What is the fund strategy?
Firstly, you need to know if the fund is being raised
‘blind’, that is without assets having been identified,
or if there is a seed portfolio ready. If a fund is raised
blind it relies on the fund manager being able to go
and find the right sort of assets. It is a risk to the
investor, who might be left with a substantial portion
of the money raised sitting in the bank after a year,
lowering returns. Some funds offer a mix – a seed
portfolio that will be able to generate returns straight
away and a pool of cash available for expansion.
The average lot size in the portfolio or proposed
portfolio is a factor in assessing the risk. Investors
should be looking to spread risk within the fund. Having
fewer assets, especially if they are spread over a
number of countries, increases the risks involved.
Equally, having multi-let assets spreads tenant risk
and makes it much easier for the fund manager to
actively manage. They allow opportunities to manage
lease terms, voids and refurbishment opportunities.
In the case of an existing portfolio, you need to know
what the rent roll looks like: who the tenants are and
how much of the rental income each contributes. This
allows the investor to gauge the quality of the tenants in
the portfolio and see where the tenant risk is spread.
It’s also important to know what percentage of the
fund, if any, is to be invested in speculative development
as this is the riskiest aspect of the real estate
market, but can also offer the highest rewards.
Investors need to know how much of the fund could
be speculative development at any one time.
Is the fund strategy reflected in its
documentation?
Crucially, you must be sure that the fund documentation
reflects the strategy and ensures the fund maintains
that strategy. For example, if a fund is set up to
invest in multi-let offices in secondary Euro-zone
cities, it should be clearly stated that this is all the
fund will do – rather than leaving leeway for purchasing
other types of asset.
What is the fund structure?
Most unlisted real estate funds are closed-ended. An
open-ended fund will have to keep a certain amount
as cash in order to deal with redemptions or delay
redemptions for several months while the necessary
liquidity is obtained.
The maturity date of the fund is also important.
Investors don’t want the fund to liquidate at the wrong
time neither do they want it to drag on in for the pleasure
of the fund manager alone. Adate ought to be set when
investors can vote to continue the fund or liquidate.
Is the fund tax-transparent? Most recently established
funds, whether structured as Luxembourgdomiciled
FCPs or as Channel Islands unit trusts, can
be made tax-transparent at the fund level.
What returns are you expecting; what
will drive these returns?
Fund managers will give IRR targets but it is important
to get a breakdown of their components of these
returns. Are they expecting high capital growth or a
high income return? In the case of a fund targeting a high income return from high-yielding assets, will
those assets’ capital values hold? Will developments
add to returns later in the life of the fund? Will the
returns be steady or lumpy?
Will the total annual return for the fund be calculated
after all costs and distinguish between realised
and unrealised real estate gains? Obviously you want to know what the total return is, so need to see it net of costs. Similarly, revaluation surpluses are unrealised gains and should be illustrated as such and should be shown separately from actual disposal profits.
You also need to know how often the fund will be
revalued and reporting. Most funds revalue every six
months and report every quarter.
What fees will be incurred?
Investors need to know when their manager is eligible
for a performance fee and what it will be. You need to
look at the hurdle rate and how it compares to the target
IRR – is the manager getting extra fees for performance below the target IRR? (In most cases, the answer is likely to be yes.)
What extra fees are likely to be incurred for acquisitions and disposals etc? These additional fees can double the base management fee. Some investors are now asking for a total expense ratio (TER) to be published.
This gives a figure for the ratio of fees to assets
over the life of the fund, partially based on certain
assumptions regarding, for example, the amount of
trading expected during the life of the fund and the
fees incurred.
What’s your record?
Investors want to pick a fund manager with performance
over the long term. By how much has the manager
previously outperformed recognised benchmarks? The
Investment Property Databank’s indices around
Europe are the most recognised and trusted real estate
benchmarking tools. However, indices are not as well
developed in many European countries as they are in
the UK and France for example. Some investors may
wish to consider absolute return benchmark.
