European banking regulation is undergoing one of the most significant periods of change since the 2008 financial crisis. With the introduction of CRR III (Capital Requirements Regulation III) The European Union is implementing the final Basel III reforms, thereby changing the regulatory framework for banks, capital investments, and, indirectly, institutional real estate investments as well.
The discussion surrounding the new European banking regulation, CRR III, is often perceived as a specialized topic for regulators, risk managers, and banking lawyers. In reality, however, it is a development that extends far beyond the banking sector. The regulatory landscape is changing noticeably, particularly in the area of institutional real estate investments. For real estate fund sponsors, asset managers, capital management companies, and institutional investors, the question is increasingly arising as to how regulatory requirements affect the attractiveness and investability of fund structures. To understand this development, we must first clarify what the CRR actually is and why its further development through CRR III may become relevant for real estate investments.
The CRR as the Framework for European Banking Regulation
The Capital Requirements Regulation (CRR) is the European regulation governing supervisory requirements for credit institutions. It is based on the guidelines of the Basel Committee on Banking Supervision and, together with the Capital Requirements Directive (CRD), forms the foundation of European banking supervision. While the CRD, as a directive, must be transposed into national law by the member states, the CRR, as a European regulation, is directly applicable in all member states. For German institutions, it therefore applies directly alongside the provisions of the German Banking Act (KWG). The starting point for the regulation is a simple principle: Banks should only be able to take on risks that they can underpin with sufficient capital. This principle is reflected in particular in the capital requirements of the CRR. The higher the risk of a position is assessed to be, the more capital the bank must hold. From the perspective of a savings bank or cooperative bank, it is therefore not enough for an investment to promise an attractive return. Equally important is the question of how much regulatory capital is tied up by this investment. An investment with a six percent return can be significantly less attractive from an economic standpoint than one with a four percent return if it ties up a multiple of that amount in equity capital.
What CRR III Aims to Achieve
CRR III transposes the so-called final Basel III reforms into European law. This is based on the lessons learned from the 2008 financial crisis and the years that followed. Regulators had found that banks sometimes assessed identical risks in completely different ways. Large institutions, in particular, used internal risk models to calculate their capital requirements. This led to situations where two banks could report significantly different capital requirements for nearly identical portfolios. Regulators saw this as a problem. When risks are measured differently, it becomes more difficult to compare banks. There was also concern that individual institutions might systematically underestimate risks. CRR III therefore aims to standardize risk assessment more closely and reduce differences between institutions. This is particularly evident in the so-called “output floor,” which limits the advantages of internal models. At the same time, numerous risk positions are being reevaluated, and ESG risks are being integrated more closely into risk management. For real estate funds, this is initially only indirectly relevant. Its true significance becomes apparent only from the investors’ perspective.
Why Real Estate Funds Are Affected at All
A specialized real estate fund, a Luxembourg RAIF, or another real estate structure is generally not subject to the CRR. Rather, the regulation is aimed at credit institutions. Nevertheless, CRR III affects the real estate industry because banks are among the most important institutional investors. Savings banks, cooperative banks, and other credit institutions invest substantial funds in fund structures through their “Depot A” portfolios. “Depot A” refers to a bank’s own investments. Unlike in retail banking, the bank invests its own capital here. Typical investment forms include fixed-income portfolios, special-purpose funds, infrastructure investments, and real estate funds. For the bank, every investment decision raises the question of how an investment will affect its capital adequacy ratio. This consideration becomes more important under CRR III. The higher the regulatory capital consumption of an investment, the less attractive it generally is. The result is a fundamental shift in perspective. Whereas in the past the focus was primarily on return, risk, and liquidity, the regulatory efficiency of an investment is now increasingly taking center stage.
