From riches to regs

While funds are increasingly attracted to real estate, regulation is becoming a headache for some investors, says Laurence Fhima of SGSS

You have more clients moving towards real estate as an alternative asset class. Why is this and what should they expect compared to other asset classes?

We do see a clear trend towards real estate as an asset class. In some cases private equiters are willing to reinvest in this asset class, but real estate asset managers are also growing business out of their initial country locations.

Compared to other asset classes, it is certainly less liquid than listed assets, but considered as a long-term investment, risk factors can often be mitigated by various asset allocation strategies. Real estate assets have been essentially boosted by low interest rates.

What are the main regulations making it difficult for investors at the moment?

For financial intermediaries such as banks, institutional investors and asset managers, the main challenge is fulfilling transparency requirements for third parties.

Each regulation requires a different set of secure and standardised reports, and each has become a headache for those who want to sell to an investor.

For example, as an insurance investor you have to be compliant with Solvency II regulation. It requires looking through all of the assets to provide the best or the worst capital points of the insurance function. As an institutional investor, you need to fix your capital in front of your activity and the development of the asset, as the deployment of capital will be highly regulated.

Real estate asset valuations aren’t, however, done using the same criteria. Investors need to consider what is relevant to the asset: location, scope, building type, construction materials used to build it, as well as internal equipment, legal entity identifier (LEI) codes, for example, which uniquely identify legal entities and structures that enter into a financial transaction and are used to help measure counterparty exposure, cannot be applied to a building.

Each regulation defines its own transparency. Some of the more active regulation today is trying to find out who investors are and how they are investing.

The Common Reporting Standard (CRS) report is coming in June, and that will be the next big one.

How does regulation differ across Europe?

In Europe, with the possible exception of Italy, the real estate investment market trend has been positive over the past four years and, over this period of time, we have seen an abundance of new real estate funds following the implementation of the Alternative Investment Fund Managers Directive (AIFMD).

Although AIFMD is a common rule in Europe, its use and market practices do differ from country to country and players in Europe tend to remain attached to their own best practices and local regulation (local generally accepted accounting principles standards, local taxes, local legal requirements, and so on). The reason for this is that real estate assets aren’t transportable and thus need a suitable ecosystem with local players.

AIFMD, as a single label, has clearly fostered the launch of real estate funds in Europe, but it’s not the only factor behind this development. Their popularity can also be attributed to negative interest rates, both this and last year. As institutional investors generally invest in bonds, the return has not been optimum, thus encouraging them to progressively turn to real estate funds.

Investors generally start with a prime office portfolio as it offers more liquid, standardised real estate assets, but half of the buildings available are already incorporated into funds.

There are a lot of niches in real estate. When you look beyond office space because you aren’t able to access prime offices, you need to look at other sectors that will provide you with an acceptable risk-reward profile.

Other aspects about the investment can appeal to investors as well. Some projects, for example, have a more environmental twist and investors are proud to be part of a project that contributes to protecting the environment.

What are the main challenges for institutional investors in alternatives going forward?

Institutional investors mainly face three challenges: understanding, classifying and benchmarking each asset in terms of risk and reward; monitoring cash flow; and properly informing relevant third parties.

The ability to understand and have access to all of the information they will have to provide when they buy an asset is important as investors will have to take on some burden with administrative tasks that they haven’t had to do before in order to be able to compare the asset’s performance. It also takes time to fill in the reports and it isn’t always obvious what data you have to put in each box. Information on this can be somewhat limited.

What are the main opportunities?

With this development, there is also growth in financing and new means for financing for funds, like crowdfunding. In London it’s impressive to see how the city has grown with the help of real estate funds investing for new projects.

In Europe, I see a few different types of real estate funds. Firstly, for retail investors, there are open-ended funds and listed funds or stock dedicated to real estate which proposes investment strategies or corporate strategies dedicated to the real estate sector. Secondly, for institutional investors there tend to be more closed-ended funds, limited to specific projects and opportunities. They need the expertise of an asset manager to follow the real estate project to the end of the project and to manage the administrative side of the business.

Closed-ended funds have two main strategies: core (buy and hold) and value-added (restructuring) or opportunistic. The core strategy is mainly buying prime offices to obtain a regular yield, whereas value-added or opportunistic strategies see the asset evolve over time with management-like private equity funds.

Fund managers manage the assets and sell the buildings after six or seven years with a profit once it has been transformed, allowing for growth in the building’s value or cash flow.

I see a clear trend with real estate and private equity players heading in the same direction. This is valuable because when the logic of private equity matches the real estate interest, you have new concrete projects and the creation of value.

Do you have an example of private equity and real estate actors doing this? What benefits does the partnership bring?

We are indeed seeing asset managers who are deeply involved in both private equity and real estate activities. There is a clear trend for asset managers looking for new havens to diversify their portfolios.

This has resulted from various factors such as private, for example, reaching an exit period and looking for new business opportunities to reinvest fresh money.

Sourcing deals in the EU seems more expensive and Brexit has created some uncertainty. For some, the booming trend of private equity in emerging markets is also still deemed too risky. As a result, the real estate market, backed by very low interest rates, looks more attractive than ever.

What will the incoming CRS Reporting mean for real estate investors?

CRS is a new regulation requiring all actors to report investor assets or investment holdings by indicating who is the final end investor or beneficial owner. All financial intermediaries dealing with investors need to be ready for reporting as of 30 June.

The challenge or obligation for real estate investors is the same as for any other type of investor: to provide, in due time, sign-off on data to be transmitted or exchanged; and to agree on the personal data to be transmitted.

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