Deep Dive: Inside the LPAC

They are the largest and most influential investors in private real estate funds. Their fund commitments – typically at least 10 percent of a vehicle’s total equity – grant them highly coveted seats on funds’ limited partner advisory committees. The number of LPAC seats ranges from four to eight for the majority of funds, but can go as high as 20 for the biggest mega-funds.

LPAC members often benefit from a faster flow of information, as many fund issues are usually brought to the committee early on or before the rest of a fund’s investor base.

Members also vote on decisions that can materially impact the way a fund invests or raises additional capital. “As a limited partner, you really have very minimal control without the LPAC vote,” explains Derek Proctor, a real estate consultant at Meketa Investment Group, a Boston-based investment consulting and advisory firm.

“We seek to be more involved in the oversight and operation of the fund and to be able to have a broad view into issues that may arise and potential conflicts,” adds Proctor, who is a member of six LPACs and is part of a real estate team that collectively sits on 22 committees.

Those issues and conflicts have been arising with greater frequency over the past couple of years, amid elevated interest rates, high construction costs and negative market sentiment. “There had been a great ride for the market for over 10 years, and in the last two years those dynamics changed,” says Robert Koot, director of Asia-Pacific investments at Dutch pension investor Bouwinvest Real Estate Investors.

Over that period, Koot has been engaged in “a lot of debates and discussions” as a member of seven fund LPACs and 11 partnerships targeting the region. Those discussions – which cover everything from capital management relating to redemptions in open-end funds to which assets to sell and hold – are “clearly different” in nature from the talks the LPAC members had during the previous 10 years, when the market was stable and growth oriented, he says.

PERE spoke with seven investors, featuring a mix of pension funds, sovereign wealth funds, insurance companies and consultants from Asia, Europe and North America, about the top-of-mind issues they are discussing with funds’ general partners and fellow LPAC members, how they are addressing conflicts and what changes they are pushing for as these committees continue to evolve.

Straightforward requests

The most obvious and straightforward of manager requests in today’s market are extensions, whether to the fundraising or investment period or the fund term. After all, the average time in market for a private real estate fund has climbed from 13 months for funds closed in 2018 to 22 months for funds closed in 2024 year-to-date, according to PERE data. Meanwhile, global real estate transaction volume has dropped precipitously since Q4 2021, declining 47 percent year-on-year in 2023 alone, according to commercial real estate brokerage CBRE.

Proctor considers fundraising extensions – typically by a quarter to a year – as “fairly straightforward to digest,” especially if the general partner has already made meaningful progress on the fundraise and the extension is to get the last few investors closed.
“Where you might get a little bit more pushback on extensions is if it’s been a fund that’s been out in market for a while,” he points out. “If we question whether they’re going to reach their target, we reach a point where we’d almost prefer to wrap up the fundraise and focus on deployment of the fund and begin execution of business plans.”

Navid Chamdia, head of real estate investments at sovereign wealth fund Qatar Investment Authority, regards fund term extensions as the least contentious issue that he discusses as an LPAC member. “We are long-term partners and if they need more time because it is not the right or best time to exit, we are willing to accommodate and be understanding about it,” he says.

Many funds have a 10-year term with two one-year extension options, subject to LPAC approvals, although in some cases, the GP may request further extensions requiring an amendment to the original limited partner agreement. In the current market environment, LPAC members have agreed to fund term extensions, acknowledging many managers have faced challenges in finding a buyer at the right price for the last few assets in the fund.

However, the condition for approving such an extension is a reduction or waiving of management fees to motivate the manager to liquidate the portfolio and not just collect fees. “That can have an impact on performance in the tail end of the fund where you have leakage of your IRR as you continue to pay fees on the invested capital,” Proctor remarks.

The role of the LPAC member is to check if “what’s being proposed is actually in an investor’s best interests,” notes Douglas Crawshaw, global head of real estate manager research at London-based consulting firm WTW. “Is what they’re proposing for the right reasons, even if we disagree with what they’re proposing? Or is it because they want to enhance their revenue?”

Extending the fund term to generate more fees is a “classic” example of a manager not acting in the investor’s best interests, he points out.

For Steven Kwon, head of the global fund of funds team at Samsung SRA Asset Management, the real estate asset management arm of Korean insurer Samsung Life, investment period extensions are greenlighted if the manager can show a strong deal pipeline and active business plans for the vehicle. “If they are doing nothing and asking for the extension to just wait for opportunities, we don’t approve it,” he says.

“There is always tension when there are tough decisions to be made”

Kian Sin Toh
AIA Group

One complication relating to dealflow, however, is friction between managers and the LPAC over transactions. “For me, the most important decisions over the last few years were around acquisitions,” says Robert-Jan Foortse, head of European real estate at Dutch pension investor APG. A manager would come to the committee with an investment opportunity that was more attractively priced than it was 12 months ago. However, the LPAC members would look at the deal and take a different view.

