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BNY Mellon: Compliance, transparency drive outsourcing

Fund accounting and custody services are the most likely operations to be contracted outside a real estate firm, according to a new study that also measured managers’ market sentiment.

As limited partners and government bodies demand increased transparency, real estate fund managers are outsourcing more operations, according to a new BNY Mellon study.

About a quarter of the real estate managers surveyed by the banking and financial services company said they have already outsourced services as a result of regulation, largely citing cost concerns and the expertise of additional staff. A majority of real estate managers with more than $1 billion in assets under management expect more outsourcing, compared with 31 percent of smaller managers, the report said.

Alan Flanagan, BNY Mellon’s global head of private equity and real estate fund services, told PERE the growth in real estate outsourcing comes at the tail end of a general increase in financial firms moving some back office operations externally. In the past, he said technology could not address the complexity of the real estate business from the fund level down to individual assets – but now, platforms can incorporate the full spectrum of real estate firms’ needs. Real asset fund managers reported that fund accounting and custody services are most likely to be outsourced in the future, according to the study.

“There are more and more requirements on the back office and at the same time investors are very focused on greater transparency to allow them to understand total expense ratios and really examining how managers run their businesses,” Flanagan said. “The impact is that managers are now looking at smarter ways of running their operations and infrastructure.”

While outsourcing operations can be intended as a play for cost savings, Flanagan said many firms are instead seeking to be cost-neutral at the beginning of outsourcing and, over time, lessen the “ever-increasing” investment in technology. Half of real estate managers would consider passing costs to their limited partners, which Flanagan said has been met with mixed reactions from investors.

“The investors feel there is value add for independence and governance and I think investors are open to that cost,” Flanagan said. “Where the challenge may lie is if that wasn’t an existing line item and they see it as an additional expense.”

This increase in outsourcing also comes as fund managers reported bullishness on the future of allocations to real estate. More than 40 percent of real estate fund managers said they thought real estate assets under management will be 50 percent higher in 2020 than at present, and 45 percent said retail investors will account for more capital raised for investments in 2020 than today.

“I was pleasantly surprised on the bullishness of the respondents in terms of where they see growth,” Flanagan said. “I’d always been bullish but it was very encouraging to see the vast majority of respondents expecting allocations to grow.”