Within the domain of the Office Fund, we distinguish the following risk clusters:
- Allocation risks
- Generic sector risks
- Specific sector risks
- Management risks
Following the decision to invest in real estate, an investor has a wide range of choices for the allocation of investments. Bouwinvest believes that it is not the allocation to real estate that determines risk levels, but the secondary conditions set for the allocation. Using the secondary conditions it has formulated, Bouwinvest allocates based on:
- Responsible costs
- Low risk profile
- Stable returns
- Corporate Social Responsibility
- Optimal diversification
The main allocation risks for the Fund are country, real estate market, portfolio, leverage and regulation risks (i.e. tax and legal). These risks are low for the Retail Fund, as the allocation for the Fund is pre-set. Risk is further limited by pre-defined core regions and core properties.
Generic sector risks
In the real estate sector, the indirect return is part of the overall return. This is why Bouwinvest devotes a great deal of attention to the factors that can influence indirect returns. The term ‘generic sector’ is used because these elements are indistinguishable from the underlying object itself. The main risks associated with the indirect return are valuation, transactions and integrity. These risks are within the scope of management and are managed as follows.
Valuation risk is the risk that the property value is affected by incorrect valuation methods or assumptions. To control this risk, the properties are valued on a quarterly basis by external appraisers, who are rotated every three years. Bouwinvest closely monitors the observance by the appraisers of the 28 recommendations as put forward by the Platform Taxateurs en Accountants (Appraisers and accountants platform - PTA). The results of the valuations are reviewed on a quarterly basis and deviations from previous quarters in excess of 5% are analysed in detail. Bouwinvest has developed its own proprietary valuation model, which complies with the International Valuation Standard Council, IPD and IFRS valuation guidelines and is considered a best-in-class valuation model in the Netherlands. The model includes a set of fixed valuation criteria, such as vacant value ratio, mutation ratio, exit yield and discount rate.
Transaction risk is the risk that there is either scarcity or oversupply (in terms of both quantity and quality) for the acquisition or sale of assets. As the market fundamentals cannot be controlled by Bouwinvest there is no way to influence this scarcity or oversupply. However, Bouwinvest does have a set governance mechanisms to ensure that market sentiment does not cause the Fund to invest in assets that clash with investor goals. A strict protocol specifies necessary steps and diversification guidelines in the process of an acquisition or disposal.
No proposal for an acquisition or disposal can be approved prior to a recommendation from the Investment Committee. This committee’s review of the proposal includes their assessment as to whether Bouwinvest’s risk return models have been correctly applied. Bouwinvest also has its own research department that continuously monitors market developments. The final measure is an up-to-the-minute cash-flow planning that reflects all changes in the cash position, including the acquisition/divestment planning based on hold/sell analyses.
Bouwinvest uses a ‘pipeline’ report, containing an outlook on all possible acquisitions and divestments and the conversion rate.
Integrity risk is the risk that the Fund may be affected by improper or unethical conduct on the part of Bouwinvest, its employees or management, such in contravention of legislation and regulations, as well as the standards set by society or by Bouwinvest itself.
To control this risk, Bouwinvest has implemented policies and procedures including:
- A Code of Conduct
- A whistleblower policy
- A policy on incidents
- Know-your-customer guidelines
- Pre-employment screening
The Compliance department has also implemented an effective monitoring and testing process and has an ongoing awareness programme to increase knowledge and awareness of risk throughout the organisation. The Compliance department reports its findings to the Statutory Director on a monthly basis.
Specific sector risk
Fund returns are to a large extent influenced by market trends and quality of asset management. Specific knowledge of the sector is crucial to the understanding of the specifics of the property and to optimising direct returns. We use the term sector-specific, as there is a correlation between the risk and the direct return of the property. These risks are within the scope of management and the specifc sector risks are:
- Sector market risk
- Legal risk
- Rental risk
- Object risk
Sector market risk
Sector market risk is the risk that a fund is insufficiently able to adopt its portfolio to important market trends. For the Dutch office market the most important recognisable market trend is a polarisation between market segments.
In 2014, the vacancy rates in the Dutch office real estate market were quite high. Revenues from rents were under pressure and the risk of vacancies remained high. However, despite relatively flat economic growth, there was still a need for high-quality and sustainable office space in prime locations, due in part to office sector trends such as flexible working practices ('The New World of Work'). In contrast with the prime segment, peripheral office locations have shown a decline in value and occupancy rates.
The polarising effects of these trends are expected to continue in 2015. Knowledge of the local markets, adequate diversification and effective timing in acquisitions and divestments can help portfolio managers to mitigate location and diversification risk.
This is the risk that the direct return is influenced by insufficient legal measures. To control this risk, Bouwinvest has its own legal department that implements policies and procedures to support the business. This department advises the business when needed and seeks external support when required. The legal department reports its findings and involvement in any legal procedures to the Statutory Director on a quarterly basis.
This is the risk that the direct return is influenced by changes in the rental conditions, or that the properties are no longer attractive to tenants. Customer (tenant) satisfaction is key to the direct returns from the Office Fund’s real estate portfolio. The Fund has introduced measures to limit this rental risk. For instance, the Fund has a system in place to monitor tenant satisfaction with both its rented property and the services provided by the Fund’s external property managers. We are currently discussing the results of the latest annual tenant satisfaction survey with our property managers and together we have launched a number of (custom-made) initiatives, all aimed at creating a consistent and adequate approach to tenants to improve customer satisfaction.
Object risk is the risk that the returns from the property will deviate from the amount that has been calculated in advance. Bouwinvest has the following measures in place to control this risk. Bouwinvest performs an annual hold/sell analysis of the properties to ensure that they continue to support the Office Fund’s overall return target. The long-term estimates on a per property basis also provide effective insight into expected maintenance costs.
The structuring of the portfolio – or the overall balance of the assets – also takes into account the following risk indicators:
- type of office (multi or single-tenant)
- regional spread, with a focus on economically strong regions
- spread in risk categories
- rent in arrears
- vacancy rate
- average remaining lease term
The IPD provides a report each quarter, based on our data, on the returns from specific properties. Bouwinvest monitors this information closely to detect any deviations at an early stage.
Counterparty risk is the risk that other parties in an agreement will default. For the Office Fund, the largest single counterparty exposure is the bank that is used by the Fund. Furthermore, this risk is largely determined by the ability of its tenants to fulfil their contractual obligations.
Bouwinvest reduces counterparty risk by having good credit controls in place, as well as sound collection processes.
This refers to the risk that Bouwinvest’s management of the Office Fund, including its management and control of the risks it faces, may in some way be inadequate or ineffective. This would affect the direct and indirect return of the Office Fund. This risk is subdivided into the following risk elements:
- relative performance
- management fee
To control these risks, there is a management agreement in place that determines the responsibilities of Bouwinvest as the Office Fund’s management company. ISAE 3402 certification provides investors with reassurance on the risk management, including risk definition and control measures, of all key processes of a company’s day-to-day operations. Bouwinvest gained ISAE 3402 Type II standard Service Organization Control (SOC) reporting certification in 2013 and received a certificate over 2014 in January 2015.