Room for improvement in corporate governance of non-listed real estate funds (EU)

The non-listed real estate industry can improve standards of corporate governance, particularly transparency, accountability and alignment, according to a report from INREV.

The results of the first INREV Corporate Governance Best Practice Review showed that levels of compliance with INREV Guidelines were good but gaps in market practice showed room for improvement.

"We would like to see more independent directors in funds, greater accountability of managers through more effective termination provisions, greater alignment of interest through more co-investment, better fee structures and controls over conflicts of interest, and generally better transparency, particularly side letters", said Alasdair Evans, Chairman of INREV's Corporate Governance Committee.

Alignment: Some of the gaps highlighted in the report reflect issues raised as a result of the downturn, such as alignment of interest. Co-investment is an important indicator of alignment between fund managers and investors. The study showed that 19% of funds in the study did not have co-investment by the manager, the sponsor or individuals, and only 9% of funds have the management team transparently co-investing.

The review also identified that funds generally have limited controls to prevent conflicts of interest with other funds run by the same manager with overlapping strategies. Stronger protection for investors is required in this area.

Alignment of interest can also be demonstrated in fee structures, although there are many instances of poorly structured fees. They include base management fees calculated from gross assets encouraging managers to accumulate assets, rather than maximising performance for investors. In addition, the vast majority of performance fees are based on absolute geared performance, thereby rewarding market movements and financial engineering.

Board structures: A key feature of the INREV Guidelines on corporate governance is the role of the non-executive officer. The study showed that 84% of funds have non-executive boards but they generally do not contain truly independent directors. There are many situations where independent directors are needed within funds, such as to resolve conflicts of interest issues.

Accountability: Accountability of managers can be shown by investors' ability to remove the manager. The review shows that 77% of funds allow removal of the manager with cause but the barriers to implementing such a clause are high which reduces effective accountability. No-fault removal is possible in only 31% of funds and then at a high price with compensation of six to twenty four months of fees and carried interest.

Transparency: Specific gaps in transparency identified were the limited ability of investors to appoint the independent auditors or the independent valuers, the limited ability for investors to call investor meetings and the very limited disclosure of side letters.

"Corporate governance has rightly come under the spotlight following the financial downturn. Fund managers and investors are already addressing weaknesses highlighted by the recent market conditions in new and existing funds. This review promotes an understanding of today's issues and we expect governance in future funds to reflect improving market practice", said Andrea Carpenter, Interim CEO, INREV.

The Corporate Governance Best Practice Review was undertaken for INREV by Loyens & Loeff. It examined the fund documentation of vehicles launched from 2007 to 2009 to understand their approach compared to INREV Guidelines. These funds represented 38% of the funds launched in that period in the INREV Vehicles Database.

INREV issued its Corporate Governance Principles and Guidelines in December 2006 to establish common and workable standards of corporate governance for institutional non-listed European real estate funds. They now form part of the integrated INREV Guidelines released in January 2009.

Source: INREV

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