Critics of external managers argue that costs could be lowered by taking those functions internally while supporters are more concerned about the corporate governance advantages of having an external management company. Typically, institutional property companies, such as Property Unit Trusts (PUTs), will favour external managers, while those funds where control is exercised by management are more and more favouring internal.

External managers are generally paid a fee based on a percentage of assets under management. In South Africa, this has usually been 50 basis points (0.50%) of enterprise value, which is the entity’s market capitalisation plus debt. Thus, external managers may be incentivised to grow total assets.

However, investors in listed property vehicles should be more concerned with a balance between sustainable income growth, and consistent capital appreciation. Essentially, therefore the interests of, and benefits to, the external manager and the shareholders or unit holders must be aligned so as to ensure rewards for each are acceptable. And this is not just a South African debate, but is one which is being contemplated globally as well.

Leon Allison, a property analyst at Macquarie First South, conducted a survey of listed property investors’ views on the desirability of internal vs. external management. Although investors favoured internal management, for the above reasons, 40% of those surveyed were either indifferent to the two forms of management or felt that there is room for both in the South African market. This would seem to be supported by international research, with both internal and external managers in existence in sophisticated property markets such as Australia.

In the case of PUTs though, the question falls away. The PUTs are, as the name implies, trusts and the assets therefore belong to the trust. They will therefore always have an external management company as this is the nature of collective investment schemes regulated by the Financial Services Board.

There are essentially three entities where unit trusts are concerned:

• The fund or asset manager, which runs the trust for profit.
• The trustees of the unit trust, who ensure the fund manager keeps to the fund's investment objective and safeguards the trust assets.
• The unit holders, who have the rights to the trust assets
   
  Craig Hallowes, spokesperson for the Association of Property Unit Trusts notes that the key to overcoming any perceived problem is to align the interests of the external asset manager with those of the unit holders and it is the trustees’ job to see that this takes place. If external managers are incentivised in line with unit holder welfare, their actions will be steered in the direction of greatest benefit to the unit holder.

What are the different ways of achieving this? One way to align the interests is  for the manco to have its income tied to the PUT unit price, or some other such means, whereby the the asset manager and the manco experience the same gains and pains as unit holders do. Alternatively, the manco fee could be based on a measure such as long-term income growth.

In addition to the 50 bp. fee mentioned above, some portfolios may have other costs which could induce unnecessary movement in properties in the portfolio. For example, there could be a fee payable for each property bought, or for each one sold, or when a property is revalued. As Hallowes points out, “Ultimately, if management in the manco have a stake in the underlying portfolio, their interests will also be aligned.”

“Regardless of whether the management company is external or internal, it is necessary to examine exactly how the management company is, and the asset managers within are, incentivised for the various functions and ensure that each way in which it is rewarded will encourage the manco to act in the best interests of the investors,” concludes Hallowes