“It may well be that, indeed, in their sector, it is a good deal,” says Foortse. “But then they don’t realize that they are competing not only within the sector, but also with other sectors. For example, if you can do a residential transaction at 8 or 9 [percent IRRs], that could be very attractive. But if you can do logistics at 11 or a hospitality deal at 15, how attractive is that residential 8 or 9?

“So I think a lot of decisions in those LPACs were basically declining investment opportunities, where managers were willing to still go ahead, and investors would be more reluctant and point towards the changing cost of capital and, as a result, changing return requirements. And managers were not always on the same page. Or it took them some time to get on that same page, realizing that the world had changed.”

Points of contention

Beyond straightforward requests lie more contentious issues. Chamdia points to valuation as one example. “Some managers are very good at adjusting their valuations to reflect the current market, but some are taking a wait-and-see approach, which can lead to debates,” he says.

Valuations have definitely “been debated more often in the last two years,” Koot concurs. “There have been instances where we said, okay, an annual valuation in these market circumstances is not sufficient. We need to increase that frequency maybe to a quarterly basis, for example.”

The LPAC has also discussed switching valuers after using the same firm three or four years in a row to get a different opinion on valuation. With the latter, the manager typically does a proposal that outlines different valuer options and the pros and cons of each, with the LPAC investors then approving a valuer, he explains.

Other conflicts include changes to the fund’s investment strategy. Proctor says Meketa has received a few requests from equity fund managers – seeing interesting opportunities emerge on the credit side because of the rising rate environment – to amend the LPA to allow the firm to pursue debt investments. “Usually, we’re putting a limit on that,” he says. “So, it’s not that the whole fund can then become a debt fund, because that’s not what we originally signed up for.”

Similarly, LPACs have also been approached with requests to change sector allocations in funds. For example, the manager of one office-focused fund raised at the beginning of the pandemic asked to increase the allocation to non-office sectors from around 15 percent of the fund to approximately 50 percent. Ultimately, they agreed to raise the allocation target to a number between 15 and 50 percent.

Kwon recalls with a $1 billion US debt fund focused on commercial mortgage-backed securities, the manager requested a revision to the fund’s investment guidelines so that the firm could acquire good-quality, cash-flowing assets at a discount because of the capital market dislocation.

Because Korean investors rarely allow changes to a fund’s investment guidelines, Kwon voted against the request, but was overruled by the other LPAC members. The fund, however, is performing well and delivering more coupons to investors in the higher interest rate environment.

Other change requests have not turned out so well, however. Five years ago, the manager of a US office mezzanine debt fund asked to expand the investment strategy to also include a retail investment in Times Square, according to one LPAC member. The investor made the only dissenting vote against the investment, which ultimately moved forward. The deal later went bankrupt.

Deleveraging concerns

Refinancing issues also are high on the agenda. An estimated $2.1 trillion in global real estate debt is projected to mature by the end of 2025, according to commercial real estate brokerage JLL. Given how real estate values have declined since the market peak in early 2022, borrowers are facing a refinancing gap ranging from an estimated $270 billion to $570 billion, JLL data showed.

Against this backdrop, some investors on office fund LPACs are engaged in difficult conversations with their managers on the best resolution for the fund’s investments – whether to hand back the keys, liquidate the portfolio or wind down the fund in an orderly fashion. Amid these ongoing discussions, the funds’ investors continue to pay fees and cover operating expenses for the investments, many of which have been written down to zero.

In the case of one US office fund, the manager has asked the LPAC for more capital to de-lever as well as complete the leasing and redevelopment plans for some of the properties. These are Manhattan trophy assets that potentially have some remaining value, one LPAC member tells PERE. However, all of the capital in the fund has been called and if the manager is unable to restructure the debt, the fund is at risk of losing those assets.
After a failed attempt to find a strategic co-investor for the fund, the GP came back to the LPAC for a loan.

“Is this the right decision to invest more capital in these properties? I don’t know. The office outlook is very bleak,” the investor says, adding the manager and the committee have yet to come up with a solution.

“How do you get through a situation like that in a very illiquid environment, a very strained capital markets environment?”

ESG on the LPAC

ESG can be a divisive issue among private real estate investors

In PERE’s Investor Perspectives 2024 Study, 59 percent of respondents believed a strong ESG policy would lead to better long-term returns in their private markets portfolio. However, 41 percent did not.

The topic has not sparked major debates on LPACs, however. “In our experience, ESG-related topics are a very firm part of today’s agenda for any LPAC or partnership meeting,” Koot says. “Many investors around the globe understand and appreciate the fact that financial and social returns could go hand in hand. For Bouwinvest, ESG is also part of our selection process so from the start we ensure we’re on the same page with our managers and fellow equity partners on targets and ambitions.”

