Corporate Governance

Good corporate governance is a cornerstone for the success of non-listed real estate investment vehicles and refers to the structure, processes, policies and laws that determine how an investment vehicle is managed and controlled. There are a number of different frameworks, some driven by local or EU regulation, which support this objective and there are many common themes which run through them.

For non-listed real estate investment vehicles that target institutional capital, the level of regulation can be lower than for other investment classes such as retail funds or listed structures.  This is mainly due to the nature of non-listed real estate funds, which have typically low liquidity as well as entrepreneurial investment managers. In such cases, a robust corporate governance model is essential. Both INREV Guidelines and the Alternative Investment Fund Managers Directive (the “AIFMD”), which regulates fund managers in Europe, tackle the key principles that are central to a robust corporate governance approach, which:

• Aligns interests between investors and the fund manager;
• Manages conflicts of interest;
• Ensures the accountability of the fund manager; and
• Promotes transparency.

The constitutional terms of each investment vehicle, stated as fully and completely as possible, should address how principles and best practices should be applied by those involved in the management of the vehicle, thus creating binding contractual obligations for compliance by the vehicle and its investors. This module describes INREV’s best practice principles and sets out guidance on how to apply these in practice.

The INREV Guidelines focus on the vehicle itself, whereas AIFMD focuses on the manager. The INREV Corporate Governance Guidelines are principle based, expecting that people apply the principles in their behavior, whereas the AIFMD is primarily describing what the legal obligations and responsibilities of the manager are. In addition to the Guidelines the AIFMD Manager Guidance report provides a practical guide for managers who fall under the EU regulation. The report explains key functions based upon the specific governance requirements of the AIFMD and the more principle-based governance best practices of INREV.

Local and EU legislation in different jurisdictions will always override principles that do not have the force of law. INREV’s principles and best practices of corporate governance represent a generic framework and can be applied across a wide range of real estate vehicles. In order that a non-listed property vehicle or an investment manager is compliant, careful consideration should be given to both local and EU legislation applicable in the domicile of these entities.

Compliance with the law is the foundation of every corporate governance framework. Being primarily responsible for this, the manager has to have appropriate systems in place to monitor, confirm and disclose compliance to the investors and non-executive officers. The non-executive officers should oversee the manager in all these respects, and should be able to seek external advice on these matters. The investors should make any and all necessary information available to the manager and are expected to immediately highlight any doubts they may have about the vehicle’s legal compliance.

The manager, the non-executive officers and the investors should all have access to sensitive information about the investment vehicle and its involved parties. This information must be treated according to the agreements in the constitutional terms. In general the need to maintain confidentiality has to be balanced against the need to ensure transparency and if there is a conflict, the need for transparency should prevail. However, information which, when disclosed, would create a competitive disadvantage to the vehicle, is expected to be treated as confidential and not to be disclosed widely. Confidentiality provisions should indenture all investors with the same restrictions and may not effectively prohibit investors exercising their rights under the constitutional documents.

Compliance with the law - The investment vehicle and its manager should always comply with the relevant legislation and regulations applicable in the jurisdiction in which it is established.

Compliance with constitutional terms - The vehicle's constitutional terms should clearly articulate the key corporate governance principles which should always be applied.

Skill, care, diligence and integrity - Investors, investor representatives, non-executive officers and managers should manage the protection of investors’ interests and their investments, with due skill, care, diligence and integrity, and should ensure adequate levels of human, financial and operational resources.

Accountability - Managers, non-executive officers, investor representatives and investors, and those they have delegated to, should always be accountable for their actions.

Transparency - All relevant information relating to the vehicle should be communicated in a way which is clear, fair, complete, timely and not misleading.

Acting in investors’ interests, including alignment of interests and conflicts of interest - Vehicles should be run in the interests of all investors. Where they arise, conflicts of interest should be managed fairly between investors, vehicles and managers; the alignment of interests between investors and managers can reduce the risk of such conflicts.

Confidentiality - Information regarding vehicles and investors’ interests in vehicles which is not publicly available should always be treated confidentially.

Vehicles must comply with all laws and regulations applicable in the jurisdiction in which they are established.

The manager should ensure that the vehicle complies with all laws and regulations.

The investor should support the manager in ensuring that the vehicle is compliant with applicable laws and regulations.

