Every real estate investment manager will say the weight of regulation is increasing, but this is only part of their burden – investors, tenants and other stakeholders are also demanding measurable performance across the compliance spectrum.
And while regulators might insist on a certain approach being taken across the whole industry, individual investors will have specific requirements which are just as important as any legal requirement for managers that want the investment dollars to keep flowing. In fact, investors are actually ahead of regulators in what they demand from their investment managers.
Brett Robson, head of Macquarie Asset Management’s global real estate business, says: “The change in perspectives within the investment community has been considerable in recent years. Investors increasingly expect fund managers to understand issues such as environmental sustainability, diversity and inclusion, data security and privacy, as well as technology. They want to know how these topics may impact the assets in which they invest, and how they should adapt their investment strategies in response.
“Given the complexity of each of these topics, some managers have been reluctant to respond, doing the minimum required to comply with regulations or meet the expectations of their investors. Others are embracing the opportunities these pressures present, evolving their business practices to differentiate themselves from competitors.”
Opportunity, not a burden
Investors might be driving many demands, but the regulators are not far behind. The EU has become a leading source of real estate regulation, and the influence of large European pension and insurance funds means that few managers can afford to disregard EU rulings. In March, the first stage of the bloc’s Sustainable Finance Disclosure Regulation (SFDR) went live.
The SFDR requires fund managers to disclose how they have integrated an assessment of sustainability risks which might have a material negative impact on fund returns. Level one also requires managers to declare whether their funds are sustainable, partly sustainable or not sustainable.
The prospect seems daunting. However, Andrew Moore, head of real estate, Asia-Pacific at Schroders Capital, says: “I believe that most managers should embrace this, since with this obligation comes opportunity.”
Robson concurs, saying that the focus of regulators and investors on ESG matters is part of a shifting operating context for real estate managers. “Sustainability is no longer an area of special interest but is considered central to the execution of investment strategies by investors, managers, regulators and other stakeholders,” he says.
“We have observed our tenants asking for more guidance from us around the ESG configurations of the buildings they lease. This provides us, as the landlord, with a unique opportunity to increase engagement with them, and better respond to their needs”
Macquarie Asset Management
Robson notes that pressure comes from other stakeholders, besides regulators and investors. “We have observed our tenants asking for more guidance from us around the ESG configurations of the buildings they lease,” he says. “This provides us, as the landlord, with a unique opportunity to increase engagement with them, and better respond to their needs.
“The need to address these issues and enhance our approach is also coming from our own people, as they want to make a meaningful impact through their work. This is offering another source of positive pressure for us to do more when we are investing and managing real estate assets.” Real estate fund managers tend to agree that, while the EU has been a leader in ESG regulation, other jurisdictions will follow the same direction of travel and introduce similar regulations which align with the SFDR.
But it is not just the EU driving regulatory pressures, says Ellis. Anti-corruption legislation, such as the UK Bribery Act and the US Foreign Corrupt Practices Act, is increasingly becoming a factor for real estate investment managers too.
“Any business with connections to the UK or US needs to consider the provisions of the anti-bribery acts and to have the systems in place to ensure they are protected if something does go amiss,” he says.
Indeed, JLL and LaSalle Investment Management’s Global Transparency Index, published every two years, has been including considerations of corruption and money laundering since 2018.
One area where investors and managers are often ahead of regulators is with regard to diversity and inclusion. Most jurisdictions have domestic regulations against prejudicial hiring or working practices, which vary widely between cultures. However, the development of international – if informal – standards is being driven by global investors and managers.
Robson says: “Investors are increasingly demanding that their managers adopt and implement policies consistent with theirs. A specific example is in diversity and inclusion, where investors want to see diversity in senior management, investment committees and boards. There is a growing recognition that not only is this socially responsible, but it also contributes to investment performance, innovation and more effective risk management.”
The increasing digitization of real estate has also brought opportunities for improved performance, but also an increased burden on IT systems and pressure to maintain data security.
Robson says: “Recent changes to data-privacy laws – for example GDPR in the EU, and similar legislation in the US and China – have impacted consumer-facing real estate investment strategies. Such regulation has prompted greater operational focus on how personal data is managed, stored and accessed by managers. It has also increased the expectations on managers to strengthen their approach to cybersecurity.”