He adds the investor is “very aligned” with the vast majority of its equity partners – which represent capital from all over the globe – on ESG-related items. “Clearly some investors are more vocal and ambitious than others, but everyone wants to end up with a portfolio that is future proof,” Koot says, referring to assets that are energy efficient, resilient to climate risk, safely built and will meet occupier and investor demand for years to come.

“In Europe, it’s a topic that’s high on the agenda of the LPAC,” Foortse agrees. Although that is not the case in the US, where ESG is a hot-button issue – he points out APG does not partner very often with US investors. “I personally do not have a lot of experience with these US investors who might be pushing back on ESG.”

That said, Foortse has observed a more positive reception to ESG in the US. “My sense is that in the US, that sentiment may have shifted. So far, when I talked to our US team, they’ve not mentioned to me that we can’t follow our ESG agenda anymore. We are still pushing our ESG agenda, because we do believe that it is important.”

Conflicts within the LPAC

Some discussions have caused friction not only between the manager and investors on the LPAC, but also among the committee members themselves. Kian Sin Toh, head of real estate at Hong Kong-based insurer AIA Group, notes there tend to be more debates around fund term extensions when a varied group of investors is represented on the LPAC. For example, while AIA may agree to an extension because of its long-term investment horizon, that may not work for an investor with more short-term investment objectives.

“In most instances, I find it challenging for an institutional investor to invest in a fund with high-net-worth individuals or family offices as there are very different considerations in terms of holding period and in terms of liquidity,” explains Toh, whose team sits on over 30 LPACs.

“Ideally, we want to invest with a group of investors with similar programs, duration and expectations. After all, there is always tension when there are tough decisions to be made, which just makes it more challenging to come to a consensus if you have a highly mixed group of investors.”

For Foortse, being one of the founding investors in a fund or partnership allows APG to set guidelines with which all other investors must agree, thereby increasing the likelihood of partnering with like-minded groups. For example, “we have a clear outline of all the ESG requirements we have when we enter the fund, or when we enter a club deal or a joint venture,” he says. “It’s a very clear outline, what we want to achieve and what not to do. And everybody knows that from day one.”

“We know who’s sitting on the LPAC, but we don’t really communicate with each other”

Steven Kwon
Samsung SRA Asset Management

While discussions can reveal obvious differences of opinion between LPAC members, some potential conflicts are not immediately apparent, Proctor points out. For example, if the manager has proposed selling an asset in Fund 2 to Fund 3 in the same series and is also raising co-investment capital alongside the latter fund, he would typically want to know if the other LPAC members are investing in the co-investment or Fund 3.

“Obviously as a Fund 3 investor or co-investor, they’re typically going to want the lowest price,” he says. “And maybe I’m not in that co-investment, so I’m going to want the highest price.”

These types of scenarios were uncommon pre-covid but are coming up more frequently today because of the difficult capital markets environment, Proctor adds: “Liquidity is really tricky to come by. [Transaction volumes] are a lot lower. GPs are having to get creative with how they manage through that and so we’re seeing more conflicts arising because of that.”

Having all of the LPAC members get on a call together without the GP can often help to sort through potential conflicts, he continues. “Then you’re typically able to have an honest conversation with those other LPAC members without feeling like you need to be guarded in your comments about a GP.”

Pushing for change

Not all investors are well connected with their fellow LPAC members, however. “We know who’s sitting on the LPAC, but we don’t really communicate with each other,” Kwon notes. “Maybe because I’m sitting in Korea and the other [LPAC members] are in the US and Europe. But we only meet once a year. And then there’s no e-mail chain to know things that are going on.”

But working together with fellow investors is key to effectuating change with managers, Toh observes.

“It is always more challenging if you are going to your manager alone,” he says.
“It is always better to discuss and work it through together with other investors, which comes back to my point about investing with like-minded investors. After all, you want to make sure that your fellow investors in the LPAC are aligned with any changes you are pushing for.”

For Meketa, some changes that the consultant has pushed for as an LPAC member include adopting a provision in the LPAC that would require at least two investors in the fund to vote the same way. This would prevent a single LP representing a large percentage of the fund’s capital from blocking a decision. As the consultant makes new fund investments and helps to set up new LPACs, “we’re going to continue to be proactive in structuring transparency into these LPAC committees,” Proctor says.

He notes he did not always have clarity on who the other LPAC members were, either because the member changed if a person from the investor organization left, or because the member was a consultant, who, like himself, represented multiple investors in the fund. Managers also were guarded about sharing other LPAC members’ contact information, he adds.

“I don’t think there’s anything significant lost in having more transparency on these committees, and I think we’ve gotten to a point where that is becoming the new norm,” Proctor says.

Whether it be advocating for more transparency or weighing in on high-stakes investment decisions, LPACs have become increasingly important voices in today’s challenging market environment.