The manager on behalf of the board of the vehicle has primary responsibility for compliance with applicable laws and regulations. Investors may be required to provide information legitimately required by the manager (such as for tax purposes) and in such circumstances should do so promptly.

Investors always need to consider carefully all information supplied by the vehicle, the manager and non-executive officers, take due note of any identified potential risks and raise questions with the manager or non-executive officers whenever appropriate, including any concerns regarding compliance, or failure to comply, with applicable laws and regulations.

The constitutional terms should set out the way equity is issued and redeemed in a vehicle.

The manager should clearly articulate how equity is to be issued and redeemed.  In the case of closed end vehicles, the issue of equity is likely to be through one or more initial closings where a number of investors subscribe at the same time, with redemption being towards the end of the life of the vehicle.  In the case of open end vehicles, the process of issue and redemption of equity would be on a periodic basis. This may be annually, quarterly, monthly or even daily. The method of valuation of the equity should be clearly set out, including the underlying valuation and accounting principles applied. In some jurisdictions and vehicle structures, the mechanism is prescribed by legislation or government regulations.

Investors should fully understand the constitutional terms before investing. Acceptance of the constitutional terms is demonstrated by signing the subscription agreement.

In order to allow an investor to fully understand the investment, the constitutional terms should state the vehicle strategy and vehicle operation, the relationship and obligations between investors and the vehicle (including investor decisions, meetings and votes), and the liquidity opportunities for investors, including the eventual exit procedures upon winding-up, if appropriate. Investors are expected to comply with these obligations. The constitutional terms should be clear and unambiguous, and include the appropriate jurisdiction in which meetings to decide on important issues which are reserved to investors are to be held.

The manager should implement a code of ethics to demonstrate integrity.

The manager operates under a duty of care to the vehicle which has appointed it, and, through the vehicle, to investors. Investors, when deciding to invest, have usually relied upon the manager’s track record, and its acknowledged standing, integrity and reputation. The manager needs to be able to satisfy both the vehicle and investors that it has performed its duties with the required degree of integrity, and that it has behaved ethically in its dealings with the vehicle, non-executive officers, investor representatives, the vehicle’s external advisers and investors.

The manager should exercise the necessary control over its staff, external advisers and third party service providers to ensure that it can operate in the best interests of the vehicle and its investors.

The manager has to demonstrate to investors that it has the required skill to meet its obligations as a manager. This may include using third party service providers. See section 3 of the Corporate Governance Assessment tool. The manager is expected to have the required level and quality of expertise in terms of staffing, external advisers and third party service providers, as well as the necessary resources, in particular:

• adequate number of properly trained staff with the required level of experience, qualifications and skills;
• access to competent external advisers and expert service providers in the relevant jurisdictions, each of whom has an adequate system of internal controls and reports regularly to the manager on the effectiveness of such a control framework.

The manager should follow INREV guidance.

The manager, in order to show that it has acted and is acting diligently, both upon the establishment of the vehicle and during its life, is expected to be able to demonstrate to investors that it conducted the necessary due diligence (in line with the INREV due diligence protocol) upon the establishment of the vehicle, and that the vehicle is legally able to adopt its strategy to achieve its anticipated returns.

The manager should implement an agreed policy on risk identification and management for the vehicle, and establish and maintain a permanent risk management function.

The manager should identify risks early and manage them in a timely and proper manner. The manager needs to be able to show that potential risks are identified, monitored and managed quickly and diligently. This can only be achieved if the manager has competent staff, external advisers and service providers with the requisite expertise. The manager should also implement an adequate system of internal controls and ensure that information on the effectiveness of such a control framework is provided regularly to investors. See section 3 of the Corporate Governance Assessment tool.

Investors should employ staff or other resources with the requisite market experience, skills, expertise and knowledge.

Investors need to ensure that they and their representatives have had the appropriate training and are up-to-date with relevant developments, so as to be in a position to seek the appropriate information from the vehicle or the manager in understanding the performance and development of the vehicle.  Investors should act diligently when requested to consent to proposals made by the manager, and should respond in a timely and proper manner.

The constitutional terms of the vehicle should contain provisions dealing with circumstances in which investors fail to meet their obligations to the vehicle. See section 3 of the Corporate Governance Assessment tool.

