AMERICAS NEWS: A whole new fund game

With a target of $3.5 billion, Brookfield Strategic Real Estate Partners is the first global real estate opportunity fund for Brookfield Asset Management, encompassing all of the Toronto-based alternative asset manager’s new commercial real estate investments worldwide. But that distinction is just one of several that set the firm’s latest vehicle apart from its previous offerings in the asset class.

The fund, which held a first close on $2.1 billion in late May, marks the first time that Brookfield Property Partners (BPY), which is likely to be spun off later this year, is expected to be the lead investor in one of the firm’s real estate vehicles, contributing about $1 billion to the first close, according to sources familiar with the matter. Of the remaining capital, about half came from the Teacher Retirement System of Texas, which committed $200 million, and New York City’s five primary employee pension systems –including the New York City Employees’ Retirement System and the Teachers’ Retirement System of the City of New York – which collectively committed $310 million to the fund. Brookfield declined to comment.

Additionally, Brookfield Strategic Real Estate Partners, which is being overseen by senior managing partners Barry Blattman and Ric Clark, is the first fund where the investment manager has offered discounts to investors participating in the initial close, which were on top of fee breaks that the asset manager previously granted to investors. The new discount was offered on a sliding scale and based on the amount of capital an investor committed to the fund, beginning at around the $200 million mark. For a very large investor in the first close, asset management fees could be lowered from 1.5 percent on committed or invested capital to below one percent, sources said. 

Another key incentive is that large investors committing $200 million or more to the fund will receive priority rights for future co-investments, for which Brookfield plans to raise capital on a deal-by-deal basis. With priority rights, such investors are given first choice of participating in co-investment deals, with their proportionate share of the deal based on how much capital they contributed to the overall pool of capital committed by large investors.

In addition to fee breaks on fund commitments, Brookfield – which at press time was said to have closed on two investments on behalf of Brookfield Strategic Real Estate Partners – also will be charging investors reduced asset management fees for co-investments. This is a major draw for limited partners because, not only do they exercise more control over their capital through co-investments, they effectively will pay lower fees on their total investment with the sponsor. Additionally, BPY will consider investing in any major co-investment deal along with the fund’s large LPs.

Brookfield, which currently has approximately $150 billion in assets under management, also could collect asset management fees from BPY’s public shareholders on any of the capital that’s invested by the entity. This includes the $1 billion that BPY is investing in Brookfield Strategic Real Estate Partners, as well as any additional capital it puts into co-investment deals. Although the fee structure for BPY has yet to be determined, the firm has addressed the double-fee concern in its previous spinoff companies for infrastructure and renewable power.

Brookfield initially is expected to own a 90 percent stake in the new entity – comprising the majority of Brookfield’s commercial real estate operations – but intends to reduce its ownership in the company over time. The larger BPY becomes and the less Brookfield owns in the entity, the more fees Brookfield is expected to earn. As this occurs, the amount of capital that firm invests in Brookfield Strategic Real Estate Partners also will decline since Brookfield’s interest in any particular real estate fund will be proportionate to its share of ownership in BPY.

Not only does this free up more of Brookfield’s capital to be invested elsewhere, but this ultimately helps to improve the company’s balance sheet. Because Brookfield is putting less equity into its real estate holdings by moving its interests in these assets off its balance sheet and into BPY and simultaneously increasing the fees it collects for real estate, it can significantly enhance its return on equity, which is the ratio of firm’s earnings over the amount of equity invested.

One concern that investors historically have raised with Brookfield’s funds is what is perceived to be a lack of alignment between the fund sponsor and its investors. A sponsor typically makes a co-investment in its fund to align itself with its LPs so that, if the fund loses money, a loss hurts both the LPs and the sponsor. However, because Brookfield’s capital predominantly comprises the money of its public shareholders and because it is such a large company, poor performance by a fund – even one where the firm has invested $1 billion – is unlikely to affect its stock price or hurt its partners.

While this has kept away some investors, this doesn’t appear to have deterred large LPs like Texas Teachers, which are willing to accept alignment issues as a trade-off for the benefits they’re getting otherwise.