Amid a more bullish atmosphere at this year's EXPO Real, INREV's new chairman, Michael Morgenroth and its new CEO, -Matthias Thomas, stress that the industry still faces big challenges, including the need to engage positively and proactively with the regulators. They speak to Martin Hurst
We don't want to fight regulation," says Matthias Thomas, who took over as INREV CEO from Andrea Carpenter in August. "Today it is more about how we make it work as efficiently as possible for the real estate industry."
Engaging in a way that is timely, coordinated and fruitful for the industry is key. Two major regulatory initiatives currently on the table - Solvency II and the Alternative Investment Fund Management Directive (AIFMD) "demonstrate that the real estate industry has not been very active in lobbying" and when it has done "it has been very fragmented," says Michael Morgenroth, who assumed the chairmanship of INREV in June, succeeding Johan van der Ende.
Morgenroth is also a management board member of the asset management arm of Cologne-based Insurance firm Gothaer. "In Germany for example there are a number of organisations, each focusing on a specific area. AIFMD and Solvency II are European industry-wide problems," he continues. "The industry has just started to realise what the impact of this regulation will really be and we now have to fight for it. As a pan-European organisation with members in 29 countries, representing all players in the non-listed fund industry, INREV should co-ordinate efforts."
The INREV leadership has thought long and hard about lobbying. In 2005 it decided against taking on a lobbying function, stressing its key goals of market transparency and education. But with the onset of regulation in response to the financial crisis and the complex set of challenges the initial drafts have presented for the real estate industry, it is clear to INREV that playing a more active role in the public affairs arena is now essential. Thomas stresses the responsibility the industry bears to present its case: "We must ensure the industry's voice is heard in Brussels - the regulators need educating."
The emphasis is important. "I avoid the word ‘lobbying' - it is more a case of public affairs," Thomas explains. "The issue is how to become involved in Brussels in the early stages of the legislative process - of being asked to participate in expert hearings so the industry can make its voice heard soon enough for it to have an impact.
"Our objective is not to argue that non-listed real estate is superior to listed or direct real estate, but to make it clear it is an asset class in its own right, with its own risk-return attributes, and ensure it is treated in a sensible and fair way.
"We need to educate the regulators that the non-listed real estate funds industry is both transparent and efficient."
In the case of Solvency II the devil is in the detail. "There is no reason to argue against having a risk-based capital approach - in theory, this is a good method," Thomas explains. "The question is whether the method chosen by CEIOPS makes sense.
Morgenroth adds: "It applies the same capital reserve requirements for a property development in the middle of the Kazakh desert as for a residential development in downtown Munich. Furthermore the capital reserve required for government bonds is zero, even if we are investing in Greek government bonds. Relative to other asset classes, government bonds are receiving preferential treatment. Government bonds have different ratings so they should also have different capital requirements, yet this is totally neglected. The same is true for real estate."
Thomas sees clear implications for the real estate funds industry. "This will feed through to the direct markets: less capital will flow to the direct real estate market and, in the long term, there will be a decrease of stock and construction activity, leading to higher rents."
Morgenroth believes that as a result of the new regulations, "insurance companies could increase their bond allocations from 80-85% to 95%."
There is a widely held view in the real estate industry that this regulation is hurting those it is intended to protect. Solvency II imposes a capital charge of 25% on direct real estate and 39% on real estate funds. The charges apply to the equity portion of the investment only.
"The aim of this regulation is to make the investments of insurance companies safer in the interests of their private clients, but it will in reality achieve the opposite," Morgenroth says. "Given that the capital charges apply only to the equity part, insurance companies will be incentivised to invest in funds with lower equity and higher leverage - to go into more risky investments in terms of returns. One consequence of this will be that no German insurance company will invest in German residential. It makes no sense. This is a mistake in the system which has to be corrected."
"Although quite a number of associations are representing the interests of the insurance and pension fund industry in Brussels, the specific issues of real estate investments in combination with Solvency II have not been picked up by them," Morgenroth explains.
"The reason for this may be that the existing associations had other priorities based on the fact that the highly dominating bond exposure of life insurers is in the area of 80-85%, while the real estate allocation is in the area of 5%."
Morgenroth sets out a further consequence of Solvency II that he believes is also contrary to the aim of the regulator of making the investments of insurance companies less risky. "The regulator is pushing insurance companies towards a monocyclic investment in fixed income. Given the environment of historic low yields the foreseeable rising inflation would then hit insurance companies and their clients with their asset allocation of 95% to bonds. What that means for capital values - you don't need to be a genius to work that out."
In order to argue the case Morgenroth believes there is a need to discuss the characteristics of real estate in its various forms in relation to other asset classes. "In this context it is all the more important to measure the performance of non-listed real estate funds. As well as being important for investors to have an index for benchmarking purposes it also helps us demonstrate to regulators that the 25%/39% capital charges are not applicable for all countries and segments."
In a major step forward in measuring the performance of the non-listed property sector, INREV published the first quarterly Index results in September. The results offer investors and fund managers the first real chance to incorporate industry-level returns into their quarterly performance evaluations of funds. Investors and fund managers find more frequent data extremely helpful for understanding and benchmarking fund performance. "This will further increase market transparency," Thomas says.
INREV is pleased with its coverage of both the annual and quarterly indices although, as he points out, "there is always room for improvement." He emphasises it is critical that fund managers provide the missing historical data in order for INREV to freeze the annual index in the next six to nine months, providing a more reliable industry benchmark.
On this last point he highlights the research INREV is carrying out on manager styles. INREV has come a long way since its first set of definitions based on IRR and leverage, and a new round of work is currently underway to further refine the definitions. "Once we are clear about the definitions we can freeze the style indices," he says.