Investors should act diligently to assess and monitor the identification and management of risks.

Investors should obtain from the manager, before investing, information they consider necessary to satisfy themselves that the vehicle strategy is appropriate, that the risks are appropriate relative to the rewards, and that the manager has the requisite experience and resources (human, financial and information) to be able to deliver the expected returns. INREV has published a recommended questionnaire for investment evaluation to assist investors in their due diligence investigations.

The manager should demonstrate how it is accountable to investors.

The manager is accountable to the vehicle and the investors as a whole. Investors will rely on the manager to ensure that the objectives established at the outset and investment plans are achieved and that the vehicle operates in accordance with its constitutional terms and all applicable laws and regulations. The manager can demonstrate this accountability, for example, by being available, upon reasonable notice, to meet with non-executive officers, investor representatives and investors to review and discuss matters relating to the vehicle. The manager would also normally be expected to exercise control over, and maintain close relations with, the external advisers and service providers, including external auditors, valuers, portfolio and property managers and risk managers.

The manager should be indemnified by the vehicle, except where the manager is negligent.

The manager should be willing to accept a certain level of liability for its actions but would generally expect to be indemnified by the vehicle for losses where the manager has not been negligent or in breach. See section 4 of the Corporate Governance Assessment tool.

The manager should be able to be terminated with or without cause.

The ability of the investors to terminate the contract of the manager, both for cause and without cause, is an indication of the extent to which the manager is accountable. Greatest accountability is achieved with a no-fault termination mechanism, after a special resolution of investors. Reasonable compensation may be due to the manager depending on the circumstances of the termination. See section 4 of the Corporate Governance Assessment tool.

Investors will expect protection against circumstances where the performance of the manager (whether measured quantitatively or qualitatively) is sub-standard. In such circumstances it may be appropriate to establish a process of dialogue with a timetable between the manager and the investors (through the non-executive officers or investor representatives) to address such underperformance.  In circumstances where the plan agreed from such a process is not followed by the manager then the investors may consider suspension of the investment period or even termination of the manager after a special resolution.

The manager should have regard to INREV Guidelines on property valuations.

During the life of the vehicle the manager will provide investors, investor representatives and non-executive officers with property valuations. Investors would expect external property valuers to be independent. In order to ensure that valuations are adequately monitored, and that the interests of investors are protected, the rotation of external valuers upon the expiry of their mandates is encouraged, and the fees paid to external valuers should be structured in such a way as not to compromise the independence of valuations.  See section 5 of the Corporate Governance Assessment tool.

The manager should report to investors on the extent of compliance with INREV corporate governance principles and guidelines including any circumstances in which best practice is not followed and the explanation as to why this is so.

The constitutional terms of a vehicle should set out the use of side letters, which should be disclosed to all investors.

We recognise that there may be circumstances in which different investors will have different arrangements with a vehicle.  For example, larger investors may receive a discount on fees payable to the manager. The manager should set out how side letters and similar individual investor agreements will be dealt with. The manager should disclose the terms of such side letters, while recognising that certain investors may request anonymity in such matters. See section 5 of the Corporate Governance Assessment tool.

AIFMD specific requirement: In case of an externally managed AIF, the AIFM is responsible for compliance with the transparency requirements of the AIFMD.

Investors should feed back to the manager their precise information requirements, and whether they are being satisfied by the vehicle.

This should help ensure that the vehicle's reporting is managed as efficiently as possible.

The manager should demonstrate that its interests are truly aligned with those of investors through vehicle structures.

The vehicle is established to deliver investment performance to investors. The manager is expected to act in the interests of investors. As far as possible, this can be assured by creating structures in the vehicle to ensure the alignment of the manager’s interests with those of the investors.

Alignment of interest may be achieved by the manager investing a meaningful amount in the vehicle. See section 6 of the Corporate Governance Assessment tool. INREV recognises that there may be circumstances in which co-investment by the manager may not be appropriate, however.

Alignment of interest may also be achieved through the fee structure, including payment of performance fees to the manager based on vehicle performance. This may not fully align the manager to downside risks, however. Any performance fee structure should incentivise the manager to behave in a manner consistent with the risk profile of the vehicle and should reflect the added value that the manager is expected to provide. For example, the element of manager remuneration related to performance is typically less for a core vehicle than for an opportunistic vehicle. See section 6 of the Corporate Governance Assessment tool.

