The INREV guidelines, widely adopted by the real estate funds industry in Europe, are being revised to reflect a significantly changed marketplace. Lonneke Löwik, Michael Hornsby and Renaud Breyer explain.

The stated goal of INREV, the European Association for Investors in Non-Listed Real Estate Vehicles, is to improve transparency, professionalism and best practices across the non-listed real estate industry. In this context, the association has actively developed guidelines that have been adopted by many non-listed real estate products within Europe. The development of these guidelines started in early 2000s and the first integrated guidelines were launched in December 2008.

Over the past 18 months, INREV has launched a thorough review in consultation with industry players and the guidelines were benchmarked with current practice. For instance, the reporting guidelines have been reviewed in light of more than 40 reports produced by large fund managers.

The Revised INREV Guidelines White Paper was released in October 2013 for members’ comments until the end of December 2013. During the months of October and November, INREV ran workshops with nearly 250 participants representing fund managers, investors and service providers. INREV members also provided feedback online. The comments and suggestions are being carefully considered and the final version of the Revised INREV Guidelines will be launched at the INREV Annual Conference in April 2014.

The objective of the revised guidelines was to align the guidelines with best practices in today’s market, but it was also intended to ensure that the guidelines were in line with new regulatory requirements, such as the Alternative Investment Fund Managers Directive (AIFMD). INREV also wished to make the guidelines practical and improve accessibility by making them available online. The use of an online version allows users to filter functionality and provides a more interactive and user-friendly version for the future. The industry will further benefit from the online tool when INREV releases a complete set of guidelines specific for various fund styles and fund types.

There have been significant improvements to the overall structure. The original guidelines were organised according to the lifecycle of a fund, with separate requirements depending on the stages, namely the launch, the operations and the exit. The revised guidelines are organ- ised by modules: corporate governance, fund documentation, reporting, property valuation, INREV NAV, fee metrics, liquidity, and INREV data delivery. The guidelines on fund performance are still under development and will be launched late 2014.

In addition to the revised structure, the language of the guidelines has been improved to make it easier for fund managers and investors to use, and facilitates assessment of the level of compliance. The guidelines are enriched with tools and enablers, such as a corporate governance assessment tool and a compliance checklist.

From a content perspective, the work done by the various INREV committees is impressive and effectively results in a much better set of guidelines. This improvement will be appreciated by all users – fund managers, investors and service providers. Overall, the previous guidelines were already quite detailed on the fund operations. The 2014 Revised INREV Guidelines include greater emphasis on the relationship between the fund itself, the manager and the investors. More guidelines, tools and examples have been developed on investor-related matters, such as a capital call- distribution enabler and further disclosure on relationship with investors.

The revisions in detail

Even though the INREV guidelines remain a framework that investors and fund managers are free to endorse and with a level of adoption to be agreed between them, INREV has reshaped the compliance framework to ensure it is more understandable. The main change is the terminology used. The principal concept is close to the previous guidelines. However, the guidelines are now split between requirements and best practices that have to be fully complied with if a fund manager wishes to claim compliance with a specific module. The former are technical by nature and are more relevant to modules such as reporting, NAV, and so on. The latter are more behavioural, more subjective and are more relevant to modules such as corporate governance and liquidity. It must be noted that the compliance framework remains a work in progress, but we do not expect fundamental changes in the proposed approach.

The corporate governance module is the module that has been the most affected by the change from the fund lifecycle approach to the modular approach. It contains a series of best practices to be adopted by managers in consultation with investors. The best practices have been aligned to a large extent with AIFMD requirements, and particularly on internal controls to be implemented by fund managers and risk management activities. In addition, it contains specific further guidance on club deals, joint ventures, open and closed-ended funds.

“The work done by the various INREV committees is impressive and effectively results in a much better set of guidelines”

We do not expect fund managers and investors to face specific challenges when implementing these revised best practices to the extent the funds and the management company are regulated and scoped into the AIFMD. To ease this implementation process, the corporate governance committee has developed a user-friendly corporate governance self-assessment, which will certainly be used by many fund managers, as previously mentioned.

