The new terrain for fees

In the private equity real estate world, fund sponsors are giving ground to their investors.

As market conditions continue to crumble, limited partners are demanding new terms on various partnership fees in the private equity real estate market.

Some LPs are demanding that there be no fees charged during funds’ investment periods, while others are asking that the size of the management fee be reduced, Sandy Presant, chair of Greenberg Traurig’s real estate funds group.

“The standard fee with real estate funds, as opposed to private equity funds, has been 1.5 percent,” he says. “Discounts were routinely given to large investors, say $100 million and more of commitments, perhaps 0.25 percent to 0.5 percent. Now the investors putting in smaller amounts, say $50 million, are requesting discounts.”

A number of factors dictate whether those requests will be granted: management teams are more willing to cut the management fee when their LPs have agreed to allow property-by-property distributions of carry, for instance. And of course the teams who are having more trouble drumming up interest in their funds are always more willing to grant discounts than those with proven track records.

Funds still in the investment period who aren’t seeing a lot of activity right now, meanwhile, are more willing to give investors a temporary break on fees until the markets revive.

Some funds for high net worth investors also carry other fees such as acquisition fees, disposition fees, and financing fees. Those fees are more likely to be negotiated than the management fee, Presant says, because the sponsor relies on the management fee to pay its employees. Presant says he’s seen everything from a 50 percent discount to a complete waiver of some of those fees.

Where they aren’t giving fee breaks, other funds are altering terms in favour of investors, such as agreeing to a no-cause removal clause.
One big change looming in the US will be the use of management fee waivers, Presant says. For two reasons, management fee waiver programmes are declining in popularity.

“The first reason is that the management fee is contingent on there being profit, and whether there are profits has become an uncertain proposition,” he says. “The second is that under the tax proposals of the new administration, they are taking away the ability to convert management fee income to capital gain by taxing all carried interest, in other words all interests and profits received for services, as ordinary income.”

This is not a uniform trend across the industry, however, and there are still some who continue to use fee waivers.

“Some people are continuing to use the management fee waiver, either because they believe the legislation is not going to be enacted, or will have a delayed effective date, or because other concessions are given to some sponsors for waiving management fees, such as not having to put in their contribution to the extent of the waived management fee. So if a sponsor is short on capital, a sponsor may want a management fee waiver to defer the time when the sponsor has to put in capital.”