EUROPE - INREV has developed a new fund-style classification to introduce what it describes as "a workable, robust and enduring" classification for the non-listed real estate funds industry.
The INREV Style Classification refines and updates its original framework introduced in 2004, which first classified non-listed fund styles as core, value-added or opportunity.

INREV said the original factors on which these styles were based - internal rate of return (IRR) and gearing - were now generally seen as inconsistent measures.
INREV chief executive Matthias Thomas told IP Real Estate: "In 2004, when the first style framework was drawn up, it was already clear it would need to be revisited.

"The idea of having a target rate of return and leverage as indicators of style was easy to understand and applicable at the time.

"These variables proved not to be robust over time, and we found that the framework was no longer synchronised with current market conditions.

"The other argument is more academic - target return and leverage are not independent of each other. The return is the outflow of the risk bundle you are prepared to take as an investor, so it cannot be on the same side of the equation as leverage, which is one of the return drivers."  
The study, based on data collected from more than 200 funds, showed that three groups of funds could be established on the basis of just three risk factors: leverage, development exposure and income distributions.
It also found that the three groups of funds determined in this way reflect low, medium and high risk, and that each group mirrored closely the classification of core, value-added and opportunity funds, respectively, with three-quarters of funds matching their current classification.
Lonneke Löwik, INREV's director of research and market information, said: "We've moved away from the principle of target internal rate of return as a determinant of fund style.

"In fact, IRR is really about the price of risk. Returns and leverage objectives have shifted over time, leading funds to drift across defined boundaries. The bundle of risks approach is more comprehensive and provides stronger data on which to base enduring classifications."
INREV also said the use of fixed numerical bands to classify styles could create boundary challenges for funds on the margins of the bandings.

The new tool provides a weighting to each of the risk factors and then combines the three to provide an "on balance of probability" allocation to a particular group.
The new funds style classification will be introduced to all newly launched funds from 2011 onward.
Löwik said: "This new approach is very exciting for the industry. It fulfils a long-standing objective to create a workable, robust and enduring basis on which to assess fund styles.

"The new approach means investors and fund managers will now be better placed when it comes to distinguishing between different fund strategies. Going forward it also makes it possible for the INREV Index to have INREV Style sub-indices which will be more robust and consistent than the current self-declared sub-indices.

"All of this enhances transparency for the non-listed real estate funds sector."
Thomas added: "While we don't expect to need to revisit the framework within in the next five years, as in the past, we will monitor the framework to make sure it remains applicable to a possibly changed market.

"Furthermore, we used data on 211 funds for the cluster analysis - if we have data for 300-400 funds in three to four years' time, and we rerun the cluster analysis, will we see identical clusters?"