INREV and AREF launch initiative for consistency in open-ended fund pricing

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INREV and AREF have launched a joint industry-wide consultation paper aimed at accelerating the debate on open-ended fund pricing policies, they announced this month.

The consultation paper, ‘Open End Fund Pricing’, is designed to improve consistency and clarity on pricing policies in the long-term. The accompanying study looks in detail at the main pricing methodologies typically used by market participants and also introduces an alternative pricing model, which blends the best of the existing models.

‘One of the triggers for our initiative was that we wanted to increase the awareness of dilution (the reduction in the ownership percentage of a share as a result of new shares being issued), its impact on investor returns and the protection that fund pricing policies offer against dilution,’ Constantin Sorlescu, INREV’s professional standards manager, told REFIRE. ‘Real estate is a long-term investment, so one of the main questions is: how do the transaction costs become allocated between existing investors in a fund and new investors?’

There’s broad agreement within the industry that more needs to be done to establish a more structured and common approach to pricing policies and INREV and AREF’s consultation paper ‘will unlock greater consistency and transparency in industry practice’, according to Sorlescu.

The ‘Open End Fund Pricing’ study provides an examination of different pricing methodologies for open-ended funds with a forensic analysis of the relative merits and drawbacks of the two most commonly used dual pricing models – the capitalization and amortization model and the classic dual pricing one. It also includes a proposed third model, which blends the calculation methodologies of both broad categories.

‘With the Cap & Am model, the costs are spread across a certain horizon,’ Sorlescu explained. ‘With the classic dual pricing model, a fixed premium is charged at the start of the investment. We found out, based on our modelling exercise, that there are no significant differences in terms of returns between the two models.’

The alternative pricing model that INREV and AREF have come up with is designed to optimize long-term returns. ‘If we apply a ‘dynamic’ dual pricing model, it offers slightly better returns,’ Sorlescu said. If you have a multi-country strategy, the transaction costs can be very different in different markets due to regulatory initiatives, he added. ‘So if you have a fixed spread, it creates a mismatch between joining the fund and the actual transaction costs. A ‘dynamic’ dual pricing model or the Cap&Am model work better as there isn’t a fixed spread. According to our calculations, the difference between the ‘classic’ dual pricing model with a fixed spread and the ‘dynamic’ model that doesn’t have a fixed spread are only between 20 bps and 30 bps over a 20-year period. As such, any of these pricing models, when appropriately applied, protect long-term investors from dilution.’

Following the launch of the study, INREV and AREF will collate feedback from their respective members. The responses will be summarised in a follow-up conclusion paper, which will be published in early 2018. The consultation will close for responses on 31 January 2018.

‘With this study, we aim to further the understanding of different pricing methodologies and how they can impact open end vehicles,’ said AREF’s CEO John Cartwright. ‘It is particularly important to seek some sort of consensus view on this topic when the non-listed real estate industry is becoming increasingly global,’ he added.

Ernst & Young, represented by partners Michael Hornsby and Robert White, was commissioned to undertake all the detailed financial modelling in the paper, with support from a dedicated project group made up of INREV and AREF members.