The Special Significance of the Look-Through Principle
For real estate funds, one concept is of central importance: the so-called “look-through” approach. Put simply, this means that an investor does not just look at the fund itself, but analyzes the assets held within the fund. From a savings bank’s perspective, it makes a significant difference whether a fund primarily holds modern logistics properties with long-term leases or whether it includes heavily leveraged project developments in multiple countries. To make this assessment, investors need information about the underlying properties, the financing structure, the tenants, the loan-to-value ratios, and, increasingly, ESG metrics. Regulatory developments are therefore promoting greater transparency in fund structures. Fund providers that can supply comprehensive data offer their investors a significant advantage. This also explains why the quality of reporting has now become nearly as important as the quality of the properties themselves.
Why German Real Estate Special Funds Often Have an Advantage
Against this backdrop, it is understandable why German real estate specialty funds continue to hold a strong position among institutional investors. They are traditionally geared toward regulated investors. Asset management companies have established reporting processes, standardized valuation procedures, and many years of experience in dealing with institutional investors. For savings banks, cooperative banks, and other regulated investors, this significantly reduces the complexity of internal risk assessment.
The structure itself is often not the decisive factor. Rather, the key issue is whether the investor can understand the risks and document them for regulators, auditors, and internal committees.
SICAV-RAIF Structures: Flexible, but Require Explanation
In recent years, the Luxembourg Reserved Alternative Investment Fund (RAIF) has established itself as one of the most important vehicles for international real estate investments. The RAIF’s appeal lies in its high degree of flexibility. International investors, cross-border portfolios, and complex joint venture structures can often be structured more easily than in traditional German fund structures. This does not pose any regulatory issues. However, it does increase the reporting burden. The more complex a fund’s structure is, the higher the requirements for transparency and reporting become. This is particularly true when multiple property companies, different financing instruments, or international ownership structures are involved. For regulated investors, it will therefore become increasingly crucial whether a structure provides sufficient information for a risk assessment. A transparently structured RAIF can certainly be just as investable as a German special-purpose fund. However, a lack of transparency creates significant hurdles.
Insurance Companies and Pension Funds: Not Affected by CRR III, but Still Part of the Same Trend
An important distinction must be made here. Insurance companies are not regulated by the CRR. They are subject to the provisions of the Insurance Supervision Act (VAG), in particular Sections 89 et seq. of the VAG on solvency, as well as the European Solvency II regulations. Pension funds are also subject neither to the CRR nor to Solvency II. Their legal framework is primarily found in the respective state laws and bylaws. It would therefore be incorrect to claim that CRR III applies directly to insurance companies or pension funds. At the same time, it would be equally incorrect to assume that these investors remain unaffected by these developments. The reason lies in the increasing harmonization of institutional risk management. Both insurance companies and pension funds must ensure the security, quality, liquidity, and profitability of their investments. For insurers, this stems in particular from Section 124 of the Insurance Supervision Act (VAG), which sets forth the principles governing the investment of reserve assets. In practice, this leads to requirements similar to those in the banking sector. Transparency, ESG data, valuation quality, and risk reporting are gaining importance among all institutional investors. CRR III should therefore be understood not so much as an isolated banking regulation, but rather as part of a general trend toward more data- and risk-oriented capital markets.
The actual implications for real estate funds
The key change is not that certain real estate funds will be banned or subject to more restrictive regulations in the future. Rather, the importance of information is shifting. Institutional investors increasingly want to be able to understand,
- which properties are held,
- how high the debt is,
- What rental risks exist,
- what ESG risks exist,
- how the structure's liquidity is organized,
- what effects stress scenarios might have.
The better these questions can be answered, the easier it will be to make an investment decision. In the future, therefore, the choice between a German specialized fund and a Luxembourg RAIF is likely to be less of a deciding factor. Rather, the decisive factor will be which structure offers institutional investors the greatest transparency and the highest level of regulatory certainty.
How is the capital requirement for a real estate fund calculated under CRR III?
From a CRR perspective, a real estate special fund, a Luxembourg RAIF, or a SICAV is generally considered to be Collective Investment Undertaking (CIU) ... The relevant provisions are set forth in Articles 132 et seq. of the CRR. Thus, the bank does not initially hold the real estate itself, but rather a fund share, which raises the question for the regulator: How is the risk associated with this fund share determined?
