Subscription lines: a view from Asia

Benjamin Lee, co-founder of Hong Kong-based private equity real estate firm, Phoenix Property Investors, and Christopher Ip, the firm’s chief financial officer, weigh in on the debate regarding subscription financing for private funds by highlighting how useful they are for paying fees, expenses, closing time-sensitive acquisitions and funding certain conditional offers.

Phoenix Property Investors has had a long history of utilizing subscription lines. From our Fund 3 in the mid-2000s to our current opportunistic Fund 5, we have found these credit lines to be useful in the operation of our funds.

Fund subscription lines are lines of credit that are extended against the credit-worthiness of the fund’s LPs. Whilst the size of Phoenix’s lines has grown over the past decade, the parameters under which these are utilized remain quite constant over time.

Here’s how we regard and use them: first, the line is drawn on to pay for transaction expenses to close deals, such as due diligence, legal and advisory costs. Second, the facility is used to pay for the funds’ fees and expenses. By utilizing the subscription line in these two ways, we help focus capital calls from our LPs on transactions that require equity.

Third, Phoenix will draw on these lines when there is time pressure to meet funding requirements. Under these circumstances, going through the capital call process could possibly jeopardize winning a deal. With a subscription line in place, we are able to rapidly deliver funds to meet the seller’s desired timetable which we may not have been able to do with standard bank financing. There are many situations in which this could happen, one of which is to pay for a deposit quickly in order to lock up a deal.

On the other spectrum of time sensitive deals, Phoenix uses its subscription lines to fund certain refundable deposits related to conditional offers to purchasers. These are normally value investments which could take some time to complete. Using subscription lines to fund these deals creates important flexibility for execution.

As seen from the examples above, Phoenix uses its subscription lines primarily for paying for fees, expenses, closing time sensitive acquisitions, as well as for funding certain conditional offers.

At times, we could also use subscription lines to pay for acquisitions in the early stages. Some investors view this practice as one that ‘artificially’ boosts IRRs. This is a controversial topic in the LP community. However, as some investors’ organizations pay their investment staff a portion of their investments’ return, using only IRR as the compensation yardstick, artificially boosting IRRs may not be as problematic.

All in the timing

Our experience is that investors generally prefer to limit the use of subscription lines to replace calling equity by limiting the amount of time these lines can be used prior to capital being called for completed deals. Normal time frames for us would be between three to six months.

Ultimately, the most attractive returns for us are those achieved through sourcing deeply discounted deals and adding value to the properties. This way, we have a good chance to create alpha for our investments using conservative senior financing only, without resorting to excessive financial engineering using subscription lines.

Overall, we believe that subscriptions lines are definitely valuable to the operation of real estate private equity funds. GPs should seek an open dialogue with their investors to understand their concern and preference and to adopt the use of their lines in ways which properly align investors’ and managers’ interests.

To read more about the debate concerning private fund subscription lines, click here.