ARC Fund Risk management framework

The Fund Manager uses a Risk Management Framework to appropriately identify, measure, manage, monitor, and report on risks. The Fund manager also sets the risk indicators, risk limits, and risk appetite for the defined risks. Fraud risks are in separable connected to risk management and are therefore integrated in the framework. The risk management performance of the ARC Fund is assessed in close consultation with the Portfolio Manager and the RCO on at least a quarterly basis and more frequently in case of significant events. The findings of the assessment are included in the quarterly Investor report's Risk Management Dashboard. The Director Finance and Risk is responsible for the risk reporting to all relevant stakeholders.

Identified risks of the ARC Fund

1. Sales / rental risk: the risk that a home or a property cannot be sold / rented out within the envisaged period at the targeted sales / rental price.

2. Operational risk: the risk resulting from inadequate or failed operational processes and/or systems.

3. Funding risk: the risk of funding shortages and mismatches between funding and commitments because the ARC Fund:

3. 1. is unable to timely fund its commitments with new or existing equity and/or debt commitments at the desired conditions and/or from divestment proceeds;

   2. is in breach of its contractual obligations for its debt funding, which results in defaults and mandatory repayments; or

   3. incurs short-term liquidity shortages due to the insufficient coordination (by timing and amount) of cash inflows and outflows.

4. Portfolio risk: the risk that the portfolio development and operational results are not in line with the Portfolio Plan and as a result targeted returns are not achieved.

5. Counterparty risk: the risk that a counterparty fails to fulfil contractual or other agreed upon obligations. The main counterparties for the ARC Fund are Investors, banks, developers, appraisers, property managers, tenants, and buyers.

6. Political risk: the risk that policy changes and regulations by (local) authorities or governmental bodies affect the strategic objectives and business of the ARC Fund.

7. Climate risk: the risk that the ARC Fund is not adequately adapting to constraints resulting from climate change and/or fails to adequately report on its actions to address climate change.

8. Governance risk: the risk that a conflict of interest is not adequately addressed by means of governance as well as checks and balances and/or the risk that the ARC Fund is inadequately equipped to operate in the event of a conflict of interest.

9. Compliance risk: the risk that the ARC Fund and its operation are in breach of legislation and regulations, which may jeopardise the Fund’s AIF status.

Risk appetite and evaluation 2023

The ARC Fund invests in income-producing real estate investments in the Dutch residential sector. The generated returns from rental income are relatively stable and the ARC Fund acquires new projects on a turnkey basis, without incurring development risk. The ARC Fund uses modest levels of leverage to enhance returns. In line with its INREV core fund risk profile, the ARC Fund has a relatively low risk profile and correspondingly low risk appetite.

During 2023, the risk indicators and risk limits for the risk categories as defined by the Fund Manager were closely monitored. Four quarterly risk meetings were held to discuss development of risk indicators together with the Director Finance & Risk, the Portfolio Manager and the RCO. The potential negative economic impact of the war in Ukraine, which includes rising energy prices and a challenging interest rate environment, received special attention. Higher interest rates have a negative impact on fund returns as a result of declining valuations and increased financing costs. So far, the negative impact of the weaker economic environment on the Fund’s operation has been limited.

Sales/Rental Risk

The sales/rental risk remained elevated due to the higher interest rates and low investment volume.

Political risk

Anticipated (local) legislation, designed to interfere in the residential investment market, may impact the ARC Fund’s ability to execute its strategy. The Dutch government and local authorities have announced new rent regulation which may impact the rent generating capacity of the ARC Fund going forward. Uncertainty still persists on the exact outcome of the legislation process and its effective date.

Counterparty risk

The counterparty risk remains elevated due to the weaker economic climate and high construction costs. We have been able to manage this risk effectively with no material defaults occurring.

Portfolio Risk

The portfolio risk increased during 2023 primarily driven by the continuing negative revaluation trend and the lack of suitable investment and asset disposal opportunities, which hampers the execution of the asset rotation strategy at commercially feasible levels.

Funding risk

In 2023, the ARC Fund made use of its committed debt facility, equity commitments and sales proceeds to fund its project pipeline and redeem participations. During 2023, an additional EUR 135 million of debt commitments were secured in order to meet future funding needs. The Fund successfully secured its first USPP transaction with the notes issued on the US Private Placement Market to a consortium of US and Canadian institutional investors.

Hence, the availability of undrawn debt commitments increased. The available equity commitments decreased as capital calls were used to draw down all remaining equity commitments. On balance, the overall funding position decreased during 2023.

Various scenarios for liquidity – covering the expected realisation time of the acquisition pipeline and going beyond the current Portfolio Plan horizon of 2025 – were calculated and monitored. No liquidity constraints occurred in 2023 or are expected in 2024. The ARC Fund plans to secure new equity and debt funding in 2024, subject to market conditions, to fulfil outstanding redemption requests as well as fund and grow its pipeline in the coming years.

Compliance risk

Due to the fiscally transparent status of the fund, the ARC Fund is not able to incur any form of development risk as part of the acquisition of new projects for its pipeline. Therefore, the ARC Fund acquires its projects on a fixed-price, turn-key basis. In certain situations, the ARC Fund is able to secure a fixed-price, turn-key project subject to final permits and planning prior to start of construction. In these cases, the ARC Fund will obtain a put-option with a longstop date from the third-party developer, in order to be able to unwind the transaction in the event that permits or planning might not be obtained within an agreed time frame.

During 2023 the Administrative Court of Amsterdam ruled in a case against an institutional real estate investor that the much-applied rent indexation clause for liberalised rental housing (CPI + a max. 5% surcharge) is unfair within the meaning of European Directive 93/13/EEC on unfair terms in consumer contracts (Directive) and should therefore be annulled. The ruling has the effect that in said tenancy relationship: i) the rent reverts to the initial rent, ii) there is no possibility of annual indexation of the rent in the future, and iii) the tenant does not have to pay rent until the excess rent paid has been recovered. The investor is appealing against the decision and in two ongoing cases another investor asked preliminary questions to the Supreme Court. The timeline at present is unknown, but it will likely take at least until H2 2024. Currently, there are 7 judgements of similar kind ongoing for the  ARC Fund. These are all individual cases and will not affect other rental contracts. The Fund shares the general market sentiment that it is a remote possibility that this judgement will be (fully) upheld.

Overall risk performance

Management has performed its risk assessments in 2023 and concluded none of the risk limits set by the Fund Manager for the defined risk categories were exceeded. 

Updated risk management framework

The ARC Fund’s Risk Management Framework is a dynamic framework. The Fund Manager assesses, monitors, and reviews the risk management function, policy, framework, and its risk appetite, indicators, and limits on an annual basis and reports on these matters to the Advisory Board and Investors of the ARC Fund.

If necessary, the Fund Manager adjusts previously described risk categories in close consultation with the RCO and its stakeholders. In the fourth quarter of 2023, the Fund Manager presented the updated Risk Management Dashboard to the Advisory Board for annual evaluation.

Figure 20 plots the risk categories on an impact/ probability axis.

Figure 26: Plotted risk (impact/probability)