Big Brother

Europe's unlisted property sector is one of the most opaque in the real estate industry. Now steps are being taken to improve its transparency and corporate governance. Is anyone listening? By Robin Marriott.

If there was one story of the past decade that rocked corporate America, it was Enron. The spectacular collapse of the energy company in 2001 not only brought down one of the country's most powerful businesses, it also had wide-reaching consequences for accounting standards and corporate governance.

In Europe change came about too, though perhaps not as pervasive as Sarbanes-Oxley. For example, the UK produced a code on corporate governance discouraging any one person from holding both the chief executive and chairman roles at a public company.

The hype surrounding such issues has died down recently, partly because the main weaknesses in the system have supposedly been dealt with. But there are still pockets of business where the long arms of regulatory watch dogs have not yet reached. One of them, of course, happens to be unlisted real estate funds. The organization for such vehicles in Europe, the European Association for Investors in Non-Listed Real Estate Vehicles (INREV), is trying to make amends. Last year, INREV asked its members for their views on corporate governance. What they found, perhaps unsurprisingly, was that a significant number, approximately a third of respondents, believe good corporate governance is severely lacking among unlisted property funds.

To help the industry clean up its act, last month the organization launched a pan-European framework for corporate governance in private real estate funds. The Seven Principles of Corporate Governance cover integrity, transparency and alignment of interests. Number 6, for example, reads: “Funds should be run in the interests of investors.”

Basic stuff, but the accompanying guidelines highlight some of the difficulties that investors face. Under the section called accountability, the corporate governance guidelines suggest managers can demonstrate their accountability by being available to meet with investors to discuss matters. Elsewhere the guidelines state that investors should have enough information to assess performance against targets and understand fee charges. Managers are even reminded that the fund has been established to “deliver investment performance to investors,” and suggests alignment of interest can be achieved by the manager investing a “meaningful” amount in the fund through performance-based fees.

Again, all very basic stuff, but the mere fact that INREV has established a set of guidelines is a step in the right direction. In true European style, however, there is no law set in stone forcing unlisted funds to behave in any particular way.

“We are not saying this is the only right way to do it,” Lisette van Doorn, INREV's chief executive, told PERE. “The thing we want is to start up the discussion.”

Though progress is being made, there are still many things lacking, including a basic awareness of the code. In the same week as the Principles of Corporate Governance were published, INREV also released its Investment Intentions Survey 2007, which admits that many investors and fund managers remain unaware of the guidelines.

The responses also suggest that, in addition to ignorance of the guidelines, there might be resistance to meeting them. One reason is cost: while most investors believe good corporate governance should cost a negligible amount, 29 percent of fund of fund managers fear significant expenditures. Such concerns may seem trivial, but the reality is that investors are increasingly weighing the costs of transparency relative to listed vehicles. And there is already some evidence that publicly listed funds are in the ascendancy in Europe.

Last year, INREV's Investment Intentions Survey found that 100 percent of respondents planned to increase their allocations to unlisted property funds. This year, that figure dropped to 70 percent. More investors are now saying they intend to invest through listed funds, probably reflecting the growing interest in REITS sweeping acrross Europe, suggests INREV, as well as the increasing availability of fund of fund securities. It could also be that some investors have enjoyed good returns from unlisted funds in recent years and are cashing out.

Whatever the reason, INREV suggests that private real estate funds need to adapt in order to become a more desirable option for institutional investors. Their advice: private equity real estate needs to become a bit less private.