Remuneration policies are required for those employees of the manager whose professional activities have a material impact on the investment strategy or the risk profile of the vehicle they manage. The remuneration policies should promote sound and effective risk management and not encourage risk-taking which is inconsistent with the risk profile of the vehicle.

The constitutional terms should set out the provisions to be applied in the event that key personnel leave the manager.

Where certain employees of the manager have been identified in the documentation as key men or personnel, the constitutional terms will often contain specific provisions to cover the situation where these personnel leave the manager. The provisions may extend to the manager being prohibited from making further investments, or even face losing its mandate. See section 6 of the Corporate Governance Assessment tool.

The manager and the vehicle should implement a written protocol documenting how to handle conflicts of interest within the vehicle.

Conflicts of interest between the manager and the vehicle may arise in a number of circumstances, such as where:

• the manager (or another vehicle controlled by the manager, or a related party to the manager) competes with the vehicle to acquire assets;
• the manager (or another vehicle managed by the manager, or a related party to the manager) buys or sells assets from the vehicle;
• changes are proposed to the fee structure or other arrangements between the manager and the vehicle;
• the manager seeks to sell its interest in the vehicle;
• investors are in conflict over a decision that is required to be made by them.

Conflicts of interest may also arise with third party service providers. For example, the external valuer may make an offer to provide additional property services to a vehicle. This could potentially compromise the independence of its valuations.

When potential conflicts of interest arise, the manager should bring them immediately to the attention of the vehicle and the non-executive officers or investor representatives, and implement the agreed conflict procedure. The manager should always ensure that dealings in related-party transactions are on an arm’s-length terms basis. For example, if the manager (or another vehicle managed by the manager) wants to compete with the vehicle to acquire assets, the manager should disclose this to the vehicle, together with a policy for ensuring fair treatment for all its clients. See section 6 of the Corporate Governance Assessment tool.

The vehicle should set out how all investors will be treated on new issues, redemptions and transfers of equity in the vehicle.

Conflicts of interest can arise whenever investors vary their holdings in a vehicle. The manager should ensure that the rules governing new issues, redemptions and transfers are clearly and transparently set out for all investors.  Such rules should be in accordance with guidance provided in the INREV liquidity guidelines and should be fairly and consistently applied. Conflicts of interest can also arise for the manager in providing a service for secondary transfers between investors, and its role in raising new capital, if applicable.  At the outset the manager should clearly articulate the role that it provides in respect of secondary transfers, including any fees charged or interaction with third party trading platforms or placement agents.

The vehicle should be run in the interests of investors to deliver anticipated returns.

Investors should advise the vehicle and non-executive officers in a timely manner if they consider that the vehicle is not being run in their best interests.

Investors should disclose conflicts of interests to other participants in the vehicle and act appropriately.

Conflicts of interest between an investor and the vehicle may arise in a number of circumstances, such as where an investor competes with the vehicle to acquire assets or an investor buys assets from, or sells assets to, the vehicle. Investors need to act with integrity, and to disclose appropriate information to the particular vehicle, the manager and other investors, in a timely and proper manner. For example, if an investor competes with the vehicle, or buys an asset from, or sells an asset to, the vehicle, the investor would normally excuse itself from the relevant discussions in the vehicle or from receiving any information. In such circumstances, an investor may have to create ‘Chinese Walls’ so that different individuals or teams of people are able to act for the different parties.

The constitutional terms should set out the obligations of confidentiality assumed by the vehicle and its investors.

The manager will be aware of information relating to the vehicle, some of which may become publicly available, and some of which may be disclosed in order to be transparent. Information which is commercially sensitive to the vehicle, however, is expected to be treated as confidential and not to be disclosed widely. The constitutional terms may contain confidentiality undertakings, so that the vehicle passes on to its investors the duty to keep certain information confidential, and to refrain from acting on it.

The need to maintain confidentiality has to be balanced by the need to ensure transparency; if there is a conflict, the need for transparency should prevail. The constitutional terms should set out the rights of non-investors, such as potential investors and their advisors, to receive information without entering into a confidentiality agreement. Confidentiality provisions should not effectively prohibit investors exercising their rights under the constitutional documents, such as when engaging third party advisors. See section 7 of the Corporate Governance Assessment tool.

