What is a fund?
A "fund" is simply the pooling of money contributed by a group of investors for the purpose of investment in assets and to enable investors to receive profitsorgains from such investments.
A fund can invest in many sectors such as stocks, shares, bonds or real estate assets and will often be managed by professional managers. Each fund will vary in its investment strategy, the typeof investments it will acquire and its overall risks.
Real estate has traditionally performed more consistently when compared to other investments and has proven to be a more stable and less volatile form of investment. A real estate fund will obviously focus on real estate assets. Real estate assets may include income generating properties (residential and officebuildingsandshoppingcentres)orthe acquisition of land for the purpose of development. It is typical for a real estate fund to reduce its exposure and risks by investing in a diversifiedportfolioofcommercial, residential, industrial, retail and international property.
From an investor's perspective, investment in real estate can eitherbe direct or indirect. Direct investment would involve an investor acquiring a real estate asset individually or collectively with other investors. A real estate fund allows indirect investment by a group of investors so that they can channel the funds required to acquire an asset through a fund vehicle to enable it to invest on its behalf.
Typically, a real estate fund will exist for a term of 5 to 10 years and the purpose of the fund will be to raise capital to make investments on behalf of investors. The investors will be provided some form of security in the fund vehicle i.e. in thecase of a company this will involve the issue of shares in the company to the investor.
The simple objective of the fund is to acquire assets, to manage such assets and generate income during the term of the fund and ultimately sell the assets for a profitattheendofthetermofthefund.
A real estate fund will require a "fund manager" to assist in choosing real estate assets for investment, managing assets, reporting on the performance of the fund and various other administrative services. Each fund will have an "investment strategy". The investment strategy will dictate the type of investments the fund will make and the overall objectives of the fund i.e. issues such as expected rental income and capital appreciation and the term of the investment.
The advantages of a real estate fund include:
Diversity - a real estate fund can investment in a more broad range of assets and will have access to professionally managed funds with proven investment strategies.
Access to high quality deals - a real estate fund will have more buying power.
High returns - real estate funds will aim to generate income during the term of the investment i.e. rental income from leases and capital appreciation upon exit from the investment.
Stability - a real estate fund has proved to be a "safer" investment than stocks and shares.
Fund Structures
The three main structures for real estate funds are:
Company
This is the most common form of entity utilised for real estate funds and will involve the incorporation of a special purpose vehicle (sometimes referred to as an "SPV") to acquire the real estate asset on behalf of investors.
Unit Trust
The concept of the unit trust is that the investors will subscribe to contribute funds to a trustee, which essentially holds such funds as a custodian whilst they are managed by an investment manager for the benefitoftheinvestors.Theinvestorsare often referred to as "unit holders". The underlying documentation of the unit trust will reflect the unit holder's pro-rata share and beneficialinterestsintheassets held by the trust.
Limited Liability Partnership
The limited partnership concept is similar to that which applies in the United States and other jurisdictions and is common for private equity funds with a limited number of investors. The investors will enter into a partnership arrangement with other investors for the purpose of investment.
Thousands of funds are currently in existence in several jurisdictions including the Cayman Islands, British Virgin Islands, Isle of Mann and Jersey, United States, United Kingdom, Europe and the Middle East.
The Cayman Islands has been a popular choice for fund vehicles due to the quality of its service providers, the speed of formation and its well developed and flexiblelegalandregulatorysystems.Caymans funds are well recognised and accepted around the world, particularly in New York, London and Hong Kong.
In terms of the GCC region, Bahrain has been the preferred choice for the setting up of funds due to its status as a financialcentre. However, the Dubai International Financial Centre is generating interest in both foreign and GCC investors looking to set up funds in the region as it aims to become the regions capital for banking and financialservices.
Fund Documentation
Once the fund manager has decided on the choice of domicile and the type of entity, it will proceed to setting up the documentation for the fund. The fund documentation will comprise the "offering documentation" such as a prospectus or information/offering memorandum as well as a form of subscription agreement. The subscription agreement will be the document that the investors will sign in order to participate in the fund.
