An evolving operating model: The outlook for fund administration outsourcing and real estate

There is a clear case for real estate investment managers to outsource middle- and back-office tasks, writes Josh Herrenkohl, senior managing director, Real Estate Solutions Group at FTI Consulting, who outlines the benefits, models and reasons why he believes almost two-thirds of funds will opt for third party administrators by 2027.

In less than two decades, real estate has evolved from a largely ungoverned, unregulated industry to a more mature one with increased regulatory scrutiny. As institutional investors continue to increase allocations to real estate investment managers, this evolution is affecting how these businesses conduct their operations. With this investment shift, investors are now focused more on the activities of these managers who must address questions that were once unanswered surrounding processes, efficiency, controls, automation and reporting.  

However, building an optimised, centralised and world-class business-support function to address stakeholders’ increasing scrutiny is, for myriad reasons, out of reach for most organisations; among the reasons is that the back-office is often not considered a core function of investment managers – at least in the opinion of those responsible for investing. Rather, the best real estate managers in the world are incentivised to focus on their core competency — investing — rather than administering the back-office. In fact, support functions provided by the back-office have often remained an operational afterthought, particularly given tightening margins. At the same time, the demands required to build a competitive, world-class infrastructure are increasing. 

Real estate technology is becoming ever more advanced and at the same time, more complex. An emerging baseline of technology is now required to compete and threatens to envelop not only the middle- and back-office, but increasingly the front-office. Ultimately, it will narrow the playing field, as those who don’t invest (or are unable to) will be left behind without insight into opportunities, deals and potentially even investment partnerships; ultimately, hesitant investors will be outpaced by the competition. 

Finding highly-skilled personnel to meet their growing technological and administration needs is increasingly challenging to managers. As allocations to real estate have ratcheted up, the small pool of skilled professionals is increasingly sought after and causing greater competition for top talent, as well as higher salaries and costs, particularly in smaller markets. At the same time, real estate companies’ “lead-by-example” approach has made many of these organisations unwilling to move to a remote work environment, further narrowing the viable pool of resources. 

Real estate industry data tend to be in divergent formats without any consistent standard, resulting in resources and costs required to manage the consistency of data. These data-challenges are exacerbated by the complex ecosystems of joint-venture partners, service providers, club deals, and varying regional standards. 

Managers are pressured to seek solutions that help them better manage their portfolios or attract more limited partners, who now expect greater visibility into portfolio and asset-level performance.  

These cumulative challenges and factors, combined with most real estate companies’ lack of scale on the part of all but the largest managers, make investing in the resources, technology and operating model that are a necessity to compete on the “tier 1 stage” largely insurmountable. 

The case for outsourcing 

All of this has led to a growing interest among CRE investors in outsourcing, with a particular focus on the back-office and parts of the middle-office (e.g., reporting, investor services, etc.).  

Managers are seeking to relieve the burden of managing non-strategic support functions in order to focus on their core strategic functions and avoid investor or stakeholder pressures to do so. Not having to handle the human resource, technology and control challenges associated with managing an increasingly complex back-office ultimately frees time, resources, and mind-share for critical investment- and asset-management functions. 

Real estate technology has advanced significantly over the last 10 to 15 years, spurred on by the just-in-time nature of business today. Advancements range from automation to analytics and reporting technologies; among other innovations on the cusp of being rolled out are AI and advanced automation. These technology advancements fuel heightened expectations by investors and other stakeholders (such as regulators, boards, etc.), which in turn, have intensified the complexity of analytics and reporting. Additionally, as more real estate owners have become registered with the SEC, the ability to build transparency for internal and regulatory purposes has also increased. 

Many large investors build specific and detailed reporting requirements into side letters or send questionnaires on a monthly or quarterly basis. Requirements such as these from investors and stakeholders introduce additional technology burden surrounding analysis and data presentation. However, most organisations do not have the internal means to understand the landscape of their technology options for requirements such as these, let alone select and implement these technologies. Even for organisations with such means, the relative cost of operationalising new technologies would be exorbitant for all but the very largest of real estate companies. 

The pressure to provide data transparency to stakeholders, concerns about keeping up with the latest technologies, while balancing the organisation’s financial reporting requirements, dealing with a tight labor market, and managing human resource costs are all drivers for institutional investors to look toward outsourcing to bring efficiencies to their organisations and investments. Moreover, unlike the situation in which managers perform such functions in-house, the fact that many investment managers are able to pass-through the costs of an outsourced provider only adds to the compelling argument behind this trend. 

Creating efficiencies for future sustainability and growth 

Data collection, extrapolation and interpretation, the need for multiple service providers (from property managers to accountants and tax advisors), and the need to leverage ever-changing technology will only become more pressing as real estate investment firms and owners try to stay competitive, grow their portfolios and deliver positive returns to investors. Outsourcing the back-office — a trend that, in large part, began less than two decades ago — will increasingly deliver efficiencies and economies of scale that more organisations will seek. 

Another one of the drivers behind this growing interest in outsourcing is an increasingly sophisticated investor base; these investors, both institutional and retail, are expecting more efficient back-office reporting and services, as well as risk mitigation and compliance. 

