Discussions about the right risk indicator for open-ended real estate funds

The ruling of the Nuremberg-Fürth Regional Court of 21 February 2025 has caused considerable uncertainty in the investment industry. It ruled that an open-ended real estate fund must refrain from disclosing a risk indicator of 3 or lower in the key information document under the so-called PRIIPs Regulation. In the opinion of the court, a risk indicator of 6 was correct. This article explains the facts, the decision of the court, gives a critical opinion and offers an outlook.

A. The facts of the case

The legal dispute between Verbraucherzentrale Baden-Württemberg e. V. (the "plaintiff") and the defendant capital management company concerned the correct classification of the risk indicator for an open-ended real estate fund. In the key information document, the capital management company initially rated the fund with risk class "2" (low) and later with risk class "3" (medium-low). The plaintiff argued that the fund should be classified in risk class "6" (high) due to the valuation methods and the frequency of pricing.

B. Decision and reasons for the decision

The court ruled in favor of the plaintiff. The defendant was no longer allowed to rate the fund with risk class 2 or 3. The decisive factor for this assessment is the court's understanding of the term "price" within the meaning of Annex II Part 1 No. 4 lit. c) of Delegated Regulation (EU) 2017/653 (the "DeIVO"). Here is a brief context:

• The European legislator introduced  a standardised key information document in the PRIIP Regulation (EU) 1286/2014 to improve the comprehensibility and comparability of investment products for retail investors. The DelVO provides a uniform template for this key information document..
• This key information document contains the section: "What are the risks and what could I get in return?", in which the overall risk of the respective product, in this case the real estate fund, must be stated. The total risk depends largely on the market risk and is always 6 if the market risk is 6.
• The market risk is to be assessed at 6 if it is a product or underlying investments of the product whose prices are not fixed at least monthly, which do not have a suitable benchmark or a suitable substitute or whose suitable benchmark or suitable substitute is not priced at least monthly (see Annex II Part 1 No. 4 c) DelVO).

In the case decided, the defendant did not use any benchmarks or deputies, so that these terms were not relevant to the court. The court ruled that the calculation of the price was based on the net asset value (the "NAV"), which resulted from the market value of the real estate fund's assets.

The court's reasoning is hardly comprehensible:

• It is true that the court correctly recognises that the risk of an investment appears to the legislature in the abstract to be higher if a price is not fixed at least monthly. From this, the court derives two conclusions, neither of which are mandatory:  
• First, the court considers that the legislature had in mind a certain method of setting prices that better informs consumers about the risk. However, the court does not explain exactly which method the legislator meant and how this method should be designed. The standard of the court thus remains unclear.
• Secondly, the calculation of redemption prices on a daily basis does not satisfy this requirement [for price fixing], since it is not based on a daily valuation of the properties. The court's reasoning is circular. It does not justify why redemption prices on trading days should not be sufficient. Nor does it explain why real estate must be valued on a daily basis.
• The court also relies on a Q&A document from the European Supervisory Authorities (the "ESAs"). It is already debatable whether this document can be understood as an aid to interpretation. On page 24, the question of the redemption price for open-ended real estate funds is explicitly raised:
  Are the redemption prices of open-ended real estate AIFs "prices" within the meaning of point 5 of Annex II of the Delegated Regulation? The question arises because the redemption price is determined on the basis of the net asset value (NAV) of the respective fund. For the NAV, the market prices of the AIF properties are determined only once a year. In contrast to UCITS, no market prices of the underlying assets are available on a daily basis.
  The ESAs' response of 14 November 2022 is as follows:
  In accordance with point 4(c) of Annex II, Part 1 of the Delegated Regulation, unless there is an appropriate benchmark or proxy which is priced on at least a monthly basis, where the net asset value is calculated on a less regular basis than monthly (e. g. only yearly), the PRIIP would be Category 1.
  The court infers from the ESAs' response that they are basing their approach on the monthly calculation of the NAV. This understanding fails to recognise that the ESAs' response is misleading, since it makes no reference to the withdrawal prices.

C. Statement

According to the court's findings, PRIIPs invested in real estate must now report risk class 6. This may surprise many, as market risk class 6 is generally associated with a volatility of 30-80 % according to Annex II Part 1 No. 2 DelVO, while real estate is mostly in the range of 5-15 %. This may contradict the intention of the DelVO, as the small investor now receives a distorted picture of the risk profile of the investment.

In order to achieve a favourable risk presentation, there are two options for capital management companies according to this ruling:

• They use appropriate benchmarks or suitable proxies that are set at least monthly. For example, the MSCI Real Estate Indices could be considered as benchmarks, which are also calculated monthly in some cases. However, this option is likely to be ruled out regularly as it is not in line with the fund's investment strategy. Most real estate funds do not track indices, but actively make their investment decisions. However, exceptions are conceivable. Theoretically, other real estate funds could be considered as proxies, but only if they calculate their NAV monthly.
• The capital management companies have monthly valuations carried out according to suitable valuation models. This will lead to a sharp increase in costs and thus increase the overall cost. For example, the defendant capital management company already spent EUR 2,205 thousand on external valuers for the affected real estate fund in the 2023 financial year, which corresponded to a share of 1.5 % of the total expenses. This figure is likely to triple. In addition, the market for real estate valuation should be able to meet the increased demand at all. This seems questionable in view of the huge number of properties in the funds and is also likely to cause costs to rise further, further reducing the attractiveness of the product.

D. Outlook

Since the decision has great economic significance for the defendant and its investors, it stands to reason that it will appeal. A decision by the Nuremberg Higher Regional Court should then be expected within a year. The Higher Regional Court will take a closer look at the discrepancy between the risk to be declared and the actual risk and will also take a closer look at the special features of the real estate asset class.