Opaque fee arrangements have become a big source of frustration for investors looking at private equity real estate funds.
In the private fund management industry, there is currently no consistent way to measure the fees and costs. And the way in which fees are calculated varies drastically from fund to fund, depending on an array of fee structures, methodologies and points of reference that differ across geographies.
It’s a long-standing issue. But lately, frustrations have grown, in large part because real estate investors in hunt for yield are moving further up the risk curve and into new jurisdictions.
“A difference in fee structures and a lack of transparency in methodologies amongst different fund managers can be a real headache for investors, making it difficult to accurately compare offerings” says Martijn van Eldik, Head of Funds Advisory – Asia Pacific at JLL.
A slight difference in fee structure can make all the difference, he says. “For example, in opportunistic funds it makes a big difference how carry is being charged – deal-by-deal or fully back-ended, preferred return hurdle, catch-up or no catch-up”.
Investors generally have a good understanding of sponsors’ target returns but, in practice, the differences from gross to net can be substantial due to how and what fees are being charged. “It is not just manager fees, but also all the other costs that impact gross to net return,” says van Eldik.
A possible solution
The industry has taken note. Plans are afoot for a globally-consistent measure for real estate investment vehicle fees and costs. The proposed total global expense ratio (TGER) aims to enable investors to make easier and more accurate comparisons across products – regardless of the vehicle domicile, structure and management activities – and so help their decision making.
An initial consultation period on the TGER closed in June, so it will be some time before there is significant further progress.
But there is widespread industry support for this approach.
“The investor community is definitely interested, and I believe more general partners are moving towards using standard definitions. ANREV and its sister organisations have made a lot of progress in driving transparency and standardisation,” he says.
As well as helping investors compare fees and costs of individual vehicles, the TGER aims to foster greater consistency of terminology across geographic regions, to create more standardised technical descriptions and definitions of the fees and costs being charged. The TGER proposal was jointly developed by the INREV, ANREV, NCREIF and PREA industry associations.
Fee model complexity
At present, the level of fees charged typically depend on whether the strategy is core, value-add or opportunistic.
For core open-end funds, base fees are typically charged according to NAV, with incentive fees related to the performance of the assets rarely a part of the package. If incentive fees are applied, typically they are linked to net operating income growth.
For value-add and opportunistic strategies, most of the base fees are charged during the commitment period for closed-end funds, and subsequently on invested capital. Charging acquisition and/or disposition fees when a property is bought or sold is getting less common, but does still exist.
“Incentive fees are still highly relevant for opportunistic strategies, as well as for value-add,” notes van Eldik. “It is fair to say that these days incentive fees are not being charged deal-by-deal anymore, but most are pooled and back-ended.”
The lack of common practices around which fees are charged, and when, is a source of confusion for investors. Investors would prefer more transparency and consistency on the gross to net spread. This would give them better like-for-like comparisons.
To do this, a clear total expense ratio will be crucial, says van Eldik. Particularly for more high risk strategies where alignment between the investor and the team that will execute the strategy and delivers returns is crucial.
Yet many factors will determine how effective such a ratio proves in practice.
“Consistent definitions around fees and costs will lead to more of a like-for-like spread in gross to net, although leverage can still create some distortion in full comparison of target fund returns.”
“We see most value for opportunistic strategies, ensuring more clarity on how a manager achieves profits and how carry is being allocated between the house and team is an important step as well.”
The new TGER measures could potentially benefit all market participants, says van Eldik.
“It will push more managers to become more transparent and realistic on the fees they charge and costs involved, and create an environment more akin to the public market,” he says.
“Ultimately, investors need to know how a manager drives net performance and how both target and realised returns stack up against their peers.”
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