FUND ADMINISTRATION: Real estate report card

A lack of industry reporting standards have resulted in LPs receiving a hugely divergent amount and type of information from each of their GPs. Is it time for some industry standards? PERE magazine's Fund Administration supplement September 2010

Investors want to know as much as possible about their investments in the wake of the worst real estate crisis since the Great Depression. They want to understand the make-up of the portfolio they are invested in; they want to know exactly what properties their capital has bought, and equally importantly, they want to clearly understand the debt tied to that deal.

There can sometimes be a disconnect between GPs and LPs in terms of the level of disclosure required.

As a private equity real estate general partner, therefore, investor relations has become a critical component of doing, and staying in, business. For limited partners in commingled property funds, having a fund sponsor able, willing and eager to respond to queries is essential to assess, forecast and plan future risks and potential investments this year, next year and in five years’ time.

Yet, in today’s private real estate investing world, there can sometimes be a disconnect between GPs and LPs in terms of the level of disclosure required today, and in the future.

Things have, of course, changed dramatically since before the collapse of Lehman Brothers. Although there was – and still remains – a huge divergence in the level of upfront information provided by GPs, during the boom years many LPs relied on quarterly reports that focused heavily on portfolio-level information, with few details of asset-level performance and underwriting. Information flowed from the GPs to LPs, often with little probing from limited partners. However, for some LPs that did try to gain ad-hoc asset-level information, such as detailed debt schedules, they could be met with a mix of responses from helpfulness, to refusal and even a failure to acknowledge the initial request.

Working it out

However, the ability of an LP to personally evaluate a GP’s assumptions is crucial to being a good fiduciary, according to Joseph Stecher, chief investment officer of Morgan Stanley AIP Real Estate. “The direct GP needs to give the LP enough information so that the LP can make an estimate as to the value of his or her interest in the fund, assuming a reasonable application of time and experience,” he said.

Joseph
Stecher

LPs are eager to assess exactly where any risks may lie in investments. After the shock of 2008 and the painful real estate write downs that followed, no limited partner wants to be caught unaware again.

“If we don’t know what risks we are taking, how can we manage those risks,” says Allstate Investments’ head of real estate equity, Edgar Alvarado. “It’s like having information that the train you are on is about to crash. You can use that information to help you get off, or if you can’t get off completely it can certainly help you reduce the impact of the crash.”

In order to manage their own investment risks, though, LPs need increasing amounts of information about underlying deals to feed their forecasts.

The direct GP needs to give the LP enough information so that the LP can make an estimate as to the value of his or her interest in the fund, assuming a reasonable application of time and experience.

Joseph Stecher, chief investment officer of Morgan Stanley AIP Real Estate

Stecher says GPs will provide LPs information above and beyond the quarterly report upon request, and once compiled often send it out to other limited partners in the fund. “In my experience when you call up a general partner and ask him or her to provide you with the information, they all do,” he says.

Joy Winterfield, Allstate Investments’ real estate fund portfolio manager, agrees: “There is no question that transparency has improved significantly. When you consider where we have all evolved from as an industry, you have to appreciate the GPs’ non-trivial commitment of time and resources to help get us here.”

Yet with the volume of reporting requests having increased at least three-fold over the past 18 months, according to many fund administration and investor relations professionals, how can GPs proactively take the issue in hand, rather than merely reacting to ad-hoc phone calls from investors?

For Stecher, Alvarado and Winterfield, highlighting portfolio and asset-level risks upfront are key. “I need a GP to give me the numbers so I can value the fund interest on my own, but I also need a GP to tell me where the risks are on an aggregated basis,” says Stecher.

Alongside property income, cash flow, occupancy and projected IRRs, capital calls and distributions, LPs are also keen to see information about concentration of risks, according to property type, geography, and even tenant-ratings. But it is gaining access to comprehensive asset and portfolio-level debt schedules that is the number one concern for most LPs.

Edgar
Alvarado

“Debt maturities have been a big issue in the last couple of years and something we jumped on two and a half years ago,” says Alvarado. “LPs need to understand the underlying risk of the asset, we want to know the counterparty risk, the loan-to-value, the extension options, the covenants and what the triggers are. What are the refinancing risks and debt service coverage?