The case for increased and more aligned outsourcing 

Historically, real estate fund managers have looked on a price-only basis at outsourcing — a commodity that often delivered unsatisfactory outcomes (as can happen when one competes solely on price). However, these fund managers are slowly realising that the commodity relationship is selling them short on the true benefits that outsourcing can provide. Outsourcing to the right third-party service provider — one with commercial real estate experience — will bring value to the manager and investors alike by delivering these benefits: 

  • Create a single point of contact across multiple, bundled, integrated services and professionals; 
  • Hire talent across a wide array of geographies and capabilities, including diverse talent with specialised real estate industry knowledge and experience; 
  • Invest in technology updates and spread the cost across many clients; 
  • Enable à la carte technology adoption based on organisational needs; 
  • Implement more efficient and streamlined processes with better controls in support of all the processes being provided (SOC-1 is typical); 
  • Quickly scale up or down when the need for support changes; 
  • Provide independent and expert oversight of the books and records to mitigate fraud, and 
  • Offer complementary advisory services to help managers meet objectives. 

Drivers for future outsourcing growth  

Traditionally, outsourcing options have been unappealing within the real estate investment management industry. The earliest providers attempted to adapt their offering to other alternatives — whether hedge funds or private equity — and jury-rigged their existing infrastructure to meet the needs of the real estate industry. Not surprisingly, the results were less than satisfactory; the technology, skills, processes and concept of properties are largely foreign outside of real estate. But more recently, better options have emerged, and this trend will continue.  

Additionally, technology is already — and will continue to be — a significant driver, as will changes in real estate products and services that will be outsourced. The demand and requirements for skilled and experienced professionals will also continue to expand. As the level of complexity within real estate fund managers and their companies grows, the requirements for skilled professionals will also increase and, at the same time, become more specific. This factor will increase costs, to the extent that the manager can even find appropriately skilled resources in the first place. Additionally, without economies of scale, work-load balancing will become extremely difficult. 

  • Real estate funds are already diversifying their portfolios as they add co-working, single-family homes, debt, secondaries and other complex product types. These assets will add new technology and skillset requirements to back-office functions as the accounting, valuations and asset management are different from ‘traditional’ assets and, in many cases, more complex.  
  • The emergence of alternative business models such as fractional ownership will require more sophisticated technology and skills requirements. New functions likely to appear as well within the outsourcing landscape include asset management, portfolio management and “on demand” technology. This growth in the scope of outsourcing will be increasingly evident as technology evolves to the point at which many functions performed manually today will be automated in the future. Options surrounding how technology-facilitated services are delivered to clients will continue to adapt to the changing landscape, as well. In some cases, services will be delivered on a transactional basis rather than as a fully-outsourced service. Different pricing models for outsourced services will emerge as functions evolve and acceptance increases. For example, as automation improves and creates greater efficiencies, the build-up for pricing models will be based on the value those services deliver, rather than on time and materials.  

Among public real estate companies, the traditional mindset has been that all functions should be performed internally. However, the benefits of outsourcing are increasingly outweighing the costs, and we are already seeing a shift among public companies toward outsourcing more functions; we expect this trend to continue. 

Two emerging models of outsourcing 

Compared to other industries such as hedge funds, real estate has been a latecomer to the outsourcing trend, in large part because of associated skillset requirements and technology complexities. But as maturity begins to set in, two delivery models will take hold, particularly as outsourcing activity within the industry grows: 

  • One is to outsource back-office operations to a combination of offshore and domestic teams in a co-shoring model. Co-shoring carves out repeatable and transactional processes that can be performed overseas (with the concomitant cost savings of an offshore operation), while an onshore team manages the more complex strategic and management-oriented functions demanded by fund managers. Co-shoring leverages the overseas team’s capabilities at a lower cost to perform functions that don’t require a high level of skills, while retaining the strategy, controls and management oversight by more highly-specialised practitioners in the United States.  
  • Another model for the future of outsourcing is “co-sourcing,” wherein the fund manager selects the skills and resources to retain in-house and buys other services on-demand to fill in the gaps. This insource/outsource model enables the manager to build centres of excellence comprised of highly specialised professionals for specific functions. 

While these models are not new in the broader world of outsourcing, they are only starting to be adopted within the real estate industry. 

Other trends, like the following, are likely to take hold as outsourcing and fund administration within the real estate industry evolve and mature:  

  • Service providers will compete primarily on expertise, not pricing. Without a doubt, pricing will always be an important factor, but the strategic value of a highly-competent and technically-skilled provider will outweigh price-only competition. 
  • Managers will contract with an entity that performs as an extension of the organisation rather than as “simply” a vendor. This trend toward partnership mentality has accelerated according to pandemic-induced remote and hybrid work models; that is, working in a different location and not from within a single location is no longer a barrier to building a strong culture that includes both internal and third-party personnel. Ultimately, the role and perception of the service provider will be best served when it shifts from “supplier” to “partner.” The latter signifies a company that is invested in the longevity of the relationship with the fund, with a commitment to client service, as well as the fund’s long-term success.  
  • Limited Partners and investors will pressure managers more broadly to outsource. To an extent, this process is already underway, particularly with investors who are accustomed to investing in other asset classes, such as hedge funds, where a much larger percentage of managers outsource accounting and other back-office functions. But as real estate investors recognise the strengthened control-environment and value of an objective third party helping to oversee billions of dollars of investment, this trend will expand. 

Whether in a co-shoring or co-sourcing arrangement — or a single comprehensive outsourced provider that integrates all technology, administrative functions and professional services — outsourcing in the real estate sector is a value-add that more managers are realising. And, it will continue to expand because of the complexities of managing large and diverse portfolios, the need to meet growing investor expectations and the difficulties keeping up with technology advancements. By 2026–2027, we expect that 60 percent or more of real estate organisations — nearly double today’s figure — will outsource significant portions of their operation to third-party administrators in order to improve their focus on their strategic imperatives, strengthen processes and remain competitive in an increasingly complex world of real estate investment.