Financial management of real estate transactions

Real estate cycle

In recent years, the Italian real estate market has undergone several developments that have contributed to refining the structure of the construction cycle. As regards the Italian situation, post-World War II building production mainly involved the design and construction phases, which were accompanied by the processes of debt and financing for the initial expenditure. Nowadays, the building production cycle seems to have become specialised, with clear distinctions between four fundamental phases of the real estate asset life cycle:

Phases of the real estate asset life cycle

• Financial management (relating to investment, divestment, financialisation and various other aspects of capital budgeting).
• Project management (i.e. the systems for planning and managing the executive project (working plan), based on the analysis of the scope, time and resources used, with the aim of minimising costs while maximising the quality of the building).
• Construction management, related to construction or refurbishment issues.
• Asset management (actions related to the management and maintenance of the building).

It is important to remember that, although the act of construction remains a focal point in the real estate cycle, in recent years, more and more construction companies (AEC) as well as specialised companies are focusing on property management, performing so-called Facility Management services. In addition to the more typical processes of design, construction and management, it is essential to add the financial component. Many realities such as SGRs or SIIQs (REITs) have been created with the aim of financialising real estate assets.

Investment lifecycle of a real estate asset

• Acquisition of the asset
• Management of the asset
• Disinvestment of the asset
• OICR (Organismi di investimento collettivo del risparmio)

OICR (Organismi di investimento collettivo del risparmio)

Gli organismi di investimento collettivo del risparmio, in acronimo OICR, in Italia, sono organismi con forma giuridica variabile che investono in strumenti finanziari o altre attività somme di denaro raccolte tra il pubblico di risparmiatori, operando secondo il principio della ripartizione dei rischi. L'attività della gestione collettiva del risparmio è un servizio che si realizza attraverso:

• La promozione, istituzione e organizzazione di fondi comuni d'investimento e l'amministrazione dei rapporti con i partecipanti;
• La gestione del patrimonio di OICR, di propria o altrui istituzione, mediante l'investimento avente ad oggetto strumenti finanziari, crediti, o altri beni mobili o immobili.

Gli organismi di investimento collettivo del risparmio sono:

• Fondi comuni di investimento;
• Le società di investimento, suddivise in Sicav, a capitale variabile, e Sicaf, a capitale fisso.

Tra i due vi è una profonda differenza: nei primi, che sono gestiti dalle SGR, gli investitori non sono soci ed i loro investimenti costituiscono un patrimonio autonomo e nettamente distaccato dal patrimonio sociale, ricevendo quote di partecipazione al fondo e mai azioni della società. Nelle Sicaf e Sicav, gli investitori al contrario divengono soci e sottoscrivono azioni direttamente emesse dalla società, senza distinzione di patrimoni.

Real estate fund

In the Testo Unico della Finanza (TUF), a mutual fund (whether real estate or securities) is defined as a capital assets pool, raised through issues of shares by a plurality of investors, with the purpose of investing on the basis of an agreed and predetermined investment policy, managed in trust in the interest of the same investors. A real estate fund is an autonomous asset pool set up by an asset management company (SGR) that raises capital from private and/or institutional investors and invests it mainly in real estate assets and related financial operations.

The closed-end real estate fund (the only one legally existing in Italy) is therefore a new financial investment instrument that transforms real estate assets (being those not liquid) into financial shares representing the package of real estate portfolio owned by the fund. This financial instrument is the first to allow a wide public of investors to buy into real estate independently of their own available capital, making investment in real estate simple and quick, even considering tax regime is based on an income tax exemption, with taxation at investor level and tax benefits for certain investors and the long time and costly nature of direct RE investments.

Requirements of a real estate fund (REF)

The requirements that an REF must have are as follows:

• 2/3 of the fund's investments must be made in the real estate sector, with some exceptions where it is also possible to invest in RE Securities related to buildings, property rights.
• Must not undertake direct construction activities.
• Must not invest in assets whose value is more than 1/3 of the total assets portfolio, and in a single location.

A real estate investment fund is a capital asset, managed by a third party (SGR), which is responsible for investing that asset mainly in real estate works, property rights and participations in real estate companies. The SGR is controlled in Italy by Bankitalia (which approves and controls transactions and policies) and by the independent public company CONSOB, which is in charge of supervising the transactions, while the depositary bank is in charge of managing the actual investment actions as an intermediary. With the acquisition of fund shares, investors do not invest directly in the SGR that manages the fund; this means that shareholders have a passive role in REFs, unlike in other real estate financial vehicles such as SIIQs, where shareholders directly acquire a share of the company's equity and acquire the right to vote for the appointment of its directors. In real estate funds, the SGR is solely responsible for the appointment of fund administrators.

