There is still much room for improvement in the governance of listed real estate companies. With low investor confidence, expect the market turmoil to drive progress. Christine Senior reports

Improvements in corporate governance and standards of disclosure are not achieved overnight, but by steady step-by-step progression. Although standards in listed companies vary enormously across the world, they are gradually rising, driven by pressure from investors and organisations such as the European Public Real Estate Association (EPRA).

EPRA's report on corporate governance earlier this year rated four key aspects of governance practice and found room for improvement even in those countries with the best standards - the UK, the Netherlands and Switzerland.

Even in these best-rated countries, standards varied considerably. But in three countries - Austria, Greece and Germany - EPRA described standards of corporate governance as "worrisome". EPRA investigated four key aspects of corporate governance - percentage of executive compensation linked to performance, independence of the supervisory board, auditing mechanisms and level of disclosure in annual reports. The first two were those areas most in need of improvement.

Although on average only 50% of executive compensation is linked to performance, EPRA says it is an effective means of creating an alignment of interests between executives and existing shareholders. As for supervisory boards, the report showed 69% of the 101 property companies rated did not have clear separation between management and supervisory board.

 "The corporate governance report we put together was well received by the industry," said Fraser Hughes, research director at EPRA. "We have had quite a lot of feedback and a number of members, some big companies, have said ‘this is a good first attempt, now we want to get involved to make it evolve well over time'."

In Europe, Austria has the dubious reputation of having some of the worst corporate governance scandals in recent years in its listed real estate sector. Meinl Land bought back its own shares without shareholder approval, and a payment of €520m went missing from Immoeast, which also suffered a catastrophic drop in its share price after writedowns of eastern European assets.

There are problems too in Germany where listed property companies have dragged their feet in providing the amount of information that investors demand, and there have been instances of companies with excessive levels of debt and poor performance. But these examples of bad practice, or even scams, have been among non-REIT companies. REIT structures are regarded as driving up standards of transparency and corporate governance.In today's market conditions companies cannot afford to compromise on governance and transparency. The tough climate is likely to force a shake-out of those companies with poor standards.

"Certain listed real estate stocks where levels of corporate governance are not as high as investors desire may not survive this downturn," says Harm Meijer, real estate analyst at JP Morgan. "Investors are increasingly reluctant to invest in such companies, which are frequently non-REITs. To date, REITs have strongly outperformed non-REITs in this downturn and that is partly because the applicable legislation dictates that REITs must have defined leverage levels, must report at certain items and are prohibited from certain activities."

In the area of financial reporting, investors are seeking greater disclosure. In spite of common accounting standards in Europe - the International Financial Reporting Standards (IFRS) - there is still a lack of consistency in the way figures are presented, which makes comparisons difficult for investors.

"Despite the fact that property companies subscribe to IFRS they are still able to report on their property portfolios in different ways," says Meijer. "For example, how do you define a yield on a property portfolio? You can do it 10 ways. So it would be fair to say that few of these indicators are truly comparable."

This point of view is echoed by Geert de Nekker, director of Cordares Real Estate, who says reporting standards in Europe are improving, but slowly. "Smaller European companies still have the habit of reporting in their local language. Also, the timing of reporting varies greatly. I would like to see a uniform set of rules worldwide, the obligation to report in one uniform language (English) and in a standard time period, for example a maximum of six weeks after quarter-end and a maximum five months after year-end."

With the publication of the SEC's road map, proposals for the US to adopt IFRS accounting standards by 2014 - bringing the US and European REITs under a common set of accounting standards - is currently under discussion. The two standards adopt different approaches to accounting - the existing US standards are more prescriptive, while the European standards are more principles based.

"US accounting standards tend to have more prescriptive rules for each particular financial situation with less flexible rules on how to report those, leaving less room for interpretation," says Gareth Lewis, finance director at EPRA. "Those rules are effectively governed by the SEC. The approach under international accounting standards, as in Europe or Australia, leaves more room for interpretation, it's more principles based. It allows management who understand best how their business works to use their judgement in how to report different transactions."

 Even though any change will mean US companies have to adapt to a new set of standards, that does not necessarily imply that only US companies will have to compromise. It will involve some give and take by both sides, according to Lewis. "During this process of convergence we might see in Europe more US influence on how the principles-based accounting standards are used in practice. We are likely to see more prescriptive guidance to interpretation - to satisfy the US preferences."
One area where European companies suffer by comparison with their US counterparts is in disclosure of information that investors find useful. The US is held up as a model of standards of openness in financial reporting by Svitlana Gubriy, fund manager of two of Standard Life's global listed property funds.

"We find a lot of companies in Europe are not willing to disclose more than they have to by law. For example if you look at reporting done by US REITs, every quarter, in addition to the standard balance sheet income statement and cash flow statement, they also publish supplementary information.

