From the perspective of the real estate industry, the key concern is that the introduction of Solvency II and equivalent for pension schemes will have a major impact on the way in which European life insurance companies and defined benefit pension schemes consider real estate as an asset class.  Key to this is how they will be required to model the capital that they will need to hold in respect of potential future falls in value of their investments. Insurers will either use a “standard formula” set down by the EU regulator (which assumes a market fall in real estate values of 25% across the board) or seek approval from their national regulator to use their own internally generated risk model.

A concern for the real estate industry is the treatment of real estate lending by insurers. With the pressure on banks causing them to retreat from real estate lending, many in the industry had hoped that the attractive risk-adjusted returns for property senior lending would attract insurers into the market.  The current proposals for the regulations are anomalous and for commercial property lending generally appear to take no account of the presence of collateral.  There are also other areas of concern so it is important that the real estate industry continues to make its voice heard in lobbying.

The most immediate effect will be in 2013 as insurance companies prepare themselves to be regulated by Solvency II from 1st January 2014. Beyond that, the impact will be broadened as Solvency II type regulation is planned to be introduced for pension schemes. Looking further out, the effect is likely to be even more far-reaching. The regulation may help accelerate the demise of traditional retirement products. Unit-linked life products, defined contribution pension schemes and other new products where the investment risk is borne by policy holders and there is therefore no capital charge will increase their dominance as more primitive species face extinction. The real estate industry is not yet well adapted to the new environment.

John Forbes is a PwC partner advising real estate investment management businesses.