Everything You Need to Know About Hungarian Golden Visa Real Estate Funds

Csaba Magyar
Budapest

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IMI Pro Csaba Magyar provides an in-depth overview of how real estate fund investments work for Hungary’s new Guest Investor Program.

• Characteristics of the Hungarian Real Estate Fund
• The Real Estate Fund Manager
• The Investment Certificate
• Advantages of the Real Estate Fund
• Risk and Investor Protection of Hungarian Mutual Funds
• Taxation of Investment Funds

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A third-country citizen whose stay is of national economic interest to Hungary can obtain a Hungarian guest investor residence permit. What does Hungarian immigration law consider to be in the national economic interest? Among other options – if the foreign investor invests in a unit, i.e., purchases an investment certificate issued by a real estate investment fund registered by the Central Bank of Hungary (CBH) with a value of at least EUR 250,000.

Different countries have different rules for real estate funds. In the following, we will review the characteristics of Hungarian real estate investment funds and cover the guarantees that protect investors.

Characteristics of the Hungarian Real Estate Fund

The fund is considered a legal entity. The special feature of this mass of assets with legal personality is that it does not have an organization or membership, so it is not capable of independent operation and decision-making. It is represented by the licensed fund manager, as a result of which the fund cannot function without the fund manager.

The investment fund, therefore, has legal capacity, and the fund manager provides it with the capacity to act. The legal personality of the investment fund is not created by registration in the register of the Commercial Court but in the register of the CBH.

We can group funds in several ways:

• By term: It is possible to create both fixed- or indefinite-term fund.
• By operating form: This classification is based on the marketing method, i.e., whether the investment units are offered to a closed group of investors, a predetermined circle, or to the public, i.e., to anyone. A public investment fund is considered to be one for which at least one series of investment units has been placed on the market through a public offering.
• By tradeability: In terms of the exchangeability of investment units, there are open-end and closed-end funds. With open-ended funds, investment units can be bought and redeemed continuously. Redemption is, therefore, mandatory on the part of the fund. In the case of closed-end funds, the unit can only be redeemed when the fund is terminated or at the end of the term.
• By asset focus: What is the fund manager’s investment policy, and which sectors does he primarily target? According to the primary asset category, there are four options to choose from: Securities funds (bonds, shares), mixed funds, real estate funds, and private equity funds.
• Finally, we can make a distinction between the collective investment fund dealing with transferable securities and the alternative investment fund (hereinafter: AIF).

The real estate fund also belongs to the AIF category. The real estate fund can be open-ended or closed-ended. Owners of units in open-end investment funds can continuously redeem investment certificates during the term, while investment certificates of closed-end investment funds are not normally redeemable during the term. The real estate fund can take the form of both a private and public fund and, as such, its investment certificates can be distributed to both professional and retail investors.

Converted from Hungarian forints, the smallest starting equity of the public real estate fund is approx. EUR 2,600,000, while, in the case of a privately established real estate fund, even half of this amount is sufficient.

A real estate fund is an investment fund that can only invest its assets in legally defined assets, which can be the following:

• Domestic or foreign real estate, including components related to the real estate;
• Shares in a real estate company;
• Property rights related to real estate;
• Securities, money market instruments, foreign currency, deposits;
• Derivative transactions; and
• Movables that are necessary for or facilitate the intended use, operation, or maintenance of the given property.

In the case of the Guest Investor Program, it is also a requirement that at least 40% of the net asset value of the real estate fund be made up of investments in residential real estate in the territory of Hungary. This means that the real estate investment fund is allowed to invest in commercial real estate, but 40% of the assets shall consist of Hungarian residential property.

The equity capital of the fund is the capital equal to the product of the nominal value and the number of units at the time of its inception, which is the same as the net asset value of the investment fund during the operation of the fund. The daily exchange rate of the investment unit shows the part of the assets per investment unit.

Real estate funds must hold at least 15% of their assets in quickly accessible assets (e.g., cash in a bank account, time deposits, government securities), i.e., liquid assets. They must also hold at least 5% of their liquid assets in government bonds issued by the Hungarian state. If the investment fund has bond investments, it must hold at least 95% in government bonds. The ratio of further assets may not exceed 52% of all assets.

