Changing Views on Real Estate Fund Terms & Conditions - October 2013 (Part II)

by Olivia Harmsworth

  • 18 Oct 2013
  • RE

When looking at the distribution of management fees by vintage year, funds of vintage years 2010-2011 are more likely to charge fees at the higher end of the spectrum during the investment period, with 40% of funds charging a management fee of over 1.75%. This is compared to vintage 2012-2013 funds and funds currently raising, of which 32% charge an investment period management fee over 1.75%. Although this is only a slight change for funds of a more recent vintage, it indicates that fund managers are beginning to concede to investors and are offering lower management fees. Despite this positive change in favour of investors, it is an important consideration for investors that persuading managers to lower the management fee does not affect their ability to successfully run a fund and pursue investment opportunities. As a consequence, management fees are unlikely to see any significant change going forward unless compromises are willing to be made by both parties concerning the operation of the fund.

The hurdle rate – or the minimum rate of return – was viewed by only 14% of investors as an area which has seen change in the last 12 months , with 14% also stating that it is an area for improvement. Looking at the actual change in mean and median hurdle rate by vintage year shows that, although the median has consistently remained at 9% for vintage 2006 to 2013 funds, the mean hurdle rate has seen slight declines since 2010, decreasing from 9.3% in 2010 to 8.9% in 2013. This decrease in the mean hurdle rate indicates a slight change in favour of fund managers, in contrast to management fees which have seen a change in favour of investors.

This shift towards lower hurdle rates may be the result of funds of more recent vintages setting lower performance expectations; only 12% of vintage 2012-2013 funds and funds in market are targeting net IRRs of 20% and over, compared to 24% of vintage 2010-2011 funds. At the other end of the spectrum, 12% of funds of more recent vintages are targeting net IRRs of less than 10%, compared to 6% of vintage 2010-2011 funds. Therefore, with managers setting lower and more realistic performance targets, they are also lowering the minimum rate of return expected from their funds.

Investor satisfaction with private real estate fund terms and conditions is particularly high, with the vast majority stating that they agree or strongly agree that fund managers’ and investors’ interests are properly aligned, and over a quarter stating that they had seen a significant or slight change in favour of the investor concerning fund terms in the past year.
Encouragingly, with the majority of investors stating that management fees are the area in which they have seen the most change in the last 12 months, Preqin’s data reveals that funds of a more recent vintage have a higher distribution of management fees at the lower end of the spectrum, demonstrating a slight shift in favour of the investor. Interestingly however, with many funds setting lower target net IRRs as a result of the difficult fundraising environment, the mean hurdle rate has seen a slight decrease in recent years, indicating a shift towards fund managers. As a consequence, it seems that although fund managers are yielding to investors’ demands for lower management fees, they are lowering the minimum rate of return below which they cannot charge performance fees.

Although investors have seen positive change in terms of management fees, this is the area in which the largest proportion felt that the alignment of interests with fund managers could be improved, with a much lower proportion stating that the hurdle rate was an area for improvement. Fund managers should consequently be aware of investors’ concerns in this area, although it is also equally important that the lowering of management fees does not impact the operation of a fund.

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