The INREV guidelines continue to gain traction throughout the European unlisted industry and beyond. In today's challenging market the logic of compliance is clearer than ever - but there are exceptions, as Richard Lowe reports

Having integrated its industry best guidelines into one document, one of the priorities for INREV in 2009 is to increase their adoption. Success of the guidelines, the association admits, can only be judged by their take-up. INREV's most recent member survey found that 92% of investors looked to fund managers to adhere to the guidelines and 76% of fund managers were incorporating the guidelines into their fund processes.

"There is quite a high level of awareness of the INREV guidelines within the investment fund management community," says Neil Turner, chairman for INREV's fee metrics working group and head of property fund management at Schroders. "This has changed in the last two to three years, as INREV has published widely in this area and organised events to discuss the guidelines and given the membership an opportunity to contribute to the debate and help structure the guidelines."

Pieter Hendrikse, chief executive at ING Real Estate Investment Management Europe, is a co-founder and board member of INREV, and sees clearly and simply the significance of the guidelines and why fund managers would want to implement them. "It depends whether you stand behind the INREV goal to make the market more transparent, visible and professional, and that you listen to your shareholders and investors," he says. "If that is the case, as a manager, there is no way back, there is only a positive look into the future… that you implement the guidelines."

F&C REIT Asset Management offers both real estate funds to investors and invests in funds on behalf of clients of its multi-manager service. "When we are looking at funds," says Iain Reichwald at F&C REIT, "it's one of the first things we ask for and when we are offering funds it is one of the first things we offer out."

INREV and its agendas, including the guidelines, is very much driven by the needs of investors. ATP Real Estate, the property investment management arm of Denmark's largest pension fund, is a founder member of INREV, and a prime example of the type of investor INREV represents which places great importance on the INREV guidelines and the principle of greater transparency that the association is driving.

"In general, managers are ready to comply with INREV standards and what comes from INREV. We support it so much that it's difficult for them not to," says Allan Mikkelsen, partner at ATP Real Estate and a member of INREV's reporting committee. "Let's put it this way: if we are restricted from information from a private equity fund in any way, we would not invest."

It may be an overstatement to say that compliance with INREV guidelines is today a pre-requisite to raise investor capital, but it is likely that compliance will significantly improve fund-raising potential, especially where European pension funds are concerned.

"I think you would be mad not to [comply with INREV] at the moment, especially in today's fund-raising environment," says Rob Short, partner and co-founder at Langham Hall, a provider of outsourced administration and accounting services to real estate funds and a co-author of the guidelines.

"You would need to be pretty bullish about not giving yourself every opportunity to get a leg up as far as securing commitments. If you were launching a fund today, why wouldn't you, if you are starting from scratch especially? I think you need to have a decent reason why you wouldn't want to be INREV compliant."

That said, Short believes there was a "heavy momentum" driving fund managers to adopt the guidelines before the advent of a much tougher fund-raising environment. It is likely that the number of managers adopting the principles and the level of compliance would have increased without the onset of the downturn. But the downturn has certainly helped the cause.

Langham Hall is seeing many funds compelled to explore the process of adopting the guidelines after prospective investors ask them if they are INREV compliant. David Adler, head of business development at the firm, says it is often seen as a valuable marketing tool for newly established and niche fund managers.

Nordic Real Estate Partners, founded in 2005 with the aim of managing focused niche funds - currently within prime logistics, self storage and high street retail in the Nordics - is looking to raise capital for its first commingled real estate fund. The firm already manages two separate accounts for a large US pension fund and a UK institution. All future funds will be INREV-compliant, explains Mikkel Bülow-Lehnsby, partner at the firm, but not so much because it is seen as a necessary evil to attract investor capital.

"Our prime motivation for using the INREV guidelines is not to really satisfy investors, but rather to increase efficiency in our company and in the industry in general," he says. "For us it just makes sense that there is one standard that we can all adhere to, as it increases comparability and over time hopefully decreases costs from running funds. In addition, being a newer fund manager, the guidelines help us determine how we should organise ourselves, what principles we should be using for valuations, etc, which fundamentally saves us time and costs."

Reichwald remembers that before the introduction of the INREV guidelines, the industry was grappling with transparency and reporting pra ctices on an ad hoc basis.