It is “imperative to have the best possible IT platform to manage data and to facilitate reporting,” says Moore, and larger managers have begun to invest heavily in IT systems, which chimes with the real estate industry becoming more tech-savvy than ever before.
A number of investment managers have also begun to invest directly in proptech, not just to generate returns, but to seed businesses which might help them better run their portfolios.
Covid-19 has heightened the pressure on managers, because their access to on-the-ground information has sometimes been limited, but also because investors became more demanding. Moore says: “Managers increased the frequency of reporting to investors in the early stages of the pandemic and I believe that investors will appreciate this being maintained as business as usual.”
“The covid pandemic means that distance has begun to matter in a way it did not previously. A multi-jurisdictional business needs to be able to operate without people flying in and out, and it needs to have the required systems in place in each location it operates from”
Mayer Brown partner David Ellis adds: “The covid pandemic means that distance has begun to matter in a way it did not previously. A multi-jurisdictional business needs to be able to operate without people flying in and out, and it needs to have the required systems in place in each location it operates from.”
The requirements on managers as landlords have varied widely across the world, says Baker McKenzie partner James Burdett. “Those holding cross-jurisdictional portfolios currently face a difficult task in tracking vastly differing schemes of government intervention, which may be subject to change with little notice.”
The pandemic has also driven wellness to become a key aspect of ESG considerations for both managed assets and managers’ operations. Robson says blue chip tenants are “scouting for a longer checklist of items which may contribute to the employee work experience.” The Global Real Estate Sustainability Benchmark (GRESB) now includes a health and wellbeing module, which is expected to gain traction with managers.
The delicate question about all this regulation and compliance is: who will pay for it? The answer appears straightforward. “Investors won’t pay higher fees to cover managers’ increased costs,” says Moore, “so managers must respond on the cost side through operational efficiencies and on the income side by offering outstanding service and by achieving superior risk-adjusted returns in order to justify their fees.”
Burdett adds: “With the greater regulatory burden on managers we continue to see greater consolidation in the market as managers try to realize economies of scale. The past few years have therefore been an active time for manager buyouts in the private equity real estate sector.”
However, there does seem to be acceptance among managers that being up to speed on regulatory and compliance matters, especially with regard to ESG, is not just a burden to be shouldered, but something that will improve the sustainability of their returns and, therefore, their businesses.
Ellis says: “There is a greater weight of regulation and compliance, and that is all a cost of doing business. However, more sustainable assets ought to lead to better performance and, likewise, more diverse teams tend to perform better. So, there are also benefits from compliance.”
ESG is becoming a core function
The increasing requirements of compliance and regulatory regimes, especially in the ESG field, are forcing managers to expand their in-house capabilities.
Most real estate investment managers now rely on a mix of in-house and outsourced capabilities for non-core areas of their business.
“Larger managers leverage in-house support from legal, risk, compliance, marketing, HR, training and other functions, and also outsource some non-investment activities, such as fund administration, to best-in-class service providers,” says Schroders Capital’s head of real estate, Asia-Pacific, Andrew Moore.
James Burdett, partner, corporate development at Baker McKenzie, says: “A greater proportion of managers are choosing to outsource activities so that they can focus on their core business. In recent times, there has also been quite a bit of demand for regulatory and operational professionals, and the costs associated with hiring talent in these areas has increased.”
And one area that many managers increasingly consider a core function of their business is ESG. Brett Robson, head of Macquarie Asset Management’s Real Estate business, says: “Like many larger managers, we have an in-house sustainability team which is dedicated to advising our global business on the full scope of strategic considerations.
“However, we do see many medium-sized managers increasingly hiring sustainability staff in-house rather than outsourcing the function too. This is in recognition of the fact that increasing expectations around ESG will require significant shifts in their investment approach and asset management strategies.”
Robson adds: “We believe that the greater the level of commitment to integrating ESG considerations into the investment process, the more likely it is that managers will need in-house capabilities. This often yields much better results than turning to a separate service provider.”