Investors should comply with the confidentiality provisions, particularly when seeking to dispose of their investment, and should not use confidential information for their own benefit.

Investors may be in possession of information which is not publicly available, and which has been communicated to them by the vehicle or the manager and which may be commercially sensitive. Investors intending to disclose potentially confidential information to third parties who are potential investors are expected to seek confidentiality undertakings satisfactory to and in favour of the vehicle from the relevant third parties. Investors may also involve the manager in discussions with these parties, and request that the manager delivers to potential purchasers such information as may reasonably be required.

In this section we deal with variations in the application of the corporate governance guidelines to open end and closed end vehicles. In practice there is not a clear division between these two categories as vehicles may have characteristics of both. Nonetheless we set out how the governance for a pure open end vehicle may be expected to vary from a pure closed end vehicle.

Liquidity mechanism for investors

Closed end vehicles would typically have a fixed life, and investors would normally expect to invest at the start of the life of the vehicle, and redeem their investment towards the end of the life, as the vehicle sells its assets and winds down. Investors may have the ability to sell their investment on the secondary market, but would not normally expect to do so.

Open end vehicles, in contrast, typically last for an indefinite period, and provide clear mechanisms for new investors to subscribe for equity, and for existing investors to exit from their equity position. Consequently, the constitutional terms governing subscription, valuation and redemption of equity in the vehicle must be clearly set out for all investors and prospective investors, along with the anticipated liquidity for investors. Such terms are likely to be more developed in open end vehicles than in closed end vehicles.

Valuation guidelines

Given the importance of the mechanism for subscribing for and redeeming equity in an open end vehicle, particular attention should be paid to the valuation and accounting principles applied. These valuation and accounting principles should be clearly set out in the constitutional terms and disclosed to any potential investors, including the frequency of such valuations. The vehicle should also follow INREV’s methodology for calculating and disclosing the INREV NAV. The constitutional terms should describe how the price for equity subscription (bid price) and equity redemption (offer price) are related to the INREV NAV.

Control or influence in decision-making

The constitutional terms will set out the extent of control or influence delegated to non-executive officers and investors in the running of a vehicle. In closed end vehicles, where investors are likely to be committed to the vehicle for its entire life, investors may seek some control or influence over certain decisions, as set out in CG10 of the guidelines. The degree of control or influence offered to investors can be less in open end vehicles, however, based on the assumption that investors should have the opportunity to exit the vehicle if the investment strategy of the vehicle no longer meets their investment objectives. Since the liquidity of open-ended vehicles cannot be guaranteed, it constitutes good governance to also provide for key investor rights in open end vehicles.

No-fault termination clauses

One indication of accountability of the manager is the existence in the constitutional terms of a clause providing for no-fault termination of the manager. A no-fault termination clause is less common in open end vehicles than in closed end vehicles, since investors who no longer wish the manager to run the vehicle, and who would vote for a termination of the manager if such a mechanism were available, may exit the vehicle through redemption. As the liquidity in open end vehicles may not be fully available it constitutes good governance to also provide for no-fault removal provisions in open end vehicles.

Co-investment by the manager

One indication of alignment of interests with investors is the manager having a meaningful co-investment in the vehicle as an incentive for the manager to perform. Co-investment by the manager is likely to be less important to investors in an open end vehicle than in a closed end vehicle, if a proven exit mechanism is available to investors who may be concerned about the commitment of the manager to run the vehicle.

Performance feeterms

Another indication of alignment of interests with investors is a performance fee structure that incentivises the manager to act in a way that is in the interest of the investors. Performance fee structures should be designed to suit the risk profile of the vehicle. Open end vehicles are typically core, not opportunistic, and so it would be expected that the balance of fees to the manager will be more weighted to base fees than for a closed end vehicle. In addition, the bid/offer price mechanism should take account of any accrued but unpaid performance fee.

Conflicts of interest

AIFMD specific requirements: The AIFM that manages an open-ended AIF shall identify, manage and monitor conflicts of interest arising between investors wanting to redeem their investments and investors wishing to maintain their investment in the AIF, and any conflicts between the AIFM’s incentive to invest in illiquid assets and the AIF’s redemption policy.

• Corporate Governance Assessment