Volcker Rule prompts MSREI to convert $3bn fund

The private equity real estate business of investment bank Morgan Stanley has devised a plan to resolve the future of the one fund on its books that stands to contravene the Volcker Rule and has put it to an investor vote.

Morgan Stanley Real Estate Investing (MSREI), the private equity real estate business of investment bank Morgan Stanley, is planning to convert one of its biggest private real estate investment funds from open ended to closed ended in a bid to comply with forthcoming US regulations.

Investors are to vote on a plan this coming month to switch the Morgan Stanley Real Estate Special Situations (SSF) III, an open ended real estate opportunity fund launched in 2006 which currently has $2.9 billion of equity invested.
As things stand it would contravene the Volcker Rule, part of the Dodd-Frank Wall Street Reform and Consumer Act, which limits the investment by US financial institutions to just 3 percent of the equity in their funds. The rule is expected to come into force midway through 2014.

Morgan Stanley’s investment in the fund is about $700 million – reflecting approximately 24 percent of its equity – and the firm has spent more than a year in dialogue with its investors and external advisors working up a solution to rationalize the vehicle.

Traditionally, Morgan Stanley has invested anywhere from 10 percent to more than 20 percent in the private equity funds on its books. Any future private equity real estate funds launched by the platform will comply with the Volcker Rule with the bank committing up to 3 percent of the equity.

SSF, through which MSREI has made non-controlling investments in real estate operating companies, predominantly in emerging markets, is invested in about 40 companies across the world. While it is $2.9 billion in size today, at its largest, the fund held almost $6 billion of equity.

Under the plan, over the next month, the fund’s chief investment officer Tim Morris and portfolio manager Willem de Geus, alongside senior MSREI executives including co-chief executive officers and co-chief investment officers John Klopp and Olivier de Poulpiquet and chief financial and chief operating officer Michael Levy, will take part in a road show to convince the fund’s approximately 40 institutional investors and hundreds of high net worth investors to back its plan.

A simple majority vote from investors would see SSF converted into a closed-ended fund and its investments wound down over about five years. Additionally, a green light would also instigate the spinning out of a team of six executives to be led by Morris and de Geus and the formation of an independent real estate investment management business called Proprium Capital Partners.

Proprium initially would operate under a sub-advisory mandate from MSREI to wind down the fund, although PERE understands that investors of SSF wishing to continue investing in its strategy would have the opportunity to reinvest their distributions to another similarly-structured fund to be run by Proprium.

MSREI declined to comment on fundraising matters but confirmed its plans to convert SSF from an open-ended to closed-ended vehicle.

While Morgan Stanley has traditionally invested large amounts of equity in its private equity funds, SSF is the only MSREI fund to present this issue for the bank. MSREI’s other funds are, by their closed-ended nature, able to wind down in an orderly manner before or within a few years of the rule’s implementation, subject to available extensions.

Levy said the fund’s advisory committee, which includes institutional heavyweights California State Teachers’ Retirement System, Washington State Investment Board and the Abu Dhabi Investment Authority, has already reacted positively to the plan – the product of independent analysis commissioned in 2011 to boutique advisory firm Evercore Partners and law firm Schulte Roth & Zabel – and was confident of it being voted through.

Nonetheless, he underlined the importance of walking investors through it: “We will seek to meet with each investor in the fund, whether it is face to face, by webcam or conference call,” Levy confirmed.

He warned, however, that the wind down of SSF would not result in assets being sold on the cheap: “Over the next five years, this portfolio will monetize. The majority of the investments may monetize before then. It’s not a contractual limit but the business plan for the underlying assets, so there will be no fire sale.”

For further analysis of MSREI’s plans for SSF pick up the February issue of PERE out later this week.