The income of the real estate fund typically comes from the sale and rental of real estate. The fund manager must prepare a management policy for the given investment fund, which includes the most important rules for management and operation and lays down the investment principles.

The Real Estate Fund Manager

In the investment relationship, the fund manager is the most important actor between the investor and the fund. Before starting its operation, it must obtain a license from the CBH. During the investment activity, the fund manager acts on behalf of the fund. A fund manager can even manage several funds.

After the fund manager has collected the appropriate amount of capital, he decides (based on the fund management regulations accepted by the investors) what to invest in, then supervises the investment and, in the event of a successful investment, pays the investor a yield or reinvest the yield.

The fund manager is entitled to remuneration for the fund management activity, which is typically a predetermined share of the fund’s profit, thus aligning the fund manager’s chief incentive with that of the investor: Ensuring the investments result in profits.

The manager of the real estate fund must have a starting capital of at least EUR 300,000. If the value of the assets it manages exceeds EUR 250 million, it must increase its capital by 0.02% of the amount exceeding EUR 250 million (up to a maximum of EUR 10 million).

In connection with the guest investor program, only a fund manager that has a premise security certificate or is on the list of the Office for the Protection of the Constitution is allowed to act.

The fund manager is obliged to appoint an independent custodian to provide escrow account services and to carry out tasks related to the fund. Escrow account management is usually carried out by a bank or a specialized financial institution, but it must have a special license for this activity.

The custodian’s task is to safeguard and manage the securities the fund owns, to manage the fund’s bank account/securities account, to supervise the fund manager, and to perform technical tasks related to the sale and purchase of investment units and the payment of yields. The custodian is organizationally separate from the fund manager. Note that some Hungarian custodians accept investment into the escrow account of the fund only if the investor opens a bank account with the custodian.

The Investment Certificate

Each investor’s share of the given wealth is embodied in the investment units. At the beginning of the legal relationship between the investor and the fund, the placing on the market and the subscription procedure are the most important steps. The essence of the process is the placing of an investment certificate on the market, which the investor acquires and subscribes to.

The investment certificate is a transferable security issued in a series by the issuer in a specified manner and form, securing a claim against the investment fund and other rights specified in the management regulations of the investment fund. The following contents are essential for the investment certificate to be valid:

• The name, the registered office, the operating form, and the allowed investors of the investment fund;
• Type of investment fund (closed-end, open-end), type (public or private), term;
• Nominal value, security code (ISIN identifier), and serial number of the unit;
• The owner’s name;
• The rights of the owner or the holder of the investment unit, defined in the management regulations of the investment fund; and
• Date of issue, register number, and date of registration of the investment fund.

The investor must pay the nominal value of the investment certificate upon acquiring the security for the first time.

KELER is a key player involved in the production of securities. KELER is a specialized credit institution that also performs a central securities depository function, within the framework of which it facilitates the dematerialized creation of securities issued in Hungary, the issuance of the securities code (ISIN identifier), and the registration and management of central securities accounts.

There are two ways to produce the investment certificate: As a printed document or as a dematerialized security. Prior to the production of the investment certificate, it is necessary to request an ISIN identifier for the given securities series. Only a printing house licensed to produce securities may print certificates, and the CBH keeps a register of these printing houses.

As a general rule, the investment certificate is considered a security embodying a debt relationship but, at the same time, due to the property service obligation, it also partly carries the characteristics of securities embodying a membership relationship. Due to the characteristics of the former, the transfer of the investment certificate can be carried out by assigning the claim to the fund.

The investor is the holder of the security. Based on investment units, the most important right of the investors is that they are entitled to their part of the fund’s assets based on their proportional unit in the fund. The goal of the investor is to increase the invested property while taking risks, that is, they want to achieve a yield on their investment.

In practice, this is realized in such a way that the investor receives a yield from the fund on the investment units (distributed yield). The yield payment can be made from the capital increase of the fund, as well as from the capital represented by the nominal value of the investment units (in case of capital transfer).

