Fees, fees and more fees!

Article Type: Editorial From: Journal of Property Investment & Finance, Volume 30, Issue 3

There has been a lot of discussion across the investment market about the level of fees, their lack of transparency and the different fee types such as tail commission. The main points have centred on how the level of fees eats into the viability and performance of one’s investment throughout its holding period. This is particularly notable in times of low total returns which is now.

Scrutiny of the property industry regarding its fees is about to intensify. The Financial Times research recently prepared by Yale and Maastricht academics found that US pension funds since 2001 received 4.5 percent pa investment return from private equity after fees, less than the 6.7 percent pa return for the same period from investing in the S&P400 index. Private equity and property fees are usually grouped together due to their high relative fees. Another study published in 2011 looked at returns from US pension funds until 2008. The study entitled “Can large pension funds beat the markets?” found that the high level of fees for private equity and property had a strong negative impact on returns.

Property fund management fees appear to be one sided in that the manager gets paid regardless of how the fund performs. This statement then directs us to assess what makes a successful fund manager. I can remember several academic works saying that performance is a random walk and alpha does not exist. So therefore, the performance is not down to skill, but to luck.

However, I think the relationship between property fund performance and manager skill is a bit more subtle than that. The particular market context is important which helps to dictate what style might be most rewarding in terms of performance.

Currently we have a risk adverse mentality in property investment which favours prime and marks down secondary property. There will come a point in the market where prime will be seen as too expensive, so investors will be going up the risk curve to achieve value.

The bipolar attitude of the current market (risk/no risk, good/bad) will start to see some cracks later this year. The trick is to be one step ahead of the market as that secondary value is being re-rated by the market.

So how does this skill and resilience get reflected in fees? Gone are the days when private equity property managers could charge 2 percent of gross capital value per annum then an additional 20 percent share in the performance above a benchmark which was not a challenge.

If you are out there trying to raise capital for your property fund, how do you convince prospective investors that you are worth it? The comparison you use is based on the salaries that are being paid in the industry plus an adjustment,depending upon your pitch. Just because everyone else is receiving x does not mean that you can get x+. There is pressure for fees to reduce which will place pressure on salaries. We have already seen this with the agents as their fees have come under pressure and reduced due to lower business volumes and too many staff chasing those too few deals.

In running a property fund management business, salaries are one of the largest overheads. As the business is consolidating, a job might be better than no job, so a reduction in salary is not a distinct possibility.

Much more detail justification of your worth will need to be done to convince clients and management that the fees are worth it for this performance.

There is resistance to change at the moment, but as returns from property will be most likely single digit for a while, the momentum will increase. Investors do not want their returns to further decease. On the property side,there is no one yet who is breaking out of the mould, although we have seen this with equities in Terry Smith’s Fundsmith fund. He has produced stellar equity returns of 8.5 percent pa in 2011 at TER of 0.17 percent pa with no initial and performance fees. The fund is now building an excellent track record for that magic three year figure which most consultants use as a benchmark.

It is relatively easy to get away with higher fee charges if returns are high. As we can see for UK property, single digit returns will be with us or a while. In order for us to remain competitive against the other asset classes, we must show that there is not a huge gap from gross to net yield.

So how equipped are we as an industry for these challenges or will we wait until something external is pushed upon us? There are always alternatives and we must remember that capital is like water, it will take the line of least resistance. As investors begin to catch on to this, there could no escape for property. Therefore, it would have to adjust quickly and brutally. We want to encourage investment in property not deter it because of the high fees.

Karen Sieracki