"We were struggling to do these things three or four or five years ago, when we were inventing these things in an amateur way. Then suddenly an INREV project would come out and you could get involved in it and six months later there was a really professional product," he says. "They are coming up with the all the answers that we'd been asking ourselves and getting a much broader sample of people's views and turning it into something meaningful, which I thought either reaffirmed what we'd done or just actually took it a bit further."

There is certainly anecdotal evidence to suggest that INREV's due diligence protocol is gaining traction outside its traditional remit. Some investors are applying the general principles to non-European funds, allowing them to ‘tick off the boxes' in important areas. For example, Reichwald says F&C REIT have applied the protocol when looking at Middle East funds and ATP's Mikkselsen says: "some of the topics we clearly try to bring to the US as well".

There are even suggestions that some in the private equity buyout funds industry have turned to INREV's due diligence protocol as a starting base for their reporting for fund launches.

Short says that INREV's due diligence protocol is so well put together that it has moved it ahead of other investment fund industry bodies like the European Private Equity and Venture Capital Association (ECVA). "The ECVA does not have anything that resembles the due diligence protocol and for that [INREV] should be commended," he says.

Adler believes this is an important point. "The thing to remember is this is a competitive market," he says. "There are different trade organisations and even within the alternative asset class you have sub-classes - you have real estate and then you have listed and unlisted. Part of the process here is to make this specific asset class - the unlisted real estate vehicle - as attractive as it would be to investors for the other asset classes. And so it's in everyone's interests that best practice happens, because otherwise it becomes, as a whole, an asset class that becomes less attractive potentially than other more transparent and easily invested-in or more liquid asset classes."

A common question Langham Hall hears from fund managers is: what if we can't tick every box; if we can't comply with every item, can we still be INREV compliant? "I think that is the thing that worries people most," says Short.

But Short is clear that the intention of the guidelines was never to be prescriptive. "If you've got no debt in the fund, when it comes to the financing section it's clearly not relevant," he says.

There is no policing on the part of INREV to ensure investors are being compliant (the association recently launched a web-based self-assessment tool, which allows fund managers to check their compliance), and Short says the bottom line is that fund managers should not be misleading in any way. "If someone tries to short cut it and claim they are INREV compliant when they are not, then it is a small world and chances are investors will view it as the tip of the iceberg," he says.

However, there are perhaps a few more problematic areas. Opportunistic funds, for example, by their very nature will be less conducive to full compliance. Put another way, it will be difficult to justify not having full compliance for a core fund, particularly in the area of valuations.

"There are certain funds that report separately," says Short. "One month after the year-end they might produce a deal-by-deal summary and send that over to investors just to keep them informed. And to actually go through all of that work again for a detailed commentary on the fund in an annual report or quarterly report seems to be doubling up on work. So there is certainly some push back on some of the more opportunistic funds. They endorse the guidelines, but unlike core/core-plus funds, they had a separate process where they would update the investors."

Another potentially problematic area relates to the secondary market guidelines. Here INREV is seeking to protect investors from being prevented by fund managers to trade their closed-ended fund interests on the secondary market in the future. The manager could achieve this by either outright forbidding it or by making the process overly difficult or complicated to get the same result. The current guidelines seek to safeguard against this.

It is unclear how effective a provision this will be in improving the liquidity of real estate funds. Limited partners are certainly in a stronger bargaining position today compared with recent years and many investors may see a fund manager that seems proactive in facilitating secondary trades as attractive. But Short believes there is still a great deal of pressure on fund managers to prevent investors from being able to exit closed-ended funds too easily. "Otherwise it is open season really," he says. "You've basically got an open-ended fund."

Simon Redman, head of business development at Invesco Real Estate, believes that INREV's recent drive to bring about a more organised and transparent secondary market is not necessarily in the interest of its traditional membership - that is, fund managers and end-investors - but it is more likely in the interest of the burgeoning fund of funds sector.

And Schroders' Turner revealed his reservations about turning the unlisted real estate funds market into something comparable with a stock exchange at Mipim earlier this year, when INREV launched the results of its liquidity provisions study. Too much liquidity could have the potential to increase volatility and make the sector behave more like listed real estate. "Just a word of caution," he said. "We are in extreme times and you just might get what you ask for if you go down that route."

Bülow-Lehnsby believes a more organised secondary market could be a positive development. "One of the big challenges of the real estate asset class compared to others is the limited liquidity issue," he says. "If there was a more established secondary market, I think it would bring investors into our asset category."