AMERICAS NEWS: Beware the clawback back

It’s never a pleasant task handing back money, not least when you’re writing a cheque for $15.7 million. However, for The Blackstone Group, there may be a silver lining in repaying a portion of the carried interest received from its 2002 and 2004 vintage real estate funds – the firm could get some of that capital back again from LPs.

As PERE went to press, the New York-based platform was preparing to repay $15.7 million of carried interest earned from its $2.05 billion Blackstone Real Estate Partners IV fund, which closed in 2004. According to sources and regulatory filings, $9 million of that total is due from current and former real estate personnel.

The $15.7 million clawback comes on top of another $3 million already repaid by the firm and executives in the second quarter of this year for carried interest paid out from the €800 million Blackstone Real Estate Partners International fund, which closed in 2002.

In repaying a portion of the carried interest received from its 2002 and 2004 vintage real estate funds the firm could get some of that capital back again from LPs.

The clawbacks were the first ever for executives at the world’s largest private equity real estate firm. However, according to people familiar with the matter, Blackstone and its staff face a rare situation in which they could actually recoup some of the repaid carried interest thanks to rising property values.

Unlike much of the industry, which has adopted a back-ended portfolio waterfall for distributing carried interest, Blackstone calculates the promote on a deal-by-deal basis. Usually only found among some of the industry’s larger and more senior players, including The Carlyle Group, Goldman Sachs’ Whitehall Street funds, Morgan Stanley Real Estate Investing and Beacon Capital Partners, deal-by-deal waterfalls allow GPs to take their 20 percent share of the profits once capital and a return hurdle, or preferred return, has been returned to investors.

In adopting a deal-by-deal waterfall test, though, certain protections are introduced for LPs in the event of losses triggering a promote clawback.

One of the main protections is to withhold part of the carried interest paid to the GP and executives in an escrow account. In regulatory filings, Blackstone said it had withheld $477.1 million in “segregated accounts for the purpose of meeting any clawback obligations of current and former personnel if such payments are required”. That $477.1 million relates to clawback obligations for around 100 current, former and deceased Blackstone employees across the firm’s asset classes and represents a portion of the carried interest earned by staff, according to sources.

Paying back $18.7 million, therefore, isn’t going to be a problem for the firm. Yet with global property valuations starting to gradually increase, Blackstone LPs could find themselves in the unusual position of receiving their own carried interest clawback: a clawback back, as it were.

In July, Blackstone’s chief executive officer Stephen Schwarzman said on a second quarter earnings call that the group’s $10.9 billion Blackstone Real Estate Partners VI fund had increased in value to 85 cents on the dollar from just 46 cents a year ago.

GPs across the board will hope to exit deals into this steadily rising market over the coming years, helping offset prior losses that might have triggered clawbacks. Blackstone has already publicly declared it expects to make a profit on all its real estate funds upon liquidation, with sources adding that clawbacks are ultimately expected to be “minimal, if non-existent”. People familiar with the matter, Blackstone limited partners were keen to receive interim clawback payments owing to future uncertainty over real estate markets globally, rather than wait for a final calculation.

A clawback obligation can exist only if promote has been paid, and not many of the most recent vintage of real estate funds have paid promotes.

Robert Insolia, co-head of Goodwin Procter’s real estate fund formation practice

But clawbacks are not just an issue for fund managers operating deal-by-deal waterfalls. Theoretically, even a sponsor of a fund that returns all capital and pays a preferred return before paying promote could have a clawback obligation.  This could happen if at any time capital is called after promote has been paid, and that capital is not subsequently returned with the requisite preferred return. “It’s more a mathematical possibility than a practical risk, but it is still possible,” said Stephen Tomlinson, senior partner in Kirkland & Ellis’ real estate practice group.

Robert Insolia, co-head of Goodwin Procter’s real estate fund formation practice, indicated that this is not currently a pervasive problem. “A clawback obligation can exist only if promote has been paid, and not many of the most recent vintage of real estate funds have paid promotes.”

For Blackstone, therefore, even being in the news for a clawback is being seen as a positive thing – after all, they made enough profits to get into the promote in the first place. As one US fund manager said: “Yes, there’s a glitch on the performance of their funds, but how many other GPs can show they are able to repay this kind of money back to LPs as and when needed?”