abuse

Transcription

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