US NEWS: Incentives to invest

A number of very large funds that either launched or are closing in the second half of this year are changing up their structures in order to make themselves more attractive to investors. The Carlyle Group, Westbrook Partners and The Blackstone Group are among some of the heaviest hitters in the private equity real estate space that are lowering fees, changing profit-sharing thresholds or eliminating catch-up provisions.
According to several sources, this is not so much a sign of desperation from fund managers as it is a sign that LPs are still somewhat gun-shy about making commitments following the recent recession. As a result, they require some coaxing from savvy fund managers.

The Carlyle Group recently closed on $2.34 billion for its sixth US opportunistic fund. Although representatives from Carlyle declined to comment, sources familiar with the situation have told PERE that the Washington DC-based private equity giant offered a third of the fund’s investors reduced annual management fees, some as low as 0.75 percent.

These discounted fees, reserved for the fund’s largest investors, were offered in part to help Carlyle Realty Partners VI gain momentum while the firm was seeking capital. Carlyle decided to begin raising its fund during the recession so it could invest in properties while the market was rebounding. Therefore, it made sense to the firm that it provide incentives to its largest investors.

Offering incentives like this, however, is far from a new or uncommon practice among fund managers. After all, management fees for the remaining investors in Carlyle’s latest fund were between one and two percent – slightly higher than the industry standard. One source noted that it is quite common for large investors of large opportunistic funds to receive discounts.

The tactic appears to have paid off, and then some. Carlyle Realty Partners VI, which is targeting properties in several different asset classes in major US gateway cities, ultimately attained the momentum it was seeking. In fact, because of its hard cap, the fund wound up having to turn away roughly $500 million of capital.

Meanwhile, New York-based private equity real estate giant Westbrook Partners also has tweaked its newest fund to make it more LP-friendly. Westbrook Real Estate Fund IX, a $2 billion global vehicle targeting assets in gateway cities, is changing its structure by moving from sharing profits on a deal-by-deal basis – which is how the previous eight funds in the series were run – to a pooled basis. This means that gains and losses will be netted out before profits are divided between the firm and its LPs.

Westbrook also has eliminated a previous “catch-up” provision, which entitled the firm to a larger share of the profits after the LPs receive their preferred return. In exchange for that concession, Westbrook lowered the preferred return hurdle from 10 percent to 6 percent. As a result, it already has received a total of $200 million in commitments during the pre-marketing phase from two endowments: Harvard University and Massachusetts Institute of Technology.

In addition to these structural changes, sources have revealed that Fund IX would be more accurately considered value-added, whereas the previous funds in this series were categorised as opportunistic vehicles. Westbrook officials declined to comment on the matter.

Westbrook’s last real estate vehicle, Fund VIII, closed on $2.3 billion in commitments in May 2008. Investors in that fund include the New York State Common Retirement Fund, the Pennsylvania State Employees’ Retirement System and the Teacher Retirement System of Texas. Fund VIII still has roughly $1 billion of equity to deploy before its investment period ends next September. As a result, Fund IX won’t begin buying properties until its predecessor is fully invested.

Despite being the most recent examples, Carlyle and Westbrook aren’t alone in incentivising LPs. Even the biggest of the big are offering similar incentives to lure in potential investors. For example, it was reported in July that Blackstone’s $10 billion Blackstone Real Estate Partners (BREP) VII is offering investors that commit $300 million or more a management fee reduction of 25 basis points to 1.25 percent.

Furthermore, documents from the New Jersey Division of Investment revealed that investors participating in the first close of BREP VII received “a management fee waiver for four months.” That equates to a savings of roughly “$1.25 million based on a $300 million investment.”

It seems LPs increasingly are willing to consider ambitious opportunistic and value-added funds, but perhaps they not ready to fully embrace them. Therefore, it is understandable that the managers of multi-billion dollar funds are becoming more willing to offer incentives to bring institutional investors from the ‘kicking the tires’ phase to the ‘agreeing to commit hundreds of millions of dollars’ point.

“Until pension funds get back in the mode of investing in opportunistic funds,” said one source, “fund managers have to be flexible.”