“Getting the information below the portfolio level is an evolutionary process and many GPs are now getting ahead of things,” adds Alvarado, who manages a $2 billion real estate equity portfolio, comprising 90 real estate fund investments. “For Allstate, providing such information will be part of the rules of us doing business with a fund.”

Real standards

One of the challenges facing GPs and LPs alike, though, is the lack of industry standards when it comes to reporting. Unlike other asset classes such as equities and fixed income, there are no agreed metrics when it comes to reporting on private equity real estate funds. Indeed, there is not even an agreed standard on what should be contained in an LP report, or even in summaries provided to LP consultants.

Stephanie
Power

That leaves GPs in the position of guessing, surveying and learning by experience, what their LPs want from their quarterly reports, and responding to LPs individually when queries come in. The effort on the part of the GP is essential to being a fiduciary and good partner, says Stephanie Power, founder of investment firm Marley Real Estate Capital and a former senior executive with UrbanAmerica.

“It would be a win-win for everyone if the industry came to a consensus regarding best practices. But in the absence of standards, a GP needs to create a reporting package that anticipates the needs of its LPs – a one page summary, a written detailed discussion of the period’s activity and a drill down to detailed metrics at the fund, portfolio and property level,” says Power.

It would be a win-win for everyone if the industry came to a consensus regarding best practices.

Stephanie Power, co-founder, Marley Real Estate Capital

Alvarado, also a committee member of the Pension Real Estate Association (PREA) plan sponsor committee, says there is “movement” towards trying to introduce industry-wide reporting standards, with PREA building on the work that the Institutional Limited Partners’ Association – which introduced its own guidelines for the private equity asset class – has done.

But as he notes: “All LPs want a certain level of detail, however what is an appropriate level of detail?” In providing even more information, do GPs also risk generating even more questions in response.

It’s like having information that the train you are on is about to crash. You can use that information to help you get off, or if you can’t get off completely it can certainly help you reduce the impact of the crash.

Edgar Alvarado, Allstate Investments’ head of real estate equity

Alvarado cautions a more macro-view of the real estate asset class, when debating the reporting demands emanating from plan sponsor real estate managers. “Investment staff are being asked to do a lot more today than couple of years ago by their own chief investment officers,” he says.

With asset allocation models being run on an almost “continuous basis”, Alvarado says portfolio managers need to be able to assess the impact of inflation, deflation, GDP growth (or lack of) and a multitude of other scenarios on a real estate portfolio. Access to the underlying portfolio (and asset) information is essential for such forecasts. Without it, uncertainty over risks remain, which for Alvarado doesn’t help real estate as an asset class.

“If I cannot tell my CIO what the risks are in real estate compared to equities, fixed income, private equity, when there is capital for investment, where do you think the investments are going to go?” he stresses. “It’s a detriment to our evolution as an asset class not having that level of risk reporting.” 



Top of the class

It takes more than just timely reports to get top marks when it comes to LP annual, quarterly and ad-hoc reports. PERE spoke to fund managers and limited partners alike on what represents best in class practices. Here are some suggestions:

* Timely reports. Annual meeting and quarterly investor updates and financial statements should relate to the most recent quarter.

* Clear and consistent valuation policies and reporting and a willingness to discuss them.

* Financial statements should include gross cost, gross fair value and equity fair value for  asset.

* Quarterly investor calls typically presenting LPs with portfolio and asset-level updates and descriptions. Portfolio and asset-level data includes occupancy analysis, tenant summaries, leasing activity with actual vs. budget comparisons for all properties.

* Net return (both IRR and MOIC) projections at the fund-level and asset-level, with international funds showing returns in domestic and foreign currencies.

* Investment committee memos and underwriting assumptions available upon request.

* Full and complete asset-level debt capitalisation tables, including loan balance; original maturity; lender information; property NOI and DSCR; LTV and LTC; recourse, guarantee, cross-collateralisations and supporting detail.

* Schedule of related party fees incurred for the GP or any affiliate.

* Detailed drawdown notices summarising projected contributions and distributions and investment thesis. Descriptions of how the capital is to be used should be included detailing capital expenditures, overview of project and forecast returns on new money. Cash flow projections should also highlight the IRRs for the life of the fund and include variance analysis to prior projections.