The world of the real estate investment manager is becoming increasingly complex. Investors demand more reporting and transparency and the sector can no longer ignore the impact of technology.
Fund administration – the range of activities carried out in support of running a collective investment scheme – is important, but rarely a core competency of real estate managers. More are looking to outsource this function and other back and middle office responsibilities to third-party specialists.
For the past 11 years, the National Association of Real Estate Investment Managers (NAREIM), a US industry body, has partnered with professional services company FPL Associates on a global management survey. Here, NAREIM chief executive Zoe Hughes talks with FPL senior director Erin Green about the outsourcing portion of the survey.
Erin Green: If we take a look at the 2019 survey results, what we see is that, on an unweighted basis, about 28 percent of firms reported that they are outsourcing fund administration services today. Another 12 percent are doing it in-house today, but they are actively considering outsourcing, and the remaining 60 percent – the majority of firms – are doing it in-house and are not actively considering outsourcing. If you look back to the first year we asked that same question, in 2015, only 20 percent of firms were actively outsourcing. So that number has gone up from 20 percent to 28 percent. It is not something that happens overnight, but there is a trend of firms moving toward the outsourced model for fund administration and it is a trend we expect to continue going forward.
Zoe Hughes: Does size matter, when it comes to outsourcing? Is this something that smaller and mid-sized companies will typically do, while larger firms have the scale to do such services in-house?
EG: If you look at the responses to this question on an assets under management-weighted basis, in 2015 we see 17 percent of firms outsourcing, compared with 20 percent on an unweighted basis. So not a material difference, but a slight bias toward smaller firms. If you look at the 2019 results, the figures are 28 percent unweighted and 32 percent AUM-weighted. What that tells you is there is a shift not only in the pure number of firms moving to an outsourcing model, but we are also seeing more and more of the larger firms move to an outsourced model.
ZH: If scale is not a primary factor in outsourcing, what are the primary motivations? Anecdotally, NAREIM members seem to want to use outsourcing to help them focus on their core competences. How have the motivations driving outsourcing changed over the past three or four years?
EG: The rationale for outsourcing has certainly evolved over the last few years. However, as you say, the number one reason is the desire to focus on core competencies, which was cited by 91 percent of firms. Even large firms, which could have an in-house team, have this desire to focus on the things that really drive their business and which make them successful.
Interestingly, transparency was cited by 70 percent of firms, whereas the first year we asked this question, only 50 percent highlighted that. This derives from a broader trend of investors wanting more transparency, more oversight. Having a third party responsible for actually calculating fund returns and pulling together the numbers is a strong message about transparency for investors.
Complexity drives outsourcing
ZH: One of the things we are seeing is a desire among managers to diversify their product offerings, whether that means going up and down the risk spectrum, or equity players moving into debt and vice-versa. Is real estate investment management becoming a more complex business and thus encouraging more outsourcing?
EG: I think you are exactly right. Product diversification has been a key trend, so managers have more vehicles and more disparate strategies. Without a doubt, that has brought a whole new level of complexity into the fund administration activities of the average manager trying to do these things in house. Also, the service providers have been getting better and better at dealing with real estate investment managers. There are now a number of service providers that can really bring an excellent level of service to the table, which was not necessarily the case a decade ago.
ZH: Technology also seems to be a factor; it is becoming a more integral part of a real estate investment manager’s business and naturally this increases pressure on finances. Fund administration also requires an increasing investment in technology, so it seems managers are inclined to leave investment in that to specialists and focus their investment on tech in their core areas.
EG: Absolutely; if you are going to keep up on the fund administration side, there are some significant investments in technology that you have to make in order to keep up with the complexity of the business. An outsourced service provider will be providing these services for a number of real estate companies, so they have a scale advantage over the individual manager. And of course it is their core business they are investing in managnig the relationship.
ZH: Managers often ask, what is that right level of outsourcing when it comes to fund administration? And of course, even when a manager outsources this function, it does not mean it can be forgotten. A question that has been regularly raised at some of our NAREIM meetings is: how do you ensure effective oversight of your third-party partner?
EG: I think it is hard to say what the ‘right’ level of outsourcing is. For every firm, there will be a continued individual assessment as to what makes the most sense for your platform. However, I believe the trend will continue as more firms really try and focus on their core competencies and as those outsourced service providers continue to boost their services.
Now, if you are a real estate investment manager, it does not mean that because you are outsourcing fund administration, you get to forget about it! There has to be a level of engagement and cooperation with that outsourced service provider. There are four things that we generally highlight. Number one is there has to be a point person, an owner of the relationship internally, and that should be somebody of seniority within the organization.
Number two is having very clearly defined expectations and, in the initial contract, having very clearly stated objectives. Number three, you then have to hold your outsourced service provider accountable to those things. Finally, you need to pull in key stakeholders, the people who have to use the work product of your outsourced service provider or who interact with them on a day-to-day basis. That point person needs to be proactive about taking the temperature among the people who interact with the service provider. That type of information is really important in forming a holistic view of how effective that service provider really is.
What does the future hold?
ZH: Looking to the future, one thing we see from the survey is that the percentage of those considering outsourcing has declined from 32 percent in 2015 to 23 percent in 2019. Are we coming to an inflection point in terms of the industry deciding whether to outsource or not? What will the future trend be?
EG: I think that there are certainly more firms which have made a decision, but there is a continuous evolution here. Some firms are scaling up and they will get to a point where they say: “Maybe we should reconsider our approach.” And likewise, there will be others that decide to bring fund administration in house. However, the main reason the percentage of firms considering outsourcing has fallen is that the percentage of firms actually outsourcing has risen. I absolutely expect this to continue. For example, we know of a couple of prominent, very large-scale managers which are actively working towards outsourcing. So we will continue to see more firms across the industry move down this path.”
Outsourcing: The manager’s view
Real estate investment managers are outsourcing more than just fund administration; other commonly outsourced functions include audit, valuation, IT and specialist real estate functions
For some managers, outsourcing to a specialist saves the cost of recruiting and managing an in-house team, as well as providing access to skills and organizations which work across multiple funds and jurisdictions. Outsourcing also allows managers to focus on what they get paid for: investing in and managing property.
Regardless of what function is being outsourced, there are a number of common priorities. As one investment manager says: “Key factors include expertise in the relevant jurisdictions, reputation, cooperative history, team capabilities, technological capabilities and, of course, fees.”
Chris Wu, finance director of Chongbang, a specialist in retail-led China mixed-use real estate, offers some advice for managers: “You need someone in-house who has ownership of the relationship with a service provider; outsourcing should not be seen as handing off an unwanted task or function to an outside service provider.”
Managers stress the importance of building a partnership with their service providers. Wu says: “Where there is a long-term outsourcing relationship there needs to be a partnership with the service provider and an entrepreneurial spirit, as we grow our businesses together.”
Another manager adds: “Values are more important than costs.”
While the functions that real estate investment managers outsource might not be core competencies, they are important, and so is troubleshooting. “There are a number of factors which might be a concern in an outsourcing relationship, whether it is ongoing or new,” Wu says.
“Firstly, continued non-delivery is an obvious red flag but we would also be concerned about a change in ownership, especially one that saw key staff leaving. High staff turnover is also a warning sign.”