Key Terms of Selected Value Add and Opportunity Real Estate Private Equity Funds

I recently reviewed the key terms of seven value add and opportunity real estate private equity funds and wanted to share some of the findings and my thoughts on these key terms.

In regards to the economic terms, there is a clear picture that terms across the board of been reduced compared to similar vintage 2005-2007 funds. Most only charged an asset management fee and a property management fee at market terms. There were no transaction fees charged in any of these funds. What this highlights is the push by investors to ensure sponsors make money only when the investors make money and, as a result, payment of transaction fees (which are not tied to profits earned from investments) are perceived as a conflict of interests. While asset management fees are still charged, their payment structure has changed significantly. Now we see an incremental reduction of asset management fees as more equity is being raised reflecting an understanding that there are economies of scale associated with managing a larger Fund than a smaller Fund. We also see these fees being structured so they are higher while the Fund assets are being acquired and then lowered as the assets are being managed and harvested.

The cash distribution waterfall has also seen significant changes to past funds as LPs look to hold GPs accountable for the profits they earn. Many of the funds reviewed offered tiered GP/LP splits after a payout of the preferred return, which averaged 10%, and a return of investor's capital. This model returns distributions in tiers up to a certain IRR at each level. While the models vary between funds, similar is a model that returns larger shares of the profits to LPs quicker that was seen in the past. Also evident was a success based model which rewarded GPs with higher splits as IRRs went up.

In regards to investment limiting terms, the life of the funds ranged from 6-8 years, which indicates a decrease in fund lengths from the average of 10 years in the past for similar type funds. This may indicate investors are not as keen on tying up equity for longer period of times.

These highlight some of the key findings. Other areas evaluated include average leverage to be used, sponsor's commitment, fund strategy, target return, exclusivity and fund governance. Please feel free to reach out to me to discuss this research and the additional findings.

In conclusion, I believe a key take-away is that a much better alignment of interest between sponsors and investors must exist. This means a partnership structure that is heavily oriented to the sponsor earning carried interest and not excessive management fees. Communication and transparency must also improve. This industry will continue to evolve and mature and these findings indicate the process has already begun.

Sagar A. Dalal is the co-founder and managing principal of Beckerman’s real estate fund advisory division. The division works with real estate fund managers by advising on all
aspects of the private fund placement process including fund structuring, competitive positioning and market assessment, preparation of fund-related documentation and providing
expert fund communication advisory services to fund managers to ensure a productive and successful relationship is maintained with current and prospective investors. He can be
reached at [email protected].