Let me pose a hypothetical question to all GPs out there. You’ve written down a real estate fund investment to zero but belatedly realised you have not charged your limited partners the full amount of the acquisition fees for the asset. Do you forgo the remaining deal fees in recognition of the fact you’ve already written the asset off or do you issue a capital call to your investors to recoup the fees?

Zoe Hughes

In a world where LPs and GPs are struggling to find a balance in terms of alignment of interests, many of you would probably accept that this is not the time to go testing investors’ patience by asking for back-dated fees for a failed deal, even though the fund investment team may have gone beyond the call of duty to keep the property afloat.

One opportunistic fund manager, however, has raised eyebrows by issuing a “gigantic” capital call to refund acquisition fees it hadn’t yet collected. Last month, Tom Arnold, head of Americas real estate at the Abu Dhabi Investment Authority (ADIA), one of the world’s largest sovereign wealth funds with an estimated $300 billion to $600 billion of capital under management, told the annual NYU Schack Institute capital markets conference about the call for a reserve commitment to cover previously unclaimed deal fees.

Arnold declined to comment further, but the situation has been branded a step too far by other LPs. “There is a real inequity about this,” one investor said. PERE understands that the GP in question was claiming fees it was legally entitled to according to a “literal reading” of the fund documents. But, after writing off the underlying investment, there was a fundamental “question of fairness”.

In a world where LPs and GPs are struggling to find a balance in terms of alignment of interests … this is not the time to go testing investors’ patience by asking for back-dated fees for a failed deal.

LPs certainly have a point. Consider the scenario of buying a car from a reputed dealer that at the outset promises great mileage, an unbelievable owner history and what could be stellar performance. When it quickly deteriorates into a vehicle that shakes, leaks and has timing belt issues that pose a serious threat to the engine, would you even consider continuing payments on the vehicle? Probably not, at least not without a serious renegotiation with the dealer.

Investors feel exactly the same way. In the case of ADIA, the sovereign wealth fund is understood to have another fund manager that had abolished fees on a deal after the investment was written down to less than 50 percent of cost. It therefore comes down to the question: What’s fair to pay fees on?

The ADIA capital call, however, is not necessarily a one-off event. Other sources have told PERE about some funds clawing back LP distributions, as well making additional capital calls to cover management fees when fund asset cash flows falter.

Of course, that is part of the challenge facing GPs. Working out a troubled investment is much more intensive, time-consuming and expensive than one that is performing well, or even just okay. As Colony Capital chairman Thomas Barrack said back in July, debt workouts, recapitalisations, restructurings and discounted payoffs were “exhausting” and were, in some cases, the financial equivalent of “hand-to-hand warfare”. Even if a deal is ultimately written off, there can be an untold amount of blood, sweat and (sometimes) tears in the run-up to trying to salvage the investment. All of that needs to be paid for.

With GPs facing declining management fee revenues, thanks to the fact they’re largely unable to raise the next commingled fund as planned, where do they turn? Most industry professionals – both GPs and LPs – would probably agree that fund managers shouldn’t turn to investors, at least not just yet.

The reputational risks for the fund manager alone are too great. Scarred by poor performance, writ
e-downs and write-offs, LPs will not entertain lightly any GP who comes raising a new fund after trying to recoup unclaimed fees for a failed investment in the last one. And it won’t just be ADIA that the GP in question could struggle to raise future funding from. It also will be the LPs that ADIA talks to regularly, not just fellow LPs in this specific fund.

“There is a lot more communication [between LPs] than what there was,” said APG’s co-head of North America real estate investment Peter Madden, at the same NYU conference. “You really start to know your fellow LPs.”