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One of the main challenges for our cities is obtaining sufficient financial resources to adequately provide their public services. Over the last few months we have been sharing several alternatives, such as strengthening fiscal capacity, diversifying funding sources, attracting private sector investment or improving the planning and execution of projects to promote sustainable urban development.
In this article we want to continue offering financing alternatives to Latin American and Caribbean (LAC) cities. For this reason, we will explain why real estate funds, despite being an instrument that has been scarcely used in urban development projects in LAC, have a significant potential to contribute to the renovation of our cities’ infrastructure.
What is a real estate equity fund?
In essence, a real estate investment fund is a type of investment that pools capital from various investors (public and private) to acquire or develop real estate properties (e.g., residential, commercial, industrial or mixed-use).
The fund is comprised of real estate assets (buildings) that generate regular cash flows, which are derived from the rental of the properties or the sale of the assets.
How do equity real estate funds work?
Real estate funds operate in a similar way to traditional investment funds. First, the fund’s operating conditions are established (e.g., duration, risk level, entry and exit conditions, guarantees and limits, among others). In a simplified way, once the rules have been defined, the fund manager assumes responsibility for selecting and supervising the real estate assets that make up the fund, although on occasion he may delegate certain operational functions to specialized experts or teams. Investors acquire shares in the fund, thereby receiving a proportionate share of the income generated by the fund, as well as appreciation in the value of the property. The income generated by the assets is periodically distributed to investors in the form of dividends.
Types of equity real estate funds
There are different types of real estate funds, each with its own characteristics and investment strategies. Among the most common are:
- Open-end real estate investment trusts (REITs): these funds are publicly traded, and investors can buy and sell their shares through the stock market in a manner similar to how company shares are traded. In some countries, REITs are required by law to distribute most of their income to investors, which can make them attractive to those seeking regular income.
- Closed-end Real Estate Investment Trusts: unlike FIBRAs, these funds are not publicly traded and have a limited number of shares available. They are usually accessible only to accredited or institutional investors and have a fixed investment period during which investors cannot sell their shares.
- Real Estate Development Funds: these funds invest in real estate development projects, such as the construction of residential, commercial or industrial buildings. They generally have a long-term investment horizon and can offer potentially higher returns, but also involve greater risk.
- Real Estate Private Equity Funds: these funds are usually managed by private equity firms and focus on investments in higher value properties or complex development projects.
- Commercial or Residential Real Estate Funds: some funds specialize in certain types of properties, such as commercial (e.g., office, retail) or residential (e.g., homes, apartments). Investors may choose these funds based on their knowledge of the market and their return expectations.
Recent examples of real estate funds promoted by public entities.
In 2019, the government of the state of São Paulo in Brazil set up its first real estate investment fund (FII) with a portfolio valued at BRL 1 billion (US$256,343,000 as of December 15, 2022). In total, the FII presented a portfolio of 264 properties, with more than five thousand units present in all regions of São Paulo. The fund’s portfolio was estimated at R$ 1 billion and the company responsible for the management would receive 0.2% of each property sold, which could reach R$ 1.94 million if all of them were sold. In addition, it was established that the company would receive an average remuneration of R$ 80,000 per month for the management of the portfolio.
In 2018, the Government of Amman in Jordan established the public company “Amman Vision Investment & Development (AVID)”. AVID, wholly owned by the Municipality of Amman, is dedicated to the investment and development of municipal real estate, acting as the lead developer. Its focus is on creating diverse investment opportunities for global and regional investors interested in participating in Jordan’s economic growth. AVID provides its investment partners with access to a range of opportunities that may be driven by market demands, by the investors themselves, or by the municipality of Amman. These opportunities meet both market and community needs. To meet its objectives, AVID proposes various partnership schemes: from direct leases to revenue and profit sharing, or equity investment for land. In this way, AVID generates attractive returns through long-term sustainable investments.
Why can real estate funds be considered as part of the financial tools to promote urban renewal?
We know that governments face significant challenges in financing urban infrastructure. These challenges include the high cost of real estate, limited access to financing and the reluctance of the private sector to invest in regeneration projects.
Public assets, such as land and property, are often underutilized or undervalued, meaning that they are not being fully utilized to generate economic or social benefits. However, these assets can offer a great opportunity for governments looking to generate additional revenue or foster economic development. Through monetization of these assets, such as selling or leasing them to private investors, governments can unlock their hidden value. Not only this can provide a much-needed source of revenue, but it can also drive investment, job creation and economic growth in areas that might otherwise remain dormant or underdeveloped. For example, in the U.S., properties are assessed on average at 33% less than their market value.
What are the benefits of real estate funds versus other types of financing?
Real estate funds can play a key role in monetizing underutilized or undervalued public assets. By raising capital from a variety of investors, these funds can acquire, develop, and manage these assets efficiently and professionally. Through expert management, they can maximize the value of these assets, transforming them into profitable projects that generate a steady stream of income through rent or sale, as well as produce local economic impact and contribute to urban regeneration.
In addition, these funds can attract private sector investment in public infrastructure projects, which helps to share risks and reduce the financial burden on governments. In this way, real estate funds not only help monetize public assets, but also contribute to economic development and urban revitalization.
Do you think your city is ready to finance itself through real estate funds? At the Housing and Urban Development Division of the IDB we will be happy to support you with technical assistance to make it possible. Do not hesitate to contact us.