Outsourcing Trends within the REIM Industry

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1 Outsourcing Trends within the REIM Industry NAREIM/FPL Pulse Series Third Quarter, 2012 FPL ADVISORY GROUP FERGUSON PARTNERS FPL ASSOCIATES

2 Participants overwhelmingly confirmed outsourcing is a trend within the REIM industry today In recent years investors have been putting pressure on fees paid to managers, while at the same time demanding more rigorous standards and reporting requirements. As a result, firms across the REIM sector are being forced to reassess their operating models and find efficiencies for protecting the bottom line and/or improving client service. Following in the footsteps of many hedge funds and non-real estate private equity firms, many REIMs have recently turned to outsourcing as a means to this end. While outsourcing is certainly not a new concept in real estate (firms have outsourced functions such as property management and leasing for many years), the widespread use of third party service providers for traditional back office functions such as accounting and information technology is a more recent phenomenon. This quarter s survey examined outsourcing in the real estate sector in more detail and asked REIM industry leaders for their thoughts on the rationale behind this emerging trend. At the highest level, participants overwhelmingly confirmed a view that the outsourcing of corporate functions is a trend in the REIM industry today. Figure 1 Do you believe there is a trend towards the outsourcing of corporate functions? In the broader REIM industry? At your firm? No 10% No 33% Yes 90% Yes 67% 2

3 Executives noted a variety of factors motivating this trend While there was broad consensus with respect to this macro trend, views regarding the primary drivers were more varied, reflecting the fact that though two firms may both choose to outsource a particular function, they may be doing so for very different reasons. Figure 2 What factors are the primary drivers for the outsourcing of corporate functions in the REIM industry? % of firms Ability to scale Managing resource demand fluctuations Direct cost savings Allows for focus on core competencies Increased productivity Expertise Transparency for investors Scalability/flexibility Many companies noted that the ability to respond to resource demand fluctuations and scale their business quickly were key benefits of outsourcing. As one industry executive outlined, Outsourcing enables us to access resources and skills without having to increase staff and incur all the associated costs of doing so. Another stated, Outsourcing allows us to keep our internal head count low while still effectively handling peak loads. Given the challenging market conditions, many firms are still facing a great deal of uncertainty regarding their future needs. Other managers may be growing, but are still reluctant to increase staffing given the tumultuous nature of the past several years. Regardless of the specifics, the flexibility that outsourcing affords provides an attractive and pragmatic option to managers. 3

4 [Outsourcing] eliminates distractions related to functions that are not part of our core competencies. Direct cost savings One of the most obvious potential benefits of outsourcing is the opportunity to realize direct cost savings. With investors and managers alike both emphasizing cost control, initiatives to reduce expenses are common. For some, outsourcing may provide a mechanism to achieve this objective. For us, outsourcing provides cost savings by focusing external resources on a specific need rather than maintaining a staff of generalists internally, noted one participant. In addition to lower direct personnel costs, outsourcing can also provide indirect cost savings through reduced office space needs and other related occupancy costs. All told, the potential savings can be significant. As one executive reported, Outsourcing can represent up to 50 percent in cost savings based upon the locale of the provider and the type of service in question. Service expertise & internal focus on core competencies Many managers suggested that maintaining an internal focus on their firm s core competencies and eliminating the tendency to become bogged down by non-real estate related activities were major arguments for outsourcing. As one respondent noted, It eliminates distractions related to functions that are not part of our core competencies, but for which services must be delivered (e.g., accounting). At the same time, outsourcing can also provide access to high levels of expertise in specific areas that are critical to meeting the requirements of investors and/or operations. Outsourcing allows us to gain expertise quickly and focus our staff on higher value add work. Reimbursable expenses Another consideration is whether outsourced services are reimbursable by the fund being serviced. One manager cited this issue specifically, saying, Most third party services are reimbursable by the funds we manage, whereas we cannot charge in-house costs for those same services to the fund. In a time where managers are doing all they can to improve profitability, this type of benefit can be a material consideration within the outsourcing debate. 4

