Companies have reasons to abide by common rules when reporting real estate investment performance.
As more institutional clients favor the services of investment managers that are complaint with GIPS (Global Investment Performance Standards), it makes greater sense for real estate firms to be looking into adopting this set of standards for representing investment performance.
The GIPS standards are based on the fundamental principles of full disclosures and fair representation of investment performance results. CFA Institute, a global association of investment professionals that established the voluntary standard, says its goals in developing GIPS are (1) to establish it as the recognized standard for calculating and presenting investment performance around the world, and (2) for GIPS to become a firm’s passport to marketing its investment management services globally.
One of the prime reasons real estate companies voluntarily adopt GIPS is for marketing purposes—they can play a role as a selling tool when the real estate companies make their sales presentations to potential institutional clients. Indeed, many investment consultants today are requiring firms to comply with GIPS before they are matched with institutional investors, notes Alicia Hyde, CIPM, managing director of the ACA Compliance Group of Beacon Verification Services. Investment managers “are able to make that claim, to show that they have gone ‘above and beyond’ by complying with the GIPS standards, which are voluntary,” says Hyde.
Most of the National Council of Real Estate Investment Fiduciaries’ (NCREIF) major members today are GIPS-compliant, says Doug Poutasse, NCREIF executive director. NCREIF’s pension fund, plan sponsor and other institutional clients may also be GIPS-compliant via another set of standards, the Real Estate Information Standards, which incorporates GIPS with accounting and appraisal standards while also building upon all three sets of standards.
“One of the main reasons that we see for GIPS adoption is that the companies want to start managing real estate portfolios for larger institutions—pensions, endowments—which usually require that they come into compliance with GIPS,” agrees Timothy Peterson, CFA, CAIA, CIPM, partner at Ashland Partners & Company LLP.
“It is becoming a de facto requirement among institutional investors,” adds Hyde. “It’s becoming a very popular screening tool. Consultants require it for [the real estate company] to enter the pool of management finalists.”
An industry survey conducted jointly at the end of last year by ACA Compliance Group, which provides GIPS verification services, and eVestment Alliance showed that a full 68 percent of the 333 investment managers responding claim compliance with GIPS. And a full 72 percent say it is essential to compete in the institutional arena. Of the non-compliant firms, only 44 percent see GIPS compliance as a requirement in the majority of RFPs. The survey also found that the larger the firm, the more likely it would be GIPS-adherent.
What is GIPS?
GIPS applies to investment management firms that manage assets, whether these are mutual funds, stocks or real estate, Hyde explains. GIPS standards for calculating and presenting financial performance information are applied company-wide to all portfolios, so that managers cannot cherry-pick the best performing assets to report performance. GIPS also include guidelines as to record-keeping and accounting for different transactions and fees.
The GIPS guidelines from the CFA Institute cover eight categories: fundamentals of compliance; input data; calculation methodology; composite construction; disclosures; presentation and reporting; real estate; and private equity. “One of the absolutely critical aspects of GIPS is to have a common definition as to how returns are calculated,” says NCREIF’s Poutasse. “GIPS is an important step in that direction.”
In a way, GIPS can be seen as a set of investment marketing standards. Existing clients may not necessarily receive any GIPS performance statements per se, explains Peterson. Instead, what GIPS entails are additional pages added to pre-existing marketing materials that present additional performance statistics and disclosures. The information in the marketing materials can remain the same—however, it cannot conflict with the GIPS requirements, says Peterson.
As the goal of GIPS is transparency, disclosures are required as to how the investment performance calculations were made. For example, the investment manager has to disclose its definition of the various composites and how they were prepared, notes Peterson. “They have to describe how the properties were selected and placed into that composite.” Any leverage also has to be described, as well as the frequency and use of that leverage in a way that communicates the risk, Peterson adds.
Under GIPS, real estate asset managers would generally be presenting returns calculations in the same way they have traditionally, except for a few extra statistics, says Hyde. “In real estate, these managers would still be presenting returns calculations in the same way. There may be a few extra statistics in service of some of the required real estate disclosures.” Examples of the additional numbers that need to be calculated and presented in the investment performance report are Income Return (the income earned off of the property) and Capital Return (the appreciation/depreciation of the value of the property). These statistics are normally not contained in traditional reports.
Another difference between GIPS and traditional investment performance calculation and presentation is the use of time-weighted rates of return (TWR) required under GIPS. Real estate investment managers are free to continue using Internal Rate of Return (IRR), but they are required to use TWR whether or not they employ IRR, says Peterson. “GIPS generally does not replace, but adds,” to existing presentations, he notes. TWR takes into account market values at each valuation date. It is a way to calculate investment performance in a way that is not distorted by capital flows such as financing. TWR, he says, also requires more frequent valuations.
Not without challenges
Real estate companies should be aware that the most challenging part of adopting GIPS may be the valuation rules. One of the requirements of GIPS is periodic valuations of the real estate needed to calculate performance returns. Hyde says firms are required to obtain the value of the real estate on a quarterly basis. This quarterly valuation can be performed internally, but once every 36 months, the valuation needs to be conducted by an external third party. Moreover, in 2010 that external appraisal is required to be conducted annually.
This valuation requirement could present an impediment to companies subscribing to GIPS. “Is the firm willing to pay for the external appraisal every year? That is one of the things they must be able, and willing, to pay for,” says Hyde. However, she notes that she has not heard of a lot of push back against the upcoming rule requiring even more frequent external valuations.
Another challenge for real estate investment managers newly adopting GIPS is the historical records they need to accumulate before they can claim compliance with the standards. Firms have to bring at least five years of their investment performance calculation and presentation into compliance. “This can be difficult in that the history has to abide by the valuation rules. The firms need to have those records and have the valuations and frequencies of valuations that are required,” says Hyde.
“Firms have a difficult time retroactively applying these standards,” agrees Peterson. “For example, an external appraisal by a licensed appraiser every three years is required. If they have not been doing that, it can be difficult to comply with GIPS right away.” Hyde says that if the real estate company is not able to produce the five years’ history of GIPS compliance records, it may have to wait a few years to gather that record before qualifying for GIPS.
One of the key requirements of GIPS is that all investments need to be grouped into different composites according to similar investment strategies. The challenge lies in deciding which portfolios are grouped into which composites, says Peterson. “For some firms, this is easy, for example, if they are involved only in strip malls. But if they have a variety of different real estate properties—multifamily housing, office, raw land—it may be more complicated. Geography also plays a role. The challenge is how you want to define what the firm’s products are.”
Adherence to GIPS adds an additional layer of oversight that can incur additional time and costs. Many firms need to hire a consultant at least in the initial stages to provide advice about how to become compliant with GIPS, says Peterson. “But usually, for smaller firms, it is easier because there are fewer issues that are already in place,” he says.
In addition to marketing benefits, there are also enhanced internal controls benefits that accrue to firms that subscribe to GIPS standards. “GIPS have policies and procedures in place that lay out, from start to finish, how firms can record-keep and calculate performance,” say Hyde.
For all their benefits to the investment manager, the bottom line may be that the benefits of GIPS-compliant investment performance reports are really directed at the investor. GIPS offer a standardized method of calculating and presenting return. “An investor can take Manager A’s real estate marketing material and compare it to Manager B’s and make apples-to-apples comparisons,” says Hyde.
“The benefits are really geared to the investors,” agrees Peterson. GIPS provides transparency into the investment and makes it difficult for the investment manager to “sex up reports and mislead investors as to what the investment history is.”
To comment on this feature, email Keat Foong at [email protected].