Investors are more focused on governance, transparency and operational aspects of fund managers and joint venture partners, writes John Forbes.
The five years from the summer of 2007 represented a period of unprecedented turmoil for the real estate investment management industry. in preparation for a report for the Association of Real Estate Funds (AREF) – ‘Unlisted funds: lessons from the crisis’, published in January 2012 – it was apparent from the interviews with fund managers and investors that there was no ‘right’ or ‘wrong’ answer as to the relative importance of each party. The objectives of investors vary significantly and often change over time. What one investor thinks is an appropriate course of action for the manager will be less appropriate for another, and the manager is therefore dealing with a complex balance of conflicting demands. the greatest challenge is clearly where the conflict is between the needs of investors and the needs of the manager – for example, the short-term need of managers to maintain assets under management to preserve fees.
the judgement of managers by investors will be determined by the wisdom of the action taken, the way in which the decisions were taken and the effectiveness of communication with investors. in view of the breakdown in trust at moments of crisis, the report left an open question as to whether the behaviour of fund managers should be constrained further, in particular through the increased role of independent representation of investors.
On the positive side, the AREF report identified this also as a significant opportunity for product development. it also identified the importance of continuing dialogue between fund managers and investors. AREF has continued to maintain this dialogue since the publication of the report, as have other industry bodies.
A conference paper for the Royal institution of Chartered surveyors (RICS) and society of Property Researchers (SPR) – ‘the pressure for global corporate governance standards for the real estate investment management industry’, published in September 2013 – also sought to contribute to the continuing dialogue. Real estate has become an increasingly global and cross-border business in recent years. However, the global financial crisis exposed a number of weaknesses in the open and closed-ended fund model, as well as shortcomings in the industry in respect to governance, transparency, communication with investors, risk management and controls environment.
The key findings of the interviews conducted in the preparation of the RiCs/sPR paper were:
• Investors are indeed much more focused on governance, transparency and the operational aspects of the fund managers and joint venture partners with whom they invest. in the aftermath of the crisis, much of investors’ attention was focused on either resolving legacy issues or taking positions in existing funds. much of the new investment was through separate accounts, joint ventures and club deals where the investors have more direct control. it is only over the past year, as the raising of blind pool funds has recovered, that the changed environment has become more apparent.
• The real estate investment world is becoming more polarised with a small number of very large funds that can continue to name their terms and everyone else where investors are very much setting the agenda.
• Investors are formalising their processes for due diligence and their ongoing relationships with investment managers and are increasingly seeking to apply standards set by trade bodies such as the European Association for investors in non-listed Real estate vehicles (INREV). Investor concerns are feeding back into the trade bodies, which are in turn revising their guidance, with both INREV and AREF updating their guidelines on fund governance.
• Investors are increasingly seeking to apply good examples they see in one area to their investments in another. this is partly through exporting the appli- cation of trade body guidelines, but also individual examples of good governance. Australian examples were cited by a number of respondents.
• There is a broad concern among investors and managers as to the impact of variations in the sophistication and resourcing at investors with doubts expressed as to the capacity of some investors to meet the additional demands that they are setting themselves.
• While most of those interviewed thought that enhanced standards of governance would remain, some did think that the pendulum might swing back, firstly as pressure to invest overwhelmed the current risk aversion and, secondly, because many investors and managers do not have the resources to maintain current standards as investment volumes rise.
Whether in funds or in joint ventures, there is a greater demand for supervision of the ongoing operations. in the case of joint ventures, investors increasingly expect to play an active rather than a passive role. in the case of funds, it is now normal to expect there to be an oversight body looking over the activity of the manager. Generally, investors are in favour of investor advisory commit- tees consisting of the largest investors.
However, it is recognised that there are a number of practical drawbacks to this:
• Many investors are resource constrained and do not have the time to devote to the role.
• The powers of such bodies are restricted by legal requirement – for example, the loss of limited liability for limited partners in a UK limited partnership.
• Concerns over legal and regulatory liabilities. this was felt to be a particular concern of some Us investors.
• Smaller investors feel disenfranchised by the increasing powers given to large investors. Despite the potential disadvantages of the investor advisory committee, this remains generally the preferred oversight body.
• Some investors felt that such bodies should have an independent chairman. Investors have seen this on Australian funds.
• Although it currently remains a minority of those interviewed, some investors are in favour of the introduction of independent supervisory boards.
People will not invest in funds just because they have good governance, but will avoid those funds that do not. many of those interviewed said there were instances where they chose not to invest because managers or joint venture partners did not reach the requisite standards of governance and transparency. Where investors were prepared to give time to comply, there were also instances where they walked away from potential investments as they felt that additional time would not solve the problem. There is a clear message to managers that this is an area where effort is needed and will be recognised by investors.
John Forbes is an independent consultant