Investment period extensions carry no stigma now, but nor are they risk free

In a healthy transaction environment, a manager seeking to extend a fund’s investment period will raise eyebrows among its investors. Why is it struggling to deploy capital? Is there a valid reason for prolonging the fee-paying period? Will this also affect the fund term and thus my returns?

In today’s market, however, the circumstances have changed. Only $615 billion in commercial property transacted globally in 2023, down 48 percent year-on-year and the lowest figure since 2012, according to MSCI. Amid a widened bid-ask spread on asset valuations and a general lack of motivated sellers in the market, there are fewer viable options to deploy successfully.

This week, PERE reported that Morgan Stanley Real Estate Investing had been granted an extension to the investment period of the latest iteration in its flagship opportunity fund series, North Haven Real Estate Fund X Global, by a year to the end of 2025. The fund, which was closed in September 2021, attracted $3.1 billion from investors. The New York-based firm began investing the capital in the same year, with a four-year investment period initially due to close at the end of this year. But in mid-2023, with only around a third of the fund’s capital committed at the time, it asked its investors for an extension to the investment period.

MSREI is not alone in doing this. A New York-based fund formation lawyer told PERE this week his practice had seen an uptick in inquiries from other managers looking to extend fund investment periods. He expects to see a significant amount of extensions materialize over the coming year as more managers reach the point at which they realize they need more time.

Most investors should – in this climate – be motivated to agree. After all, no institution wants their capital returned undeployed. That transpiring is second only to losing capital in the pantheon of negative fund outcomes.

The rub, however, is fees. When an investment period is extended, there is more of a discussion about whether fees should continue to be charged on committed capital, the lawyer told us. The obvious compromise is charging the management fee on invested capital only.

So far, so good for investors. But is there also a discussion to be had on the impact on performance? Only if the hold period is also extended, compromising exit timing and IRR projections. An investment period extension is not always followed by a hold period extension – at least not immediately, if deployment recovers at a healthy pace – although that must be considered a new risk.

This risk can relate to a fund’s strategy. Managers that are employing a higher-risk approach to their investments, deploying later than planned but still exiting to the original timeframe, could squeeze the value-add business plan and thus may not be feasible.

Firms running opportunistic funds of more recent vintages than NHREF X will have taken this into account. Blackstone, for example, has near six-year investment periods for the 2022-vintage Blackstone Real Estate Partners X and 2023-vintage BREP Europe VII. In comparison, their 2019-vintage predecessors, BREP IX and BREP Europe VI, have three- and four-year investment periods, respectively.

The biggest factor in whether an investment period extension will ultimately be followed by an extension to the hold period, however, is the future market environment at the point of exit. Following a string of recent macro and political shocks, this is even more of an unknown for managers investing today.

So, while it will prove easier for investors to accept an investment period extension in the current market, an approval does not entirely relieve the pressure on managers when it comes to deployment.