Samuel Weiser, NES
Financial

Real estate investment managers are increasingly looking for larger and more sophisticated investors, and institutional investors are answering the call by committing larger and larger sums to real estate investment funds. According to London-based research firm Preqin, U.S.-based public pension funds allocate 6.8% of their total assets, or an average of $758 million, to commercial real estate; private pension funds tie up 5.2% of their assets, or an average of $434 million, in real estate investments; and endowments have allocated 6.1% of their money, $143 million on average, to commercial property. All of these allocations are below target goals. Public pension funds aim to have up to 8.1% of their total assets allocated to commercial real estate, private pension funds aim for 6.7%, and endowments aim for 9.2%, with these targets only continuing to increase. The majority of the $107 billion raised by funds closed in 2015 went to large established commercial real estate funds, supporting the expectation that AUM for real estate investment managers will continue to grow.

So how does an emerging manager attract these growing commitments from institutional investors? How do they differentiate themselves in an increasingly competitive environment? Less than 20% of institutional investors will make commitments to start-up managers or managers with a track-record of less than two years. As a result, investment managers need to augment their offering to clear institutional due diligence and create the scalability that will enable institutions to make a commitment.

One solution is to outsource back-office operations to an independent fund administrator. This solution expands the functionality of a fund’s back office, enabling it to not only meet accounting demands but to also solve regulatory and investor reporting requirements. Outsourcing to an independent third-party fund administrator provides all the controls and security that institutional investors require in their operational due diligence reviews. Underinvesting in back-office resources can stunt growth, while building an infrastructure that exceeds your needs can stretch manager’s budgets. An administrator provides a predictable cost structure while enabling scalability as the fund complexity grows and new funds are added. Additionally, fund administrators are viewed as independent third-party oversight for fund managers.

Regulators are increasingly focusing on private equity and real estate fund managers. Among the priorities of the SEC for the current examination year are expense allocations, asset valuation, cybersecurity, and anti-money laundering. Former director of the SEC’s Office of Compliance Examinations and Investigations, Andrew Bowden, described what he called a “remarkable level of lawbreaking and cheating” among the 150 private equity advisory firms inspected so far in the SEC’s presence exams. Since many institutions are required to only invest with regulated investment managers, with institutional capital comes regulatory oversight that has not been prevalent in the real estate fund industry until recently. Fund managers could be forced to register as investment advisers with as little as $25 million of third-party money under certain circumstances, significantly increasing the operational burden on the manager’s firm.

Since fund administrators represent a viable outsourcing solution for real estate fund managers, how does a real estate manager select an advisor? There are the large administrators that primarily service hedge fund managers who claim to provide services to private equity and real estate managers. However, these organizations are generally running private equity and real estate firms through a sausage grinder designed for a different fund structure and different investing regimen. The technology platforms and operating structures weren’t built for PE and real estate funds so the firms must work around the technology to provide an “also does” service. This “spit and glue” approach fails to take into account the unique requirements of PE and real estate funds, which are unlike the basic GAAP accounting needs for securities based funds.

The ideal solution is to work with an administrator that has built a technology platform designed specifically to service real estate funds. Firms like NES Financial offer real estate managers a technology-enabled end-to-end solution for real estate fund managers. In addition to basic accounting functionality, NES Financial offers an investor portal, a manager portal, plus compliance services that address AML requirements, among other functions that support a manager’s regulatory requirements. Real estate investment vehicles generally contain complex waterfall structures for profit sharing related to realized investments. It is important for the administrator to demonstrate their understanding of this complexity up front so there is no confusion as the fund matures about how profits are to be split among the investors and the manager.

So, as institutional investors become a larger part of the real estate investment investor pool, fund managers have to consider how to secure and retain these types of investors. One clear pathway is outsourcing to a fund administrator that understands the industry. A dedicated service platform for real estate managers can ease the operating burden on fund managers and allow the manager’s professional staff to focus on the investment portfolio and securing new investors. With an increasing appetite among institutional investors for investments in real estate, partnering with a service provider might be the best path to tapping this investment pool.

Sam Weiser is financial managing director of NES Financial, San Jose, Calif.