The previous version of the guidelines contained limited requirements on the fund documentation, even though a detailed template of a private placement memorandum was proposed. This module has been significantly enhanced with a detailed list of disclosure requirements to be incorporated in the documentation defined at the launch of a fund.

The new requirements list the terms to be included in the prospectus, and refer to the initial disclosure requirements proposed in other modules. Fund managers should carefully review these revised guidelines for funds they launch after April 2014 to ensure the documentation is complete.

Liquidity guidelines have also been significantly developed. The previous guidelines were quite limited in scope and mainly covered secondary market transactions, but INREV has now included further guidelines on issues and redemptions of fund units, as well guidelines for fund extension and fund wind-up. Similarly to the corporate governance module, the liquidity guidelines mainly consist of best practices. The only requirements for fund managers are to define a liquidity framework in agreement with the investors and to disclose the level of compliance with this framework.

The reporting guidelines have been redesigned on the basis that they should set a framework for the communication between fund managers and investors on the fund’s performance, operations and risk management policies. In this context, the reporting guidelines have been split into two blocks of requirements:

• Requirements to disclose quantitative data. These quantitative data are encouraged to be provided in the standard data delivery sheet template, as issued in 2012 by INREV, for standardisation purposes. They can alternatively be included in the annual and interim reports to investors;

• Requirements to disclose qualitative data that consist of analysis, comments and explanations on the quantitative data. This approach should not fundamentally change the content of the reports to investors. It provides a more comprehensive and understandable frame- work. However, we expect that the implementation of these disclosure requirements to be less relevant for funds where investors are close to fund’s operations and, therefore, do not need such a level of disclosure to understand the fund manager stewardship when running the fund. In addition to the annual reporting requirements, INREV has introduced interim reporting guidelines. These have also been developed based on best practices observed in the market. These interim reporting guidelines encourage finance teams to provide investors with an abridged report, for instance on a quarterly basis. The interim guidelines have been designed to encourage fund managers to provide an update on the fund performance and operations to the investors, rather than a full picture. Therefore, the interim report is expected to be in an abridged form, which is consistent with most European GAAP.

Even though the wording is pretty similar to the previous version of the guidelines, the onus is on the fund manager to take more ownership of the outcome of the valuation process and to ensure that this valuation is properly done. For instance, the fund manager must ensure that comprehensive, appropriate and transparent information is provided to the external valuer and the manager should formalise internal valuation review and approval process.

We do not expect this change to significantly affect the fund operations because, as a result of AIFMD and many corporate governance rules, fund managers will upgrade their internal controls, including the ones on the property valuation.

The NAV module has been subject to a lengthy review process, as it is a key performance indicator that investors monitor closely. During the review process, the amortisation of set-up costs and acquisition costs over a period of five years have been heavily debated. The consensus reached is to maintain the five-year amortisation period for these costs and to continue the debate between fund managers and investors globally in co-operation with industry associations in the US and Asia in the coming years. Hopefully, a wider consensus will be reached on this matter.

The change in the INREV NAV requirements that will have the biggest impact on NAVs is the possibility for fund managers to reverse the negative net assets of deals that have a negative net equity, to the extent there is a limited recourse mechanism. We expect fund managers to welcome such an adjustment, as the NAV will better reflect the economic value of the fund.

The computation of the total expense ratio (TER) and of the real estate expense ratio has been clarified. They are required to be computed on an annual basis and no longer on a quarterly basis. In addition, the allocation of certain costs, such as related party costs, has been clarified and the example of fee computation has been upgraded.

In summary, the revised INREV guidelines propose a set of comprehensive and more understandable set of rules that will encourage fund managers to raise their game. As they stand, the guidelines remain most targeted towards the core end of direct funds, and therefore may not fit the needs of all funds. In this context, INREV committees will put a lot of effort in the coming years to develop guidelines specifically for different fund types and styles.

Lonneke Löwik, left, is director professional standards at INREV. Michael Hornsby, centre, is partner and real estate funds leader and Renaud Breyer is director at EY Luxembourg.