The SGR is the company responsible for the management of the real estate portfolio and deals with the entire life cycle of the real estate fund, according to the following activities:

• Fund Promotion (gathering investors)
• Fund Set-Up (agreement on investment policies)
• Fund Management (management and valorization of the assets portfolio - outsourcing allowed)
• Fund Liquidation

Categories of real estate investment funds

Real estate investment funds can also be subdivided according to the following 4 categories:

• Resource collection: Participation (the purchase of shares) in a fund can be made through money or, in the case of Contribution funds, through real estate assets. The main difference between the two is that in Contribution funds, the size of the portfolio is clearly defined from the beginning of the SGR's investment operations. Therefore, the assessment of the market value of the portfolio and the physical conditions are of fundamental importance for the Contribution Fund.
• Participation: Closed (the only one present in Italy) maximum duration of 50 years, the process of shares acquisition can be done only in the set-up phase and the liquidation of shares to investors can be paid in the final phase).
• Semi-closed: Semi-closed funds follow the same subscription and liquidation procedures as closed funds, but offer more opportunities to buy and sell shares, opening up more periods of purchase and sale, always agreed in the initial set-up phase.
• Open: Open opportunity for investors to acquire and sell shares. Higher liquidity but higher risks on debts insolvency.

Types of investors

• Retail: Limited minimum cost of share for the investment (wider number and types of investors). Low profile of risk. Possible to use a leverage up to 60% for real assets investments or other core activities.
• Institutional: The shareholders can be only institutional entities (e.g., banks, insurance companies, pension funds and so on). Moreover, the shares must be traded only between these parts. The difference with Retail funds are: higher risk profile due to more diversified portfolio, and higher returns due to the higher riskiness of investment policies.
• Speculative: Related to institutional investors but with a higher minimum level of investment, a maximum number of shareholders, and apparently without leverage restrictions. These factors imply that this type of fund is the riskiest and the one with the potential highest returns on capital.

Risk-yield strategy

• Core investment funds: Lowest risk/yield level (systematic aka market risk and investment risk). Portfolio mainly with safe and stable incomes, low use of leverage. Time horizon: 10-15 years.
• Core plus investment funds: Similar to core investments but with a more aggressive use of leverage and consequently a higher, but still moderate, risk/yield level.
• Value added investment funds: High level of leverage in order to undertake projects of refurbishment, valorization and resale of buildings (short term: renovate – lease – sell).
• Opportunistic investment funds: Highest level of risk/yield. Highest use of leverage (i.e., E/D+D). As well as the value added, projects are mainly on buildings to be refurbished, valorised and sold, mainly adopting changes in the use destinations (short term).

SICAF: Società investimento a capitale fisso

Compared to SGRs which are the only responsible for capital investment policies, SICAFs will allow investors to take advantages of the legal personality associated with the corporate form. Thus the shareholders will have the right to appoint one or more members of the Board of Directors, so they will have the power to influence the management activity by the investors. A SICAF can buy, outsource to renovate making value added investments, lease the asset and sell it, even managing the facility along its lifecycle. SICAFs may provide several investment compartments, for each of which a particular category of shares may be issued giving different asset and administrative rights to their holders. This allows investment by different categories of investors, each of whom is interested in a specific investment objective. The SICAF could be of two types: self-managed and managed by third party. In our case, RealStep SICAF is managed by its founders (first type) which have full control and discretion on the decisions and investment strategy. RealStep SICAF does not have a management fees system, (differently from the SGRs) but has a covering costs system that provides to bear all the operation expenses (salaries, regulation costs, bills, office rent, etc).

SIIQs (Real Estate Investment Trusts - REIT) and differences between SIIQ (REIT) and RE funds

SIIQs represent a viable alternative to the widely used Closed-end Real Estate Funds. SIIQs are joint-stock companies resident in the territory of the Italian State aimed, for the most part, at the rental of real estate (objective requirement). A SIIQ is defined as a real estate investment joint stock company that benefits from full exemption from corporate property taxes (IRES and IRAP in Italy) and operating mainly in the real estate rental sector. FUNDS and SIIQs have fundamental differences in terms of the type of investment and participation systems. In the case of real estate funds, the manager is separate from the owner and, in most cases, coincides with the SGR that created the fund; in SIIQ, on the other hand, the management is appointed by the majority of investors and the company therefore has a governance similar to listed companies. Unlike real estate funds, SIIQs operate exclusively in the real estate rental and are managed directly by members nominated by their shareholders.

SIIQs have the following peculiarities: they decide autonomously on the maximum percentage of indebtedness (in contrast to German REITs).