5 Managers overwhelmingly prefer best-in-class, specialized service providers Respondents were relatively consistent when reporting what criteria they look for in a third party services provider. Deep expertise, positive track record, integrity, and transparency were universally seen as absolute requirements. Interestingly, the vast majority of respondents indicated a preference for specialized services providers rather than a totally integrated, one stop shop type of partner. Most firms explained that they search for true expertise and bestin-class experience which is viewed as more readily available through specialized service providers. As one participant explained, We look for the best-in-class provider in everything that we would outsource, which often means that the integrated firms are not the vendor of choice as the convenience of using one provider is not as important as being the best at the task needed. The use of third party service providers can offer a number of strategic benefits that, for many managers, outweigh the inherent downsides of outsourcing, namely the loss of control. For these managers, outsourcing represents a mechanism to meet operational and investor needs without overburdening existing employees or scaling internal staffing levels. Overall, it s clear that outsourcing is top-of-mind for managers and is a trend that shows no signs of slowing in the near future. 5

6 Index This quarter s index value was 60, indicating that most executives feel current real estate investment management conditions are improved from the previous quarter. However, the downward trend over the past three quarters reflects a softening of this perspective. How do current Real Estate Investment Management industry conditions compare to the prior quarter? Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q About the Index: The index is calculated as follows: a point value is assigned to each response, worse (0), about the same (1/2) and better (1) then dividing the total number of points by the number of respondents. Therefore, an index of 50 indicates the overall sentiment is about the same as the prior quarter; similarly, any value over 50 indicates a better environment and under 50 indicates a worse environment. 6

7 Methodology In early September 2012, NAREIM and FPL Associates Consulting sent out a survey questionnaire for the purpose of gathering investment managers perspectives on outsourcing. The survey consisted of two multiple choice questions, two open-ended questions, and our recurring market conditions question included with each survey. Participants vary in size, strategy, and location and represent a cross-section of real estate investment managers (see Survey respondent list for a representative group of participants). FPL gathered, clarified and analyzed the responses to the survey as well as interview feedback to develop this summary report. Due to company policies and/or unique aspects of their operations, not every participating company was able to provide information for every survey question. In cases where certain participants did not respond to a particular question, they were excluded from the reported statistics related to that question. Survey participants represented the following companies (please note that not all participants chose to be listed): Almanac Realty Centerline Capital Group Cornerstone Real Estate Advisers LLC Grosvenor Fund Management Henderson Global Investors (North America) Inc. IDS Real Estate Group Inland Institutional Capital Partners Corporation Kensington Realty Advisors, Inc. Kimco Realty Corporation LaSalle Investment Management MacFarlane Partners McWalters Advisors National Real Estate Advisors PNC Realty Investors Principal Real Estate Investors Prudential Real Estate Investors Sarofim Realty Advisors Co. Trail Creek Capital TriMont Real Estate Advisors UBS Realty Investors LLC We extend our sincere appreciation to all participating organizations for providing valuable information. Contact Please direct all inquiries regarding this study to: Gunnar Branson Chief Executive Officer NAREIM 410 N. Michigan Ave. Suite N 330 Chicago, IL Phone: (312) gbranson@nareim.org Loren Croskey Manager FPL Associates L.P. 191 North Wacker Drive, Suite 2850 Chicago, Illinois Phone: (312) lcroskey@fplassociates.com 2012 FPL Advisory Group LLC. All rights reserved. No business or professional relationship is created in connection with any provision of the content of this publication (the Content ). The Content is provided exclusively with the understanding that FPL Advisory Group LLC is not engaged in rendering professional advice or services to you, including, without limitation, tax, accounting, or legal advice. Nothing in the Content should be used in or construed as an offer to sell or solicitation of an offer to buy securities or other financial instruments or any advice or recommendation with respect to any securities or financial instruments. Any alteration, modification, reproduction, redistribution, retransmission, redisplay or other use of any portion of the Content constitutes an infringement of our intellectual property and other proprietary rights. However, permission is hereby granted to forward the Content in its entirety to a third party as long as full attribution is given to FPL Advisory Group LLC The views and opinions expressed by each participant are such individual s own views and are not necessarily the views of FPL Advisory Group LLC, NAREIM, or such participant s employer. 7