This article is sponsored by Ocorian
The global economy has been rocky for the past 18 months, yet real estate investment managers have had no let-up in the demands placed on them by investors and regulators. At a time when managers need to focus on assets and investors, the demands of their back and middle offices are growing. Technology offers a solution, but can also be another potential headache. PERE’s Mark Cooper talks to Simon Burgess, head of alternative investments at fund services specialist Ocorian, about the challenges facing managers and how they can ease their burdens.
What upheaval has covid-19 caused real estate investment managers?
We see a large number of managers re-evaluating their business models and considering if there are other ways of working. Any business, when there are periods of change or even distress, will look to focus on its core competencies. For private equity real estate managers, there are probably two core pillars: firstly, the underlying assets, making sure they can buy good stock, manage and enhance it and then either enjoy the income return or sell it to create a capital return; and secondly, looking after their investors to meet their objectives and to ensure a future supply of capital.
Of course, there’s a tremendous amount of work to be done between those two pillars, and for managers, that kind of work, while key, is not at the heart of what drives their business performance. So, for a manager wanting to focus on their core competencies, this middle- or back-office work is the area to consider another way of working.
Managers are in some cases dealing with distress in their own portfolios, especially in the retail and hospitality sectors. But for capital rich managers and investors, this is an opportunity. The need to be able to move quickly is key because the opportunity and response needed to that market opportunity is now, not in a year’s time. So, working alongside business partners, like Ocorian, enables them to respond to the market when they need to and to scale up without having to employ more middle office teams.
On top of this, there is continued pressure on fees. Having in-house middle office and technology teams also favors larger groups, as they can spread the cost of functions across greater AUM. The other choice is to outsource these middle office and technology functions to specialist business partners which are able to spread the cost across a far wider client group.
What are the particular pressures on fund managers today?
We carried out a survey of investment managers and 99 percent are expecting more regulation. And the biggest area that’s going to create a wave of activity for real estate managers is ESG.
There is a particular drive to report on the environmental impact of property, particularly due to real estate’s carbon footprint, but also social aspects, because buildings are an intrinsic part of a community and its impact can be positive but also negative. It’s also part of the evolution of property as an investment.
Gone are the days of a strict landlord and tenant relationship where the use of the building and its environmental impact rests with the latter. Today, the approach has to be one of mutual partnerships between investors, managers, occupiers and users of buildings. As directors on fund and property boards, this is an area where we’re having more and more conversations with managers driving the agenda to ensure their buildings meet requirements demanded by tenants and investors alike.
On the regulatory side, the EU’s Sustainable Finance Disclosure Regulation has now arrived as one of a package of initiatives being introduced by the European Union with the intention of harmonizing the ESG for financial services. This is an area we’re watching carefully to see how it will be responded to and managed.
Is ESG pressure coming from regulators or investors?
It comes in tandem. There’s certainly been a growing swell over the past decade of investors, particularly pension funds, which have been demanding a new way of looking at managing their carbon footprint, or the energy performance of a building or a portfolio, and what else can be done to make a positive impact on the environment.
Leading investors are using their voices to influence the behavior of building owners, but it’s also about government as well. The green agenda has been quickly developing with roots from the United Nations Framework Convention on Climate Change in 1994 through to the Paris Agreement in 2016, which was adopted to address climate change and its negative impacts.
For the real estate industry, monitoring and managing environmental impact is complicated because of the sheer amount of data held in multiple places. But if it’s not addressed, the effect will be adverse to value. A key risk factor associated with real estate investing is obsolescence, so if the negative environmental impact of a building is not addressed then the risk of obsolescence will accelerate and the value will decline.
How are managers adapting to these operational challenges when considering outsourcing?
The starting point is to determine their underlying business goals, and where they see their business going. And that involves breaking down the composite parts of their business as well. For example, do you decide to maintain an internal legal team, or do you outsource it? Do you maintain teams of accountants completing the bookkeeping and payment of invoices, producing management accounts and lender reporting? Or do you outsource that? Are your investors happy with the manager sitting on the fund or holding boards, or do they expect independent boards?
The day-to-day company secretary work in property investment structures typically involves multiple companies. This is important to create liability blockers between assets. For large portfolios, this involves sometimes hundreds of special purpose vehicles, possibly companies, unit trusts and partnerships in multiple jurisdictions each with their own legal and regulatory framework.
Ensuring each entity is maintained in good standing is important, especially if share sales are expected as a future exit, but if your core competency isn’t managing the governance required, could you ask a specialist to take the strain? This is something Ocorian’s real estate funds team specializes in and is the topic of conversation we have with many of our clients.
The other area we’re seeing managers examine more and more, particularly on the fund side, is increased governance, looking at enhancing the governance of the fund or structure to meet growing investor demand. So, that relates to having independent boards, having scrutiny panels, committees, and maybe investor committees, which can critically review business independently from the fund manager. Ocorian’s real estate director team are seeing increased calls to provide directors to boards, and this is an area where we expect to see more activity.
How can managers use technology to relieve the burden of regulation and reporting?
Managers need to consider how to keep all of this data in a safe yet accessible way and how they’re going to manage it, whether internally or externally.
Good technology can do marvelous things, but it’s also expensive and requires significant investment in both procuring and maintaining systems as well as the specialist people able to manage it. And, of course, none of this is a core competency for a real estate investment manager. Managers can choose to leverage fund administrators like Ocorian that spread the cost of technology across many clients. Whereas if you’re a fund manager with, say, two or three funds, the cost divided across just the two or three funds can be quite costly. Naturally, bigger managers can have their own technology solutions.
Your recent survey of investment managers found 85 percent reporting increasing demand for offshore vehicles. What is driving that?
Demand for offshore vehicles, or to be more accurate, entities domiciled in international financial centers, will increase over the coming years because of the globalization of real estate investment. We’ve seen a sharp increase in the number of investors from locations such as the Middle East, Malaysia, Taiwan, Hong Kong and Singapore. They have a wide range of needs, whether it’s specialist sharia compliance or the need to easily move capital globally without cost leakage or double taxation.
This internationalization also means service providers must step up in order to serve global managers with a global client base. Many leading jurisdictions require a physical presence, where certain work has to take place there. But not all the work has to done in the jurisdiction in which the structure is based.
At Ocorian, we’ve found that we can assemble client service teams that offer an optimum operating model. For example, our specialist Islamic finance team is located across Dubai, Jersey, UK and Mauritius, but they work together as a single unit. Clients like that coverage.
And, of course, other jurisdictions continue to build out their own fund legislation to make it easier for private equity real estate funds to be launched. For example, we’re seeing those changes happen in Ireland. Also, Singapore is developing as a fund jurisdiction and our 30 people there are continuing to expand their work in this area.
AIFMD II: Clarifying and enhancing
The draft revised version of AIFMD is expected this year, but Simon Burgess, a director of Ocorian’s own AIFM, is not expecting drastic changes
“We all watch with bated breath as to what AIFMD II will mean, but we’re anticipating that it is going to focus on clarifying and enhancing what AIFMD does today rather than bring wholesale changes. There is also expected to be clarification of what a professional investor is, which might help differentiate between institutional investors and professional private investors. Introducing a harmonization of marketing rules, including a focus on pre-marketing rules is also coming (a directive to be enacted by member states).
“For real estate investment managers, although it depends where they do business, the additional requirements of AIFMD II are not expected to be too taxing if they are already following the rules.”