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Return Patterns of German Open-End Real Estate Funds

An Empirical Explanation of Smooth Fund Returns

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Sebastian Gläsner

The aim of this study is to better understand stable capital growth of German properties and to contribute to the explanation of stable fund returns. In the course of the investigation, evidence is found that both phenomena are interrelated. All analyses are based on publicly available data; therefore they are not limited by client interests. Results show three different pieces of evidence on return smoothing, namely the influence on valuation, the timing of valuations, and the influence on returns resulting in return differences by calendar months. Together with the notion of internationally uniquely stable returns, it seems impossible to extract true asset volatility from the observed appraisal-based time series.

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1 INTRODUCTION AND OVERVIEW

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1.1 Introduction German open-end retail funds (GOEF) represent the prevailing form of indirect real estate investment for private investors in Germany. By the end of 2008 44 funds have property investments of 90.0 bn. EUR under management. As funds employ financial leverage, gross asset values (GAV) exceed net asset values (NAV). In terms of net asset value of managed funds, only bond funds with 143.4 bn. EUR and equity funds with 133.6 bn. EUR rank before GOEFs with 84.3 bn. EUR NAV (BVI, 2009a). Although funds are not listed at the stock market, the investment is highly liquid as participations can be redeemed to the investment company on a daily basis at NAV. This liquidity transformation from a daily available investment into long- term property allocation is a central characteristic of the investment product. To guarantee product liquidity and to protect the retail investor, funds are strictly regulated under the Investment Act (2008). The act comprises several regula- tions to limit the risk of a liquidity shortage. Funds have to hold at least 5% of gross asset value in cash, up to a maximum of 49%. The maximum leverage is also restricted to 50% of real estate asset value. In case of a liquidity squeeze however, funds are allowed to delay the redemption of participations up to twelve months1, to protect remaining investors from a disadvantageous forced sale of properties. The Investment Act further more requires that every property is being appraised by an independent external appraiser at least once...

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