Level 1: Look-Through Approach
The most favorable regulatory scenario is the so-called Look-Through Approach (LTA).In this process, the fund is “made transparent.” The bank treats the fund’s individual assets as if it had acquired them directly itself. For example:
A real estate fund holds:
- 20 German residential properties
- 10 Logistics Properties
- 5% liquidity
- 25% debt financing
If the bank has sufficient information, these positions are analyzed for regulatory purposes. The risk weights are then derived from the respective underlying positions. That is why institutional investors today demand enormous amounts of data:
- Object Lists
- Market Values
- LTVs
- Tenant Information
- Country Allocations
- ESG Data
- Debt-to-Equity Ratios
The better the data, the more accurately risk weighting can be performed.
Level 2: Mandate-Based Approach
If the individual holdings are not fully known, the fund’s investment limits may be used as a basis under certain conditions. In that case, the question is, wWhat is the maximum amount the fund is allowed to acquire under its investment terms and conditions? The capital requirements are then based on the permissible risks of the fund mandate. This, too, is governed by Article 132a of the CRR. For a conservative core real estate fund, this may still be relatively favorable. For opportunistic real estate strategies with high leverage, the treatment becomes significantly less favorable.
Step 3: Fallback Approach
If neither a look-through nor a mandate-based approach can be applied, the CRR generally requires a risk weighting approach of 1.250 % This is often referred to as the “fallback approach.” The regulator treats the position almost as if the capital deployed were entirely at risk. For banks, this is typically extremely capital-intensive, and in practice, such aFunds that do not require CRR reporting are not investable for many banks – jNot entirely accurate from a legal standpoint, but often true from an economic perspective.
It is precisely for this reason that, in particular, Savings banks, Cooperative banks and State-owned banks Fund managers now frequently prepare special CRR reports.
In Luxembourg, people often talk about CRR Reporting, CRR Certification or DSGV Reporting. These reports are intended to ensure that the investor can apply the look-through approach and does not fall under the significantly less favorable catch-all rule.
| factor | Weight |
|---|---|
| CRR Look-Through | 25 % |
| LTV | 15 % |
| Diversification | 15 % |
| ESG | 10 % |
| Liquidity | 10 % |
| Manager's Track Record | 10 % |
| Tenant Covenants | 10 % |
| Quality of Reporting | 5 % |
Such models do indeed exist in a similar form at many institutions, but they are called different things depending on the institution (Investment Score, Risk Score, Investment Score, RWA Score, etc.). However, there is no uniform, legally mandated CRR III score for real estate funds. This would hardly be possible anyway, as the fund structures and risk profiles vary too widely.
Changing Selection Criteria
For many investors in the banking sector, the question is not just about the expected return, but also about the return the fund generates per unit of regulatory capital tied up. A savings bank can compare two funds with identical distributions of 6%. If Fund A ties up only half as much regulatory capital as Fund B, Fund A will often be more attractive from a Depot-A perspective. This is precisely why terms such as RWA Efficiency, Capital Efficiency or Regulatory Capital Consumption have become key selection criteria. Today, professional Depot-A investors often consider four factors:
| Key figure | Purpose |
|---|---|
| Return | economic return |
| RWA consumption | regulatory burden |
| CET1 usage | Impact on the Equity Ratio |
| RORC | Return on Capital Employed |
In the case of a direct real estate loan (senior or junior loan), a bank receives the preferential treatment applicable to real estate financing secured by a mortgage in accordance with the relevant real estate provisions of the CRR. In the case of a real estate fund, however, the bank does not hold a real estate loan but rather a fund share classified in the equity segment. This gives rise to entirely different regulatory issues. Consequently, it may happen that a property that is economically very secure is treated as less attractive from a regulatory perspective within a fund structure than a directly granted real estate loan.
