Empowered by its economic strength, Germany is one of the most interesting markets for foreign investors, even though its legal system is not based on common law. Having performed a continuous growth within the past ten years, the German investment fund industry exceeded the EUR 3 trillion threshold of managed assets according to a BVI (German Federal Association of Investment and Asset Management) survey. More than half of this amount is managed via special funds, respectively funds in which only professional and semi-professional investors (i.e. institutional investors such as insurance companies and pension funds) are invested, whereas the doors are closed to the general public. A key differentiation concerning fund structures is whether they are open- or closed-ended. This distinction depends on the question whether the investors are entitled to return their units in the respective Alternative Investment Fund (AIF) prior to the commencement of its liquidation phase or wind-down. If this holds true, the fund is qualified as an open-ended fund.
Even though German investment law offers a range of different investment vehicles, basically two fund structures have been proved as being most suitable for German and foreign real estate investments of German as well as international institutional investors, respectively the special contractual trust fund (Spezial-Sondervermögen) for open-ended structures and the special investment limited partnership (Spezial-Investment-Kommanditgesellschaft or InvKG) for closed-ended structures. Despite their – for the German language typical – long terminology, both fund types can be structured in an efficient way for both German and international institutional investors and German and foreign real estate.
Such regulated as well as commonly used vehicles must be managed by a licensed fund management company (AIFM or KVG). Both types of funds and their management companies are regulated by the German Capital Investment Act (KAGB), which is based on the EU Alternative Investment Fund Manager Directive (AIFMD).
Open-Ended Structure
The Spezial-Sondervermögen is a fund of the contractual type, which means that it has no legal personality but consists of contractual agreements between the KVG and the respective investors. Therefore, it cannot be registered in the commercial register and cannot be holder of rights. The assets of the fund are basically legally owned by the KVG and are managed by the KVG for the account of the fund investors. This is comparable to the English common law trust concept where the trustee holds legal title and the beneficiary holds beneficial title to the asset. A depositary supervises the compliance with certain statutory and contractual requirements.
Being qualified as an open-ended fund, the Spezial-Sondervermögen usually neither closes after having issued a pre-defined number of units or after having raised a specified amount of capital, nor does it have a pre-determined term. The frequency of the redemptions of their fund units by the investors can be agreed between the investors and the KVG, and are mostly on a monthly basis but at least once a year with potential redemption terms.
However, this redemption right is only a theoretical one for special real estate funds as often only a small number of institutional investors are invested and, therefore, the liquidity situation of the fund might not always allow the redemption of a large portion of fund units. Therefore, if institutional investors plan to disinvest, they generally elaborate a suitable action plan with the KVG.
Finally, the statutory provisions for the Spezial-Sondervermögen are stricter than those applicable for the InvKG. Especially this holds true in relation to both external and internal financing.
Closed-Ended Structure
The InvKG is in principle a limited partnership (Kommanditgesellschaft) to which the general provisions for limited partnerships are applicable but modified by German investment law; investors are invested as limited partners.
This fund vehicle was developed with the implementation of the KAGB in 2013, and it was not replicated after or based on existing retail fund models. Hence, its internal governance can be agreed in a more flexible way compared to the Spezial-Sondervermögen, and it is possible to give investors an extensive management power or veto rights; alternatively, they can also be basically totally excluded from decision making processes of the fund.
The InvKG being structured as a closed-ended fund means that it has a term, whereby the longest possible term is 20 years plus an extension of at maximum up to ten years.
In contrast to the Spezial-Sondervermögen, the InvKG has a legal personality; the assets belonging to such funds are therefore owned – directly or indirectly – by the InvKG. Whereas the InvKG has its own legal personality, it still has to be managed by a KVG which is connected to the fund through a fund management agreement. This agreement allocates substantial rights to the KVG which is obliged to ensure compliance of the respective fund with regulatory requirements.
There is basically no leverage limit for a special InvKG in Germany. However, in order to qualify for the real estate quota which is relevant for certain German institutional investors, financing through bank loans must be restricted to 60%. An InvKG must also have a depositary, which serves in the same role as is the case regarding the trust funds.
Taxation
Whereas the InvKG is taxed based on the general German income tax provisions for partnerships, German investment tax law is applicable for the taxation of the Spezial-Sondervermögen. As long as the InvKG is structured in a way that avoids the qualification of its income as being trade income, the fund can be treated as a fully transparent vehicle, and the income is taxed only at the level of the investors with their respective tax attributes and rates. Therefore, the fund should only perform private and long term investment management (Vermögensverwaltung) – which does not exclude real estate developments subject to proper structuring – and, besides the fully liable managing general partner, the fund should implement a managing limited partner to avoid a trade infliction (gewerbliche Prägung).
If specific regulatory and investment requirements are met according to the German Investment Tax Act, also a Spezial-Sondervermögen can opt for tax transparency without being subject to corporate income tax. However, before deciding whether to opt for such transparency or not, the tax consequences have to be analyzed in detail; especially taking into account the specific tax status of potential investors, non-transparent fund structures could be beneficiary for certain investor groups like insurance companies or other taxable corporations.
Outlook
Global economic warfare and political uncertainties may lead to a sustainable growth of foreign investments in the economically strong and politically stable German market with a focus on real estate – especially from institutional investors investing with a long term horizon. Germany has an effective legal system to enforce and secure such investments and provides specific regulatory frameworks for investment vehicles in the real estate fund sector investing in German and foreign real estate which are suitable for German as well as international investors.