Investors also have the right to request information about the operation of the fund and the fund manager. At the same time, the investor does not have the right to vote either in relation to the fund or the fund manager. Based on this, it is clear that the investment certificate provides the investor with only limited rights, primarily of a financial nature. At the same time, it is appropriate to point out that in other European countries, it is possible for investors to have more ownership rights, even those of a shareholder nature.

The redemption period for newly issued investment units is at least T+180 days. This means that anyone who has invested in a new real estate fund and later redeems it will have to wait six months for their investment.

In the case of the Guest Investor Program, the applicant must hold the investment certificate of the real estate fund for at least five years from the date of acquisition.

Advantages of the Real Estate Fund

Buying a real estate fund’s investment certificate instead of real estate has many advantages; it takes a lot of administrative and investment decision burden off the investor’s shoulders. In the case of investment funds, it is generally the fund manager and not the investor who makes the investment decisions, but for the benefit of the investor. So, the investor only needs to enjoy the return on their investment, while a team of experts make the associated professional decisions.

It is worth investing in a real estate fund for the following reasons, among others:

• The properties included in the real estate fund’s portfolio are continuously evaluated by a real estate appraiser commissioned by the fund manager.
• In order to acquire the property, the investor does not have to take out a loan, but the real estate fund takes out a loan if necessary.
• The selection of properties to be included in the fund’s portfolio is not the responsibility of the investor but of the team of experts working at the fund manager, just as the utilization (renting, operation) and sale of the properties owned by the fund are handled by the fund manager and not by the investor.

Risk and Investor Protection of Hungarian Mutual Funds

Liquidity risk is related to the harder sellability of real estate. In the event of a sale, it may be more difficult for the fund manager to complete the redemption of the investment units and he may therefore suspend it. For this reason, the rule presented above was introduced, according to which a redemption period of at least T+180 days is expected.

Considering that the profit of real estate funds can come not only from the sale of real estate but also from their utilization and rental, some risk is tied to whether the fund manager can profitably rent out properties in the portfolio. Fund managers usually try to minimize this risk by using safeguards built into lease and operating contracts.

Considering that, in the case of real estate funds, the real estate appraiser establishes the net asset value per share based on the value of the real estate in the fund’s portfolio, the difficulty of the current valuation of the asset in ever-changing market conditions is another risk. For this reason, the real estate fund must commission a real estate appraiser who, converted from Hungarian forints, has a property guarantee of at least approximately EUR 650,000.

The availability of investment certificates and deposit amounts is a priority. Investment service providers have an obligation to send the CBH the balance of securities and customer accounts, as well as the list of securities, every month. In the CBH-administered online application, account holders can check the statement sent to them with the data reported to the CBH.

The institution of compensation is meant to mitigate the damages that investors may suffer as a result of the inability of the member of the Investor Protection Fund (IPF) with which securities or money have been deposited to issue their rightful claim. This insurance covers commission, commercial, and portfolio management activities, securities custody, and securities account and customer account management services. IPF pays compensation up to a maximum of EUR 100,000 per investor and in aggregate.

Taxation of Investment Funds

The fund is a legal entity, but it is not subject to corporate tax. Therefore, the fund is not liable to pay taxes on the profits generated in the fund. The profit only “flows through” the fund since the purpose of the fund is to pay a yield to investors. In this way, after the profit generated in the fund, the investors will be liable for tax payment based on the yields received, but only if they receive a payment.

The investor can typically receive income thanks to their investment certificate in three cases:

• the investment certificate can receive a yield payment during the term;
• the investment certificate can receive a yield payment at the end of the term; and
• The investor may receive income from selling the investment certificate.

If the investor receives a yield payment through his fund-issued investment certificate, Hungarian tax rules classify the yield as a dividend. Hungary applies a withholding tax of 15% to dividends paid to foreign individuals, but a double taxation avoidance agreement between Hungary and the investor’s country of tax residence can reduce this rate. According to Hungarian tax rules, the profit realized on the sale of the AIF investment unit is considered interest income. A 15% withholding tax is also applicable to this, unless a tax treaty overrides the rule.

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