Fee overhaul recommended

Management fees should be charged on invested capital rather than committed capital in future, according to a research report recommending an overhaul of private equity real estate fee structures.

Consultancy firm Watson Wyatt has called for a fundamental review of most fees charged by the industry, saying the current system lacked investor appeal.

Unfortunately, the fee arrangements make us much less positive on backing many of the vehicles that are actually available for clients to invest in.

“We are positive about the strategic case for opportunistic real estate investing as part of a
diversified real estate asset strategy for long-term investors with good governance,” the report said. “Unfortunately, the fee arrangements make us much less positive on backing many of the vehicles that are actually available for clients to invest in.”

Earmarking management fees based on committed capital and gross asset values, the report said fees should instead be calculated on invested equity capital (or at most net asset values). Few fund managers, Watson Wyatt said, were new platforms in need of a |steady income to remain in business”, while fees charged on gross asset value could encourage GPs to take on too much debt.

The report also urged an end to deal-by-deal carry. The industry was split largely between those that paid carry following the return of capital to investors, compared to those that paid on a deal-by-deal or periodic basis. “We believe that performance fee payments (calculated above the preferred return/hurdle) should only be paid once capital plus fees has been returned to investors.”

In October last year, Pacific Star told PERE it was changing the performance fee structure of its vehicle, Asia Fund Select, after failing to corral capital commitments in its original guise. Adopting a back-ended fee structure whereby the firm would receive its share of the fund’s performance proceeds above an agreed hurdle once the investor divests his units, Pacific Star president Frank-Rainer Vaessen said: “Investors told us the fund was well received but some said they had problems with our front-ended performance fees provision and the notion of unrealised capital gains.”