Seeing is believing
Full transparency is expected in the equity and bond markets and similar standards have been adopted across most developed economies. However, investors have far less confidence in the availability and reliability of information on unlisted real estate funds. Finding a solution to this is key to unlocking future capital flows into the real estate industry and for protecting the capital already exposed to the sector.
The INREV investment intentions survey published in 2005 clearly indicated that lack of transparency is one of the fundamental obstacles to greater investment in the sector.
While transparency is identified on its own merit as desirable, it is also fundamental to the issues of liquidity and high transaction costs. Investors and potential investors must be able to analyse and monitor real estate funds in the same way they do for equity and bond funds. If there is less secrecy surrounding unlisted funds liquidity will undoubtedly increase.
If the information provided to investors and potential investors was timely and reliable, with common definitions adopted across the industry, transaction costs would drop as due diligence requirements are likely to be reduced.
This has already been experienced in the UK, where transparency is greater and investors place greater confidence in a manager’s net asset value, which is based on regular external valuations. As a result stakes in closed-ended funds often change hands between experienced investors with limited involvement of lawyers and accountants. The savings in both time and money help to considerably enhance performance.
Transparency will also increase the price achievable for secondary stakes in existing funds. One US investor summed up this issue very well when he said: “There is no discount for liquidity; there is simply a discount for lack of information.” After all, it is reasonable for an investor to assume the worst case when presented with scant information.
Transparency means different things to different people. In determining what level of transparency is required it is important to identify the potential market participants and their reasonable information requirements. This applies to both existing and potential investors.
Many managers who are secretive about their funds adopt the policy of providing their investors with very detailed periodic reporting even down to the tenancy level. However, they impose confidentiality agreements in the constitutional documents to ensure no third-parties, including potential investors, receive this without their consent.
Some investors require this depth of information so they can try to consolidate all their holdings as if they were all direct holdings. Some are comforted by the knowledge that they can refer to it if needed. However, some are only interested in the executive summary and would prefer to save trees!
With all forms of indirect investment it is important that investors trust and empower managers to carry out their role in a professional manner, but it is also about striking the right balance. Investors need sufficient information to monitor the investment in the context of their wider portfolios and track progress against the original business plan.
However, investors should not be encouraged to seek to second-guess the manager or absorb excessive management time by getting them to justify specific transactions. This is likely to reduce the time available to manage the portfolio and deliver the returns anticipated.
For the liquidity of unlisted funds to be enhanced, it is important that there is a degree of transparency even to potential investors. Although there will always be an element of window shopping, the challenge is to give out enough information to interest potential investors while not breaking any confidences.
If one is to provide summary information rather than detailed analysis, it is critical that all investors have confidence in the definitions used for each element of information disclosed. At present this does not exist either on the accounting side (what is included in net asset value?) or in property portfolio analysis (does ‘void rate’ include developments? Does ‘average lease expiry’ assume break clauses are exercised?).
Obviously, standard definitions need to be agreed. Investors should expect to receive information that is current and available at the same time after each period.
In the UK many managers provide ‘pooled property fund questionnaires’ on a quarterly basis. This has been developed between a number of investors and managers. It contains detailed information at a portfolio level but limits disclosure at the individual asset level where sensitivities are greater. Each element of the questionnaire has been clearly defined. As a manager one might not always agree with the definition but it does allow the investor to compare funds more accurately and build financial models which consolidate the information on their portfolio of holdings. It also allows them to investigate the impact of adding or removing any given fund from their portfolio.
From the manager’s point of view, there are clearly advantages if all investors can be persuaded to use the same data as it allows more efficient reporting. Bespoke reporting both to existing and prospective clients is time consuming and expensive to produce.
One of the arguments commonly given by managers for limiting the transparency of their information is that the extra reporting is costly in terms of resources and valuation fees. The reality is that efficiencies exist when one increases the level of reporting provided systems are in place to deliver it.
External valuation fees increase as they become more regular but not pro-rata. We estimated that the cost of moving to quarterly external valuations is often less than 10 basis points per annum. For many investors this might be a price worth paying for the potential liquidity and performance measurement that could result.
At Schroders we can issue NAVs within 24 hours of receiving the external valuations. Reporting to investors is completed within three weeks of the quarter. It is resource intensive, but pays for itself through the demand for the products and particularly the fee income derived from the secondary trading in both our open-ended and closed-ended funds.
INREV has recently launched a working party to establish standard definitions for the industry on a pan-European basis. The adoption of common definitions will have considerable impact on several initiatives including the evolution of a secondary market in unlisted funds, development of fund indices and fee comparisons. Clear definitions will also establish a sound platform on which future initiatives can be built.