That could be 50 pages long; they would list every single property they own with all the debt they have associated with these properties and they list all the activity they have done on the leasing front. In the UK, companies often cite commercial sensitivity of that information and aren't willing to disclose it to investors. It creates a difficult situation, especially in today's environment, when everybody's focusing on the strength of the balance sheet - you need to know what's happening there."

Another particular area of concern in today's tough market conditions is valuations.
Definitions of fair value are harder to come by in an environment where there are fewer transactions to provide accurate data. But there is an issue of comparability in countries where external valuers are used compared with those where they are not. Simon Hedger, senior portfolio manager, property securities, at Principal Global Investors, says the UK and Australia, for example, beat the US for transparency here.

"Some countries like the UK and Australia have an annual open market assessment by one of the external agents," says Hedger. "There is significant clarity as to what the underlying net asset value of the stock is. Compare that with the US - they are not required in the US to fall in with external valuation on an annual basis; they can rely on director valuation. They can massage valuations down to suit themselves."

These variations in the level of transparency of valuation have affected share prices, as valuations are priced into the share, knocking back the value of shares in Australia and the UK. US companies, on the other hand, have held up relatively well through the effect of directors' rather than open market valuations.

In parts of Europe, such as France, the level of writedowns that would have been expected in current market conditions has not materialised, distorting valuations.
But Hedger says less transparency on valuations should ultimately have an effect. "Better broking houses take a more global view on what is happening. If they don't believe valuations being reported by the companies truly reflect the real situation they will be suggesting the writedown should be greater and therefore you would assume that would be reflected in the share price with deeper discounts."

Investors have the ultimate power to disinvest if they are not happy with the level of information provided by companies, but even without going that far shareholders are able to put pressure on to force companies to be more transparent. Shareholders are in a good position to get improvements, says Gubriy.

"Quite often companies would seek advice from shareholders in terms of improvement of disclosure," she says. "Shareholders have seen different types of disclosure and can point to areas of potential improvement. If investors are not happy with disclosure they can always sell their stake. That may put pressure on the stock price and over the long term this kind of pressure would have a negative impact on the company's performance.
In reality when we meet with the company's management we discuss the issues."
Market turmoil is likely to have a beneficial effect on regulation in Asia according to Peter Mitchell, chief executive of APREA. Improvements could be triggered by regulators' concern at the exit of investors from publicly traded real estate markets over the past few months.

"Regulators are quite rightly asking why that has happened and what needs to be done in other areas for improvement to remove that volatility," he says. "We are making submissions to a number of regulators at the moment and I think what we are going through will undoubtedly lead to a better operating environment moving forward."
As elsewhere, in Asia there is concern at the disconnect between the stock value of REITs and the NAV of the underlying assets.

"Whatever one's appreciation of what NAV is, undoubtedly many of these stocks are trading at way below, and there is a major mismatch between stock price and underlying asset value," says Mitchell. "There will undoubtedly be an upward correction at some point. There has been a massive overcorrection. A lot of investors are looking at more value in REITs stocks than in direct real estate at the moment."

APREA is helping regulators in certain countries to iron out specific difficulties. Japan, for example, is characterised by concerns on how mergers and acquisition and privatisation activity rules apply to REITs, and there are liquidity issues for some of the smaller REITs. Mitchell expects legal changes to improve clarity over takeovers and privatisations for REITs in Japan. APREA is involved in moves to enable REITs in Japan and Singapore to have an expanded set of capital management tools available. For example, in Japan REITs currently are not able to buy back shares and in Singapore overnight placements need to happen more quickly.

Australia has long been admired for the transparency standards of its REITs. Australian REITs provide an enormous amount of detail on property holdings, compared, for example, with the UK. Nevertheless, in Australia there is still room for improvement. Reforms are being sought in the area of stapled securities, which have in some cases brought REITs and non-REIT activities within a single security.

"That has led in some cases to some gearing and opaqueness issues with regard to some well publicised difficulties in the Australian market," says Mitchell. "Because of the advent of stapled structures REITs in some cases lost the essential characteristics of traditional REITs, taking on more risk. There was a drive for more and more return to investors. I think there will be a review of regulation of REITs in the Australian market moving forward."

APREA is currently helping regulators on proposed REITs regimes in Thailand, India and the Philippines. "Despite what we are going through at the moment there is an inevitability of more REITs markets developing in Asia," says Mitchell. "We are working generally on a number of levels in providing member input on how regulation of REITs can be improved.

Within the next few weeks a handbook of best practice recommendations will be presented to the board of APREA. This is currently under scrutiny by members before the final version is agreed. The organisation also runs courses on corporate governance and best practice standards for interested people throughout Asia. The flagship course leading to a certificate of real estate investment finance, which covers corporate governance, regulation, asset management and applied valuation, attracts participants from across Asia.