Friday Letter Early bird specials

While private equity real estate firms always offered fee breaks to large investors willing to commit to first closes, it is becoming increasingly clear that competition in giving such incentives is heating up.

For the first time in its history, Starwood Capital Group has offered management fee breaks to institutional investors that signed up for a first closing.

Now on its ninth global fund, the Greenwich, Connecticut-based firm offered breaks to both first movers and those larger ticket writers willing to commit more than $150 million to Starwood Distressed Opportunity Fund IX, for which it is seeking between $2 billion and $3 billion in equity.

In offering fee breaks to early investors, Starwood is following a rapidly-growing number of large private equity real estate fund managers aggressively competing on incentives as they fundraise in order to land a large first close quickly. Offering major discounts on fees to land a first close isn’t just something the boutique private equity real estate shops are doing; it’s a game the big boys are playing too.

In addition to Starwood, firms like The Blackstone Group, Westbrook Partners and The Carlyle Group have recently trimmed fees, eliminated catch-up provisions (which entitle GPs to a larger share of the profits after investors receive their preferred return) and changed their profit-sharing structures to be more favourable to early and big investors. Some fund managers are even offering deals on a sliding scale basis right off the bat in their memoranda.

Fee concessions offered to investors taking part in first closes are not entirely new, even for the big firms. But this growing sense of competition among them in offering such incentives to early bird investors is something of a current flavour for sure.

Let’s face it: capital-raising has been a little anaemic over the past few years. So it stands to reason that growth in incentive-giving should become a by-product of the financial market we’re in.

You don’t have to look far to see such practices happening elsewhere in the industry either. Indeed, just as managers offer investors increasingly competitive fee breaks, landlords are offering occupiers competitive rent-free periods and other incentives and they, in turn, are likely to be trimming their prices or costs for their clients too. In other words, these practices are happening all over the space, not just in the world of opportunistic funds.

Of course, these days the competition among managers in offering incentives is helping to drive expectation for such offerings from investors. In its recently published annual Fund Trends Survey, the law firm Nabarro found that nearly 80 percent of investors polled — particularly large investors — had received, or would expect to be given, a reduced management fee in return for committing to a first close.

If the market picks up in the next few years, the tide could indeed change and fund managers may scale back these breaks. However, as things stand now and with the market the way it is, private equity real estate is going to have to continue matching the aggression it shows in the actual real estate marketplace with the same competitive spirit in the fundraising arena.