To succeed in today's challenging market, fund managers will need to pay all the more attention to AREF's golden rules as Rachel McIsaac, CEO of the Association of Real Estate Funds, reports

The lifeblood of the City has always been innovation, and the doubling of AREF's membership in the last three years, from 29 to 65 members, reflects the large number of new UK property fund launches. Even in today's challenging market there are several large new funds planned for launch in 2008.

Several other institutions are set to follow, evidence enough that there is life in the market in 2008. It's not only the large players entering the market - the last few years have seen the rise of several smaller boutique fund managers emerging as serious contenders for institutional money, running successful funds in an industry previously dominated by the fund management arms of international banks. Innovation is not only important at the fund level but, as this article explains, is also  a key skill for asset managers at the property level in creating value for investors in today's market.

So how easy is it to set up a new UK unlisted property fund? What are investors looking for? How can fund managers sell a credible opportunity in today's market and prove they have the track record and skills not only to attract new money into their fund, but also to outperform their competitors in a challenging economic climate? Can innovation make all the difference?

I receive many enquiries about setting up new property funds. AREF, whose members manage over £37bn (NAV) of UK real estate in 65 member funds, welcomes such calls. Using AREF's Code of Practice, which is endorsed by the NAPF, as a framework, new fund managers can set up approved governance procedures, reporting structures and accounting standards that institutional investors expect as a minimum. The association also offers networking opportunities and workshops so new entrants can learn from more established fund managers.

However, it is indisputable that the financial and real estate landscapes have changed. Both fund managers considering a new fund launch, and those marketing existing funds to investors, need to bear the following in mind in 2008:

There is cash available: Pension funds have not changed their allocations to UK commercial property, which remains a long-term hold and a core asset class in any balanced pension fund. Overseas investors and private equity groups are also making 2008 allocations to UK real estate. This is because the sector's fundamentals are still in place: diversification, low correlation with other asset classes, good long-term performance/risk adjusted return compared with other asset classes and attractive income yields. The UK pooled real estate fund market also remains a global leader in performance measurement, transparency and governance standards.  The fund proposal needs to make sense: A fund will only produce above average returns in this market if the fund manager can create value. Ideas currently include: a good rental growth story because the location is getting more and more desirable (London's Borough Market/SE1 for example); the continued exploration of ‘new' asset classes such as car parks or purchasing generally unavailable quality assets due to sellers requiring cash. Joint ventures with local authorities and bodies such as the NHS also still offer opportunity for the skilled asset manager and negotiator.  Track record is key: The experience of the manager in dealing successfully with difficult market conditions will make the difference between under performing and outperforming competitors. For example, robust rent collection standards are vital. One fund in the 1990s gained a strong competitive edge following successful litigation in the US, Bermuda and Hong Kong against a multinational tenant of an industrial unit who tried to walk away from their lease, which had a bond value of over £12m.  Leading a ‘gold standard team': If you do not already have the right people, fund managers need to be able to tell investors that they will recruit and lead the team needed to make a fund successful. Outstanding real estate fund management requires a diverse set of skills - financial astuteness, good project management, up-to-date planning and other technical knowledge, good negotiation skills, entrepreneurial and innovative ability and, above all, the ability to manage and lead other bright, demanding professionals such as lawyers, investment agents and accountants.  Be tenant led: Occupational demand is still good. Fund managers need to demonstrate to investors that they are skilled at understanding and meeting tenant demand for properties, and indeed are occupier led in buying stock. This means deep, dynamic knowledge of local markets, design led refurbishment and marketing, and competitive leasing packages. Fund managers must actively select and manage and actively manage letting agents who are the local leaders in doing deals. Investors also need to understand the role of strategic voids in the value-creation process. This is where space is not being actively marketed because it is being refurbished in an area of strong rental growth, so the fund manager is holding back to achieve a higher rent at a later date or is awaiting planning or other consents. Preserve income stream quality through tenant covenant monitoring: Reflecting the credit principles banks use to monitor their loan books, progressive asset managers now use key credit indicators to monitor the financial ‘health' of their largest tenants. Investors will soon request this as standard. Income rating data derived from payment patterns, credit history, loan defaults and profit warnings are all used to score tenants that are monitored for monthly and quarterly changes. The importance of innovation, creative thinking and problem solving: In a less benign property market, performance is achieved through the creativity and innovation of asset managers. This means the ability to: Create, at the lowest cost possible, new lettable space and therefore new income streams,  Anticipate changes in tenant demand and creating space to reflect those changes,  Solve persistent management hassles through service innovation, and  Run portfolios more efficiently and cost effectively.
Good governance brings investor confidence: Fund managers need to demonstrate to investors that even in difficult market conditions their procedures are robust and accountable. All AREF members are required to externally value their property portfolios quarterly, be fully transparent on management, performance fees and insurance rebates and produce annual reports. Best practice is also participation in the AREF/HSBC sponsored UK IPD Pooled Property Fund Indices, which at the end of the year will show investors exactly how a new fund has performed compared with its peer group and competitors.