Transparency May Be a Challenge, But Investor Trust Is a Worthy Goal
Real estate investment managers are under pressure to disclose fees and expenses to investors in greater detail than ever before. Transparency is good for our industry. But how much disclosure is enough—and how much is too much—in a sector with extremely active asset management and a history of long-term relationships between investors and managers?
The pressure to disclose is coming from the Securities and Exchange Commission. Private equity funds, including real estate, have been subject to SEC review only since 2012, with the passage of the Dodd-Frank financial reforms. In May of this year, the Director of the SEC’s Office of Compliance, Inspections and Examinations called on private equity and hedge fund players to make more complete disclosures of fees and expenses, in a public statement known as the Sunshine Speech.
In the speech, SEC cited a long list of private equity disclosure sins, from poorly defined valuation methods to a lack of safeguards against conflicts of interest, to “zombie” advisors who hold assets long past their expected terms in order to squeeze out more fees. “Most importantly, we see that most limited partnership agreements do not provide limited partners with sufficient information rights to be able to adequately monitor not only their investments, but also the operations of their manager.”
The real estate sector may not have been the primary target of the Sunshine Speech, but the SEC’s recent adoption of new rules for non-traded REITs reinforces the message that investors must have transparency to fees and expenses.
The question is where to draw the line. Because real estate requires more active management and ongoing capital expenses than most other private equity investments, disclosure of fees and expenses is both more difficult and more important to maintaining a trust relationship with investors. Accounting for every box of paper clips may be overkill; but if work formerly done in-house is now farmed out and charged to the fund, investors should be informed.
The call for deeper disclosure comes at a time when some investors have considered lawsuits against fund managers whom they believe overcharged on fees. Would greater transparency provide more ammunition to disgruntled investors? Most likely the opposite– informed consent may be a shield against liability in some cases, and more disclosure would motivate managers to avoid questionable practices in the first place.