I. Introduction

The European Long-Term Investment Fund (ELTIF) is a European investment instrument that was introduced for economic policy reasons to provide additional financing options to certain sectors and companies. Although the ELTIF was launched by the EU Commission in 2015, only relatively few ELTIFs have been approved since then. As of July 2023, according to ESMA's public register, there were only 95 ELTIFs in existence, mostly launched in Luxembourg, France, Spain and Italy.

Nevertheless, the ELTIF is being discussed a lot this year, especially in Germany. Why? The ELTIF Regulation has since been fundamentally revised. The new regulations will come into force on January 10, 2024 and will bring with them a number of changes. We are taking this reform as an opportunity to compare the new ELTIF with the open-ended real estate mutual fund and to point out any advantages and disadvantages of the new investment product.

FURTHER INFORMATION

II. Fixed assets

The ELTIF is a multi-asset product. In contrast to open-ended real estate mutual funds, the ELTIF is not limited to a strict investment catalog. Rather, the permitted investments of an ELTIF can be divided into two asset categories: On the one hand, investments can be made in so-called “permitted fixed assets”, which are generally illiquid and require a commitment for a certain period of time. These include real assets (including real estate, communications, environmental, energy or transport infrastructure, social infrastructure), equity or equity-like instruments from “qualified portfolio companies,” loans to “qualified portfolio companies,” and shares in target funds, which in turn are invested in ELTIF-eligible investments invest. In addition, ELTIFs are allowed to invest in all assets suitable for UCITS - probably for the purpose of investing liquidity.

Open-ended real estate mutual funds may only invest in land and property rights, property management assets, investments in real estate companies as well as certain securities, money market instruments and bank deposits for the purpose of liquidity investment.

ELTIFs therefore have a significantly broader range of investment items than open-ended real estate mutual funds. The wide range of investment opportunities in real assets is particularly interesting, as this significantly increases the flexibility of asset managers. The only requirement for a material asset is that it has an income value due to its nature or type, which offers a wide range of investment opportunities. This makes it possible to not limit the risk to just one asset class, to spread it better and, if necessary, to combine investments that are related (e.g. real estate and investments in project development companies). In comparison, open-ended real estate mutual funds are only allowed to invest in real estate.

III. Portfolio composition and diversification

While an ELTIF was originally required to invest at least 70% of its capital in eligible investment assets, this ratio has now been revised to 55%. At least 55% of the ELTIF's capital must therefore be invested in the above-mentioned “permitted fixed assets”.

In addition, the diversification rates were adjusted. An ELTIF may now invest a maximum of 20% of its capital in instruments from or loans to the same qualified portfolio company, a maximum of 20% of its capital in a single tangible asset and a maximum of 20% of its capital in shares in a single ELTIF, EuVECA, EuSEF, UCITS or EU AIF and acquire a maximum of 30% of an ELTIF, EuVECA, EuSEF, UCITS or EU-AIF.

Open-ended real estate mutual funds must invest more than 50% of the value of the special fund in real estate, with a maximum of 15% of the value of the special fund being allowed to be attributable to a single property. In addition, the total value of all properties whose individual value is more than 10% of the value of the special fund may not exceed 50% of the value of the special fund. Land in the condition of development may make up a maximum of 20% of the value of the special fund. A maximum of 49% of the value of the special fund may be invested in bank deposits, money market instruments, investment shares, securities and REITS. The capital management company must also ensure that an amount corresponding to at least 5% of the value of the investment fund is available for the redemption of shares.

IV. Borrowing

In order to finance their investments externally, ELTIFs can take out loans. The regulator increased the debt capital ratio from 30% to 50% of the ELTIF's net asset value. The manager of the ELTIF must state in the prospectus whether it intends to take out cash loans as part of its investment strategy and what upper limit is set for taking out loans. However, the upper limit only applies a maximum of three years after the date on which sales of the ELTIF began.

The debt capital ratio of open-ended mutual funds, on the other hand, is a maximum of 30% of the market value of the real estate belonging to the special fund. Additional short-term loans may not exceed a maximum debt ratio of 10% of the net value of the fund.

The higher borrowing limit of the ELTIF – compared to the open-ended real estate mutual fund – can certainly have advantages. In particular, this enables the ELTIF to increase leverage and thus potentially achieve higher returns. However, it should be noted that the respective calculation bases for the debt capital ratio are different, so that the ELTIF's borrowing limit, which initially appears to be significantly higher, may have a smaller impact than it seems at first glance.

V. Liquidity requirements and return options

An important difference between ELTIFs and open-ended real estate mutual funds lies in the liquidity requirements and return options.

ELTIFs are aimed at long-term investments. Therefore, they are basically closed funds. This means that investors in an ELTIF cannot request the redemption of their shares before the end of the term specified for the ELTIF. A clear, specific date for the end of the term of the ELTIF must be stated in the investment conditions or the articles of association of the ELTIF in question.

However, under certain conditions, the investment conditions or the statutes of an ELTIF may provide for the possibility of unit redemptions during the term. For this purpose, an investor-related minimum holding period must be set with an individual period. In addition, the manager of the ELTIF must demonstrate that the ELTIF has an appropriate redemption regime and appropriate liquidity management tools that are compatible with the ELTIF's long-term investment strategy. The relevant ELTIF redemption policy must clearly state the procedures and conditions for redemptions. Finally, the ELTIF's redemption policy must ensure that redemptions are limited to an individually determined portion of the ELTIF's UCITS-compliant investments and that investors are treated fairly by granting redemptions on a pro-rata basis if necessary. Investors do not have to be contractually promised an unconditional, comprehensive redemption of their shares during the term of the ELTIF.

The return of shares in open-ended real estate mutual funds, however, is possible after a minimum holding period of 24 months and subject to a return period of twelve months. If the liquid assets available in the real estate mutual fund are not sufficient at this point to pay the redemption prices of the shares to the investors, the redemption of the shares must be suspended. In this case, the assets of the real estate mutual fund must be sold quickly to obtain liquidity in order to be able to meet all redemption requests. If this is not achieved within three years, the fund must be wound up.

VI. Distribution

ELTIFs can be approved for cross-border distribution throughout the European Union via the EU passporting procedure for AIFs. All that is required is a report to the competent authority of the home Member State. In contrast to other AIFs, sales can take place both to professional investors and to small investors in other EU countries. Since the reform, the ELTIF is likely to be an increasingly attractive investment vehicle, particularly for small investors, as the previously applicable minimum investment amount of EUR 10,000 and the ten percent upper limit for private investors with liquid assets under EUR 500,000 have been removed.

A Europe-wide distribution of real estate mutual funds, on the other hand, requires individual, nationally regulated approval by the responsible authority of the relevant member state. Only cross-border distribution exclusively to professional investors is possible without authorization using AIF passporting.

Like the UCITS, the ELTIF therefore represents a European investment product that can be sold across borders without national authorization to both professional investors and small investors, which enables easier distribution compared to retail real estate funds.

VII. Conclusion

Due to its broad investment spectrum, the increased borrowing limit and the cross-border distribution options without authorization, including to small investors, the ELTIF could represent a real alternative to open-ended real estate mutual funds. While the cross-border distribution of mutual real estate funds is usually laborious due to the effort involved in obtaining the required approval in the relevant member state, in the case of an ELTIF, a notification to the competent authority of the home member state is sufficient. The dreaded scenario of a suspension of redemptions, possibly followed by a forced liquidation of the fund, could also be avoided with an ELTIF through appropriate contractual provisions.