Excessive gearing brought industry into ‘disrepute’

A small minority of real estate funds that took on excessive leverage during the boom years stand accused today of bringing the industry into disrepute.

The European Association for investors in non-listed real estate funds (INREV) published a study insisting that while the wider industry behaved “rationally”, many didn’t.

Lonneke Löwik, director of research and market information said: “(Our) analysis indicated that excessive gearing used by a minority of funds brought down returns and (the) industry into disrepute, but it is unfair to stigmatise the wider industry that behaved more rationally.”

The comment came as the association published “Re-evaluating the case for investing in non-listed real estate post-crisis.”

The report concludes that non-listed real estate investment weathered the recent financial crisis no worse than other real estate investments, but that many larger investors were now increasingly using their financial firepower to influence the shape of the fund management industry.

“Our research demonstrates that on a like-for-like, un-geared basis, non-listed real estate has performed on par with other real estate investments, accepting the overall weak performance of the sector,” said Löwik. “Many of the reasons that make non-listed an attractive investment have endured, but the industry has changed with investors demanding deeper due diligence and a more binding relationship with fund managers than before the crisis. We consider this a natural evolution, not revolution.”

The report particularly points the finger of blame at debt-gorging value added vehicles. The study did not include the performance of opportunity funds as such, but it did include highly-leveraged value added funds.

It said value added funds formed a smaller proportion of the non-listed real estate funds universe in the INREV Index – its benchmark performance measure. However, the combined impact of negative gearing alongside the sharp re-pricing of non-prime assets had resulted in a “long negative skew” to the distribution of non-listed returns.

“This has a marked effect on the mean performance of funds at the aggregate level, disproportionately dragging the INREV Index down,” it commented.

It also recounts how there has been “a break down in trust” not only between fund managers and investors, but to some extent across the entire investment fund universe.

“It has led to closer alignment of interest between fund managers and investors, manifested in changes to management and performance fee structures with more insistence on continuity of personnel and co-investment, and a much greater emphasis on rewarding value realised over the longer term, rather than notional value in the short term,” claims the report.

In addition, large institutional investors will increasingly seek to partner fund managers in creating new products as a means of underwriting strategy and ensuring alignment of interest, according to Matthias Thomas, INREV’s chief executive.

He added: “As investors seek greater control and more accountability, fund managers are paying the price for the failure of a few who did not exercise their fiduciary duty during the crisis. While the strong reasons to invest in non-listed real estate proved extremely durable over the crisis, the report shows that investors are much more engaged and demanding fundamental changes in  the investment model.”