The prospectus will be a comprehensive document covering the investment strategy of the fund and will contain the essential information that an investor will rely upon when considering whether or not to invest in a fund.
The fund documentation will also include constitutional documents of the fund such as the incorporation documents of a company including the articles and memorandum of association. The articles and memorandum of association will govern the objectives and powers of the company and the rights of theinvestors and the manager.
Common Issues for funds in the UAE/Dubai
Due to the laws and regulations within the UAE with regards to foreign ownership and real estate activities generally, there are several issues that may arise forany foreign real estate fund looking to invest in the region. There are obvious risks that should be considered by a real estate fund which are inherent in any real estate market and in particular in an emerging market like the UAE.
The issues may be summarised as follows:
Choice of domicile
Real estate funds will most likely be a company incorporated in a jurisdiction that is "investor friendly", tax efficient,with no or minimal regulation and will facilitate the activities of the fund.
Legal ownership and security
Due to the restriction in foreignownership in the UAE generally, a foreign fund will need to consider the impact of this when assessing a real estate asset. Regardless of the nature of the fund vehicle, the issue of whether it can acquire a real estate asset will depend on the ultimate beneficiariesofthefund i.e. the investors behind the fund. Therefore, a foreign fund vehicle cannot acquire legal ownership of a real estate asset which is not available for foreign ownership.
Regulation
The UAE has a strict regulatory regime with regards to licensing of activities which are conducted by companies particularly in the areas of construction, development, leasing and selling ofreal estate property.
A real estate fund should consider whether its activities will require a trade license.
Shariah compliance
Some funds may need to comply with the principles of Islamic Shariah Law or the Shariah. Generally, the Shariah forbids interest, alcohol and gambling amongst other things. If a transaction or the use and the income derived from an asset exhibit any of the forbidden aspects of Shariah, then it will fail to comply with the Shariah. This will dictate the nature of the real estate asset that can be acquired and all transactions and documentation involving the fund.
Fund and property management
It is important for a real estate fund to be managed effectively by appropriately skilled professional managers. The management agreements appointing a fund or property manager should be carefully reviewed in order to ensure they are consistent with the overall strategy of the fund.
Leveraging/Financing
If a fund is interested in obtaining bank financingtoleverageitsacquisitionof an asset then its structure and documentation will need to be legally sound and offer the appropriate security to a bank before it will agree to financethe fund.
Legal due diligence
Legal due diligence will inevitably be required on the real estate asset prior to the fund's acquisition. This will involve the review of the title documentation for the real estate asset and if it is tenanted, a review of the leases. There are many factors that will come into play when undertaking the due diligence on a particular asset. The legal advisors will need to consider the legal issues arising from the fund vehicle and its investment strategy. If a fund vehicle is unable to acquire an asset directly in its name then the investors will be at risk as they will not have an interest in the asset. Moreover, the real estate asset must fitthe investment strategy and allow for exit i.e. disposal at the appropriate time.
Conclusion
As the market matures in the UAE and in particular in Dubai, real estate funds will increasingly become the preferred choice for foreign investors as the route to investment in the region.
There are obvious legal issues and hurdles for any foreign investor looking to invest in a real estate fund investing in the UAE. These issues start from the setting up of the fund and acquisition of its assets through to the closing of the fund in order to ensure that the fund will flourishandtheinvestorsinterestsareprotected.
However, there are several real estate funds (both GCC and foreign) which are already enjoying high yields and capital appreciation from their investments in Dubai. The DIFC will assist foreign funds looking to set up in the region as it will provide access to professional fund managers and other financialserviceproviders located within the DIFC. The DIFC laws and regulations intend to provide a platform that is in line with international practices and standards. This will encourage further investment and promote Dubai as a base for real estate funds.
By Mohammed J Kamal
Al Tamimi & Company 2006
