Recently, the Pension Real Estate Association (PREA) in USA ,released its 2014 study of fee terms ? including both management fees and incentive fees (aka ?carried interest? or ?promote?) ? associated with 164 private real estate investment vehicles targeting institutional investors and investing in all types of US and non-US real estate.Many of these trends are not particularly surprising, this study is a very helpful confirmation of evolving market practices .
Among other things, the study revealed the following:
- The most typical basis for management fees for closed-ended funds was limited partner commitments during the investment period, and invested equity thereafter. Open-ended funds, separate accounts and joint ventures were much more likely to utilize a different basis and typically did not apply different bases over time. The most common management fee basis for open-ended funds was net asset value.
- The median rate applied to closed-ended funds using invested equity as a management fee basis, was 1.5 percent, with a fairly sizable standard deviation of .41 percent (i.e. Just over 2/3rd of such fee rates fell between 1.91 percent and 1.09 percent.) For open-ended funds using net asset value as their management fee basis, the median rate was .99 percent, with a standard deviation of .11 percent.
- Almost all closed-ended funds (the vast majority of which pursued a value-added or opportunistic strategy) charged some type of incentive fee, but more than a third of open-ended funds (the vast majority of which pursued a core strategy) did not.
- Incentive fees charged to closed-ended funds most often (69 percent of the time) took into account a 100 percent return of capital as part of the determination of when such fees are distributed. But there was a significant difference based on fund vintage, with 64 percent of pre-2011 funds and 88 percent of post-2010 funds using such test.
- A majority (almost 60 percent) of closed-ended funds used a catch-up in calculating incentive fees, but catch-ups were almost never used for open-ended funds. The catch-ups, that closed-ended funds used were most often (66 percent of the time) a 50-50 general partner-limited partner (GP-LP) split or a 60-40 GP-LP split.
- Closed-ended funds not using a catch-up (the vast majority of which pursued a value-added strategy) set their first ?hurdle? at which incentive fees begin to be distributed (most commonly expressed as an internal rate of return or IRR) at 9.21 percent on average. The average incentive fee rate for such vehicles was 18.54 percent. The 2014 study did not separately report first hurdle rates and incentive fee rates for closed-ended funds using catch-ups or for open-ended funds (in isolation), nor the use of additional hurdle rates and incentive fee rates for all closed-end funds not using a catch-up.
- Only a minority of closed-ended funds or open-ended funds charged other types of fees for managing the funds, such as acquisition fees (25 percent for closed-ended and 24 percent for open-ended), debt arrangement fees (4 percent for closed-ended and 19 percent for open-ended) or disposal fees (1 percent for closed-ended and 5 percent for open-ended).
- Study participants noted a trend of real estate investment vehicles aligning fees to achieve more transparent fee structures, although participants also believed that existing funds had implemented only a few changes in fee structures over the past two years.
Although many of these trends are not particularly surprising, this study is a very helpful confirmation of our anecdotal experiences. Indeed, a number of investors have recently cited the study in negotiations with our real estate sponsor clients, particularly when the investors view the information as revealing ?off market? fee terms. Sponsors ignore this information at their negotiating peril.
This article is taken from Client Alert, published by Latham & Watkins as a news reporting service.