Private equity real estate fund managers like to think of themselves as forces for good – improving properties, creating value for their investors, possibly even creating jobs in the process.
But in 2007, private equity real estate, by dint of the funding structure adopted by many of its managers, got lumped in with a group of financiers that some policymakers and members of the voting public came to see as public enemies numbers one and two – private equity and hedge funds.
Darling: no more taper relief
From London to Washington to Seoul, alternative asset managers came under attack from various parties, including unions, lawmakers, tax authorities and the press. The charges leveled against private equity GPs included secretiveness, job destruction, overleveraging of assets, underpaying taxes and throwing overly expensive birthday parties.
The negative attention brought to private equity and hedge funds spelled trouble for firms in the business of buying and adding value to real estate. At the center of much of the controversy was the preferential rate of tax on carried interest – a partnership term enjoyed by private equity real estate general partners. The seemingly sudden success of private equity GPs led some to question why these fortunate few should pay less in taxes than their own cleaning ladies, as more than one critic put it.
In the UK, the 10 percent taper relief on carried interest will be replaced with a flat rate of 18 percent on carried interest following an announcement from Alistair Darling, the UK Chancellor of the Exchequer. In the US, legislation has been drafted by Senator Charles Rangel that would raise the tax on carried interest to a new height of 37.9 percent from the current capital -gain rate of 15 percent. The proposal has been dubbed by opponents as the “mother of all tax hikes.”
Rangel: tax hike father
In Asia, discussions of tax rates and foreign ownership rules were infused with domestic politics to create a sometimes hostile atmosphere for cross-border real estate investment. For example, a scandal in South Korea stemming from Lone Star Funds’ purchase of Korea Exchange Bank led the country’s tax authorities to review longstanding tax treaties used by Western private equity firms as domiciles for investment vehicles. Meanwhile, in the two most sought-after emerging markets, India and China, financial authorities are considering further controls on foreign direct investment, intended in part to handicap the efforts of Western investors while bolstering indigenous alternative investment firms.
If a substantial number of the proposed policy changes in both established and emerging markets are enacted, private equity real estate market participants may look back on 2007 as not only a golden period for harvesting investments, but as the last days of relatively benign regulatory regimes.