EUROZONE: Style police

INREV, the European Association for Investors in Non-Listed Real Estate Vehicles, is not like the Securities and Exchange Commission in the US or the Financial Services Authority in the UK. It cannot, for instance, command that all those operating real estate funds in a certain jurisdiction comply with a set of guidelines or standards.

With 320 members, INREV doesn’t claim to be the universal body for all those operating in unlisted real estate either. Still, the association does have a leading role in introducing transparency in the market for the benefit of institutional investors, and it is taken seriously by them.

That is why it is worth noting that last month INREV took another step along the way in trying to control the industry by unveiling its Style Classification, which tears up the 2004 definitions of core, value-added and opportunistic based upon notions of leverage and internal rates of return and replaces it with something that is based on “bundles of risk”.

The new definitions, INREV hopes, will be widely adopted and used by funds launched in 2011 and onwards. The purpose is to provide clarification in terms of what each strategy means when a GP is marketing and managing a certain type of vehicle.

Ian Gleeson, chief investment officer for the global multi-manager arm of CBRE Investors, called the new classifications “hugely significant”. He said: “It sends out a very powerful message to the investment community in terms of what the investors want.” Christian Schulte-Eistrup, head of capital markets at MGPA, argued it was a useful tool. “It is a useful building block for LPs to categorise funds relatively easily,” he said. However, no one, Schulte-Eistrup included, is pretending that the three definitions are perfect.

Although the classifications were produced by examining ‘clusters’ of funds and their key characteristics, the association acknowledges that some might judge the style definitions to be a bit too narrow. Debate already has opened up on the merits or otherwise of the project work upon which the new definitions are based.

For example, under the new style guide, a fund that has up to 40 percent leverage as a percentage of the fund’s gross asset value comes within the definition of ‘core’. However, some might say 40 percent is too high.

Alessandro Bronda, head of investment strategy at Aberdeen Property Investors, wonders why, in the light of new Solvency II requirements, there wasn’t a fourth category for an unleveraged core fund.

Others pick up on the fact that there is no universal definition yet for any of these styles. When CalPERS says it aims to have 70 percent of its assets in ‘core’, how can anyone in Europe be sure they know what it means? In a global marketplace, this is a significant weakness.

Other shortcomings include how ‘target percentage of development’ is a key characteristic, but it seemingly overlaps with the first characteristic, ‘target percentage of non-income producing investments.’ There also seems to be not much scope for measuring how close a fund is to entering into another strategy under the new system.

Lastly, given that these are entirely new definitions that INREV wants everyone to adopt from this year onwards, it will be difficult to benchmark new funds against funds raised in prior years.

Despite the objections, INREV is sticking by its new classifications. Mahdi Mokrane, head of research and strategy at AEW Europe, who was among those that worked on the style definitions, acknowledges it will take time to build up a database in order to benchmark new funds.

Furthermore, INREV has no intention of “re-writing history” by sweeping away the definitions of existing funds retroactively, Gleeson insisted. “These metrics haven’t been decided upon; they have come up,” he said. “This is what the industry is doing in Europe. These are defining the market, and this is how we propose to use them going forward.”

Still, for an industry that is trying to introduce transparency and certainty into an uncertain world, no one is criticising INREV for giving it a go. However, the true test of whether these new definitions are good or not will be time.

It took about three and a half years of work to settle on the three definitions we now have before us. Who can really be confident in saying they will be as reflective of the industry in three years’ time, though?

Leverage, for example, is such a key reference point in the definition, but it is not beyond reason to imagine that, in just a few short years, attitudes towards debt may have adjusted. One can well imagine that the leverage bands settled on by INREV might become outmoded.

In the meantime, it seems the most sensible thing to do for general partners is to take careful note of the definitions, but make sure that the tail doesn’t wag the dog. The key to success will be to listen even more acutely to what clients are saying and see if one cannot produce a product that matches the clients’ needs with the GP’s skills.