Does the fund manager’s real estate research team
have a record of picking growth towns and sectors
and has this been applied to the fund? The fund manager
needs a strong research function (in house or otherwise)
with a solid track record.
Who are the people managing the
fund?
Investors need to look at the resources that are dedicated
to the fund. How many people are going to be
working on the fund on a full-time basis? What is
their personal track record; are they long-term performers?
Additionally, while most fund managers
will be happy to have the name of their hotshot individuals
associated with their funds, but if those managers
have another five funds to deal with, how much
attention can they pay to this one?
What about gearing?
One benefit unlisted funds offer to the institutional
investor is the chance to gear up. Many pension funds
are forbidden from doing this with direct real estate
holdings. Obviously the more highly a fund is leveraged,
the more risky it is. However, in a low interest/
low-growth environment, gearing can be
invaluable in boosting returns. Looking at the cost
of debt, the all-in cost of funds is the important figure
– not just the cost of the largest/cheapest
tranche.
What is also important is the way the debt is
structured. The fund’s length of fixed debt should
be matched to the weighted average lease length of
its portfolio but with some added flexibility.
Investors don’t want the fund to be prevented from
selling into a booming market because of debt
breakage costs.
What measures have been taken to
align the investor’s and fund manager’s
interests? What other corporate governance
measures are in place?
The most obvious way to align the interests of
investor and manager is co-investment, so the fund
manager is working for itself when it works for its
clients. Investor opinion varies on whether a small
amount of ‘hurt money’is enough, or whether significant
co-investment is needed to align interest. However,
not all fund managers have the balance sheet to
be able to do this. Some investors however also insist
that key individuals involved in the fund also have a
stake in it.
Is there an independent board separate to the fund
manager? There has been a debate among large
investors as to whether this is necessary (see Investor
Forum Winter 2004). Some believe it is essential to
protect the investor and to mediate in disputes
between fund manager and investor. Others say all
that is needed is an adviser in the case of specialist
funds to assist investors whose expertise lies elsewhere
and that alignment of interest through coinvestment
is more important.
What makes you different?
Alast round-up question – to get your fund manager
to say what differentiates the service it offers from its rivals and what value its approach to real estate will bring. This is also a good time to find out what competing products are available and why you should pick the one you’re being offered.

Styles of investing
Investors and fund managers often talk about
investment styles: core, core-plus, valueadded
and opportunistic, but often with widely
varying views on what they actually mean.
European unlisted funds body INREV last
year published a report entitled ‘Manager
Styles in Real Estate: AModel Approach’. This
project, which was led by Lisette van Doorn,
was the first a comprehensive study of the various
different styles and risk profiles of funds
available to investors.
The conclusions of the study, which was
based on a survey of INREV members, is that
‘style’ in real estate funds is most meaningfully
defined by a combination of the target return
investors are offered and the level of gearing. It
is a strategic choice of the managers, but not
one of style, whether the promised returns are
delivered by focusing on a specific country
and/or sector market, rather than through
diversification.
The report shows that most INREV members
recognise three investment styles – core,
value-added and opportunity. Some also use
the term core-plus: almost always synonymous
with ‘value-added’. INREV members
define core funds as having low risks and
returns, target IRRs up to 11%, and gearing up
to 60%. Value-added vehicles target moderate
risk and returns, IRRs between 11.5% and
17%, and gearing from 30% to 70%. Opportunity
funds are high-risk, high-return vehicles,
with target IRRs of at least 17%, and gearing
of at least 60%. Inevitably there will be overlaps
between target returns: in this case gearing
is used to define the style.
Van Doorn said: “Disclosure of information
also needs to be improved; only 62% of the
289 vehicles included (total value €215bn)
record target IRR. The model will also need
adjusting as market conditions change. And as
data in the INREV database develops, the
model should become more sophisticated,
perhaps using a larger number of factors to
define styles.”
Last year around 40 new funds were
launched in Europe, dominated by valueadded
funds and with very few opportunity
funds launched. Most of the funds launched
were diversified pan-European vehicles, followed
by diversified funds investing in a single
country.

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