New regulations, market growth and greater investor demands are ushering in a new era for real estate fund managers, writes Phil McGowan
As real estate funds begin to emerge from a period of major structural changes to embrace a recovery in global markets, leaders are laying substantial plans for growth. And while these industry shifts come with vast opportunities, they also bring challenges, according to the results 2013 State Street Alternative Fund Manager Survey, conducted in collaboration with Preqin and canvassing almost 400 alternative fund managers globally.
A new environment of intense regulatory scrutiny continues to be at the forefront of real estate fund managers’ concerns. At the same time, the sector faces intense pressure from increasingly sophisticated investors that have new and higher expectations than ever before.
With nearly 40% of real estate managers in our survey saying that adapting to regulation will be a top challenge of the next five years, it is clear that compliance continues to be a topic of burden and uncertainty. Among the many global regulations, there are three main structures that are of particular concern to our survey participants:
• EU Alternative Fund Managers Directive (AIFMD);
• US Foreign Account Tax Compliance Act (FATCA);
• US Dodd-Frank Act: Private Fund Registration and Form PF.
European and North American respondents had slightly different areas of emphasis: European managers are most concerned with AIFMD provisions on remuneration, while North American managers are less concerned. However, it’s clear that the daunting requirements of new regulations are looming large across the board.
“AIFMD is too burdensome, to the point that our firm will not market to EU investors, as it simply isn’t worth it,” says one real estate fund survey participant based in North America.
Uncertainties – about the precise requirements of these new rules, as well as what the ultimate effects will be on the industry – continue to weigh on the industry. According to another North American real estate fund, “the Dodd-Frank Act is a killer. Tons of regulation, yet no one can describe the pay-off for the work.”
One thing is certain: regulation is raising costs for real estate investing, requiring funds to find new operational and cost efficiencies.
In recent years, institutional investors have allocated more to alternative funds, which is creating a new dynamic in the industry. Alternative fund managers are increasingly relying on institutional investors as important sources of capital, but that money is accompanied by new demands. According to our survey, investor demand for greater transparency around risk and performance is the top driver of change in the industry. This was cited by 51% of real estate managers.
Real estate managers that will be most successful in this new environment are already taking measures to keep up with investor demands. More than half say they are now reporting more information to investors on holdings, risk and performance, while 18% plan to do so in the next five years. Flexibility in fees has also been high on investors’ list of needs, with 30% of real estate managers saying they have adjusted their fee structure in the last five years.
The reverberations from the global financial crisis, which caused havoc in global banking, debt provision and the general economy, have not faded away entirely. But the leading players are now shifting their focus to growth. For example, only 11% of survey respondents say they plan to further reduce their leverage in the next five years.
Meanwhile, investor appetite is increasing. There have been several high-profile moves among real estate managers to set up new global real estate funds with targets in the region of several billion US dollars, and investor interest in at least one of these has exceeded expectations.
A related trend in the real estate sector is that more funds are planning to expand into new regions. Almost one-third of respondents plan to do so in the next five years and 16% have already done so since 2008.
Real estate funds will need to navigate a number of challenges to achieve their growth ambitions. The majority of respondents (82%) say fundraising is a top challenge for their businesses in the next five years – a higher proportion than for hedge funds and private equity managers in our survey. Generating performance and adapting to regulation are also high on the list.
Some real estate funds are recruiting external support in the form of independent service providers to help them overcome challenges and focus on main competencies. The greatest benefits of outsourcing the administration function cited by real estate managers in our survey are that it allows them to focus on their core business of investment management, as well as to access best practice industry standards.
The challenges ahead are sizeable, but there are huge growth opportunities for real estate fund managers that can develop the right strategies to navigate regulatory pressures
while satisfying investor demands.
Phil McGowan is senior vice-president and head of private equity and real estate fund services at State Street