An ever-increasing tide of money is pouring into the private real estate space from a diverse range of sources. That influx is driving investment managers to create ever more complex fund structures to satisfy the varied needs of capital allocators, and managing those structures is no small challenge in an increasingly labyrinthine regulatory landscape. Priya Nair, managing director and global head of product management for Private Capital services at RBC Investor & Treasury Services (RBC I&TS), reflects on the nexus between capital demand and regulation, and reviews the results of PERE and RBC I&TS’s joint survey of investment managers’ domiciliation and regulatory concerns.
PERE: How is the increasing demand for real estate investments influencing the regulatory challenges facing asset managers?
Priya Nair: The real estate asset class continues to grow not just in terms of absolute numbers but also the complexity of the business. An influx of new investors is happening at a time when new types of structures are coming online and there is an increasing need for transparency and reporting. As that growth continues asset managers need to think about how to provide and manage structures that are more sophisticated and less standardized than they were in the past in order to capture more diverse sources of capital. With growth comes complexity and the need for asset managers to navigate a landscape of intricate regulatory and accounting rules.
The PERE-RBC I&TS survey of investment managers demonstrates that there is a growing focus on, and interest in, real estate as an asset class. We are going to see sustained growth in allocations from existing investors. Meanwhile, asset managers that were not previously looking at this asset class are going into the real estate arena. That allocation is if anything getting bigger over a 10-year horizon: 79 percent of managers surveyed said they would grow their private real estate assets under management by more than 31 percent over that period.
That appetite is largely driven by macro-economic factors, such as the chase for yield in a low interest rate environment and demographic trends like urbanization. Real estate is also seen as resilient to future interest rate rises and other macro-economic shocks because it is perceived as uncorrelated to more traditional assets classes. That means it acts as a diversifier away from fixed income and equity listed instruments if there should be a negative shift in the economic climate.
PERE: Does the survey demonstrate a change in the type of capital flowing into real estate?
PN: The increase in that allocation continues to be largely from institutional and corporate investors, but there is now a focus around other sources of capital including the retail fund segment. Of the investment managers surveyed, 47 percent expected that the proportion of their investor base made up of retail investors to increase. The steady increase in allocations to real estate among institutions is not a surprise. A lot of these investors are pension funds that want to match their liabilities in the long term by using the stable cashflows that real estate provides. However, it is hard to glean whether this is new money coming in or existing investors increasing their allocation.
Managers also expect a large increase in the proportion of Asian capital. Increases are also anticipated from North American and European-based investors, although at a lower level. That may reflect the maturity and depth of the demand for real estate investment that already exists in those markets, but a steady increase is expected nonetheless. I suspect that the predicted influx of Asian capital will include a number of new entrants from the region’s pension funds, sovereign wealth and high-net-worth family office investors. The dynamic demographic-led growth in the Asia-Pacific region means the cashflow that can be generated by investment strategies there is useful in terms of liability matching for the pension funds.
PERE: How is investors’ choice of fund domiciles evolving?
PN: We are seeing European institutional investors requiring more regulated structures and that creates the need for third-party banks to act as depositories. When that is combined with the potential consequences of Brexit and the need for structures to be compliant under the AIFMD and other EU directives, that makes the choice of jurisdiction even more relevant. A large proportion of the industry is still domiciling funds in Delaware and the Cayman Islands, but other jurisdictions are becoming more relevant, particularly where asset managers are looking to raise European investment capital, namely Luxembourg and the Channel Islands. The results of the survey show a surge in funds domiciled in Luxembourg, with nearly a third of respondents saying that they will use it as a domicile for their next private equity real estate fund.
“If asset managers are unable to provide for investors’ needs in different jurisdictions they won’t be able to compete with their peers that can”
Historically, Asian investors have been focused on the Delaware and Cayman Islands domiciles. As the weight of Asian capital increases it will be interesting to see if they are captured by similar requirements to the ones that European investors need to fulfil under AIFMD. That might change how they think about domiciliation in the future. When the growth in an asset class is at a nascent stage there are fewer requirements in terms of regulatory compliance, but when there is an increased allocation to a segment of the market from a group of investors, as is currently the case with Asian capital and real estate, it drives a lot of interest from regulators that want to ensure the appropriate safeguards are in place.
PERE: What are the main regulatory headwinds that investment managers face?
PN: Most of them are around transparency and reporting requirements with regard to regulations that are coming in like the European Union’s General Data Protection Regulation and directives that are already out there like AIFMD. Investors are operating lots of different structures in different domiciles, so the need to be transparent, do more reporting and comply with accounting rules in various jurisdictions definitely changes how investment managers run their business operations and allocate resources. Some vehicles may be the first structure of that type in a particular jurisdiction so there is a lack of standardization across different regulatory environments. If asset managers are unable to provide for investors’ needs in different jurisdictions they won’t be able to compete with their peers that can.
PERE: What strategies are managers adopting to deal with that organizational challenge?
PN: They will need to focus more on some of the technological tools available to enhance their offering, serve clients better and become more efficient. The survey highlights the importance they are placing on technology and data management strategies to provide them with the means to comply with regulatory requirements. As a consequence, managers are considering entering into outsourcing partnerships where they can leverage outsourcers’ investment in technology and free themselves to focus on fundraising and investment strategy. The survey results show that in the next 12 months some of the areas investment managers would like those partnerships to be focused on are regulatory services and data management.
This article is sponsored by RBC. It appeared in the Regulation and Fund Domiciles supplement with the May 2018 issue of PERE.