As fundraising for private real estate funds became more challenging in the wake of the financial crisis, it appeared that there was a shift in certain areas of fund terms and conditions in favour of LPs. With fundraising conditions extremely crowded and institutional investors more demanding than ever, wider conditions pushed GPs hoping to be successful in securing commitments towards offering potential LPs concessions in regards to fund terms and conditions. However, while headline fund terms and conditions became slightly more LP-friendly in 2009 and 2010, they are now swinging back in favour of GPs.
Institutional investors have demonstrated strong disapproval of the annual management fees charged by private real estate funds, as LPs are keen to ensure that these fees cover a GP’s expenses/costs without representing a significant source of profit. Pressure from the institutional investor community on real estate fund managers to lower management fees increased in the wake of the financial crisis; however, there have been minimal decreases in fees. Management fees have remained fairly consistent, albeit with more variance by vintage year for larger funds than for smaller funds. Indeed, it appears that management fees have increased slightly for 2011 and 2012 vintage funds and funds currently raising, with these funds having average management fees of 1.6% for funds over $500mn, and 1.5% for funds under $500mn. While management fees have remained relatively consistent at an industry level, there a growing number of GPs offer reduced fees for investors that commit before the first close of the fund, or similar concessions that encourage early investment. In general, changes in management fees are unlikely to be dramatic. The institutional investor community generally recognizes the need to balance between incentivizing GPs via carried interest as opposed to non-performance linked fees, and reducing such fees to the detriment of the fund. Fund managers are unlikely to drop fees below a certain level, as doing so risks damaging the day-to-day running of the fund and the potential for generating attractive future returns.
With the exception of 2010 vintage funds, mean management fees have historically been slightly higher for smaller funds than for larger funds. For 2008 vintage funds smaller than $500mn, for example, the mean management fee is 1.5%, compared to 1.2% for funds over $500mn. Despite the criticism levelled at real estate fee levels in recent years, particularly those charged by larger funds, the disparity between the management fees charged on funds of differing sizes seems to be narrowing, with 2011 vintage funds over $500mn and under $500mn charging similar amounts. Managers of larger funds are more likely to be able to reduce management fees than smaller funds, as they benefit from an economy of scale. For example, it is unlikely that a firm managing a $1bn fund will have twice the costs in terms of wages and other expenses as a $500mn fund and, because of the size of the fund, firms can earn significant amounts of money from these management fees.
The management fee charged during the investment period is generally calculated as a percentage of the total commitments made by LPs to the fund. The rationale behind this is that the major part of a GP’s workload at this stage is the search for potential investments, which is driven by the aggregate size of commitments to the fund and not the amount invested at this point in the fund’s life.
For vintage 2011 and 2012 funds and those currently raising capital, the majority of funds (44%) charge a management fee of 1.50-1.74% during the investment period. There has been a slight shift towards higher management fees during the investment period, with 22% of funds charging a management fee of 2.00-2.24%, compared to 14% charging the same amount for 2009-2010 vintage funds. Additionally, 3% of 2011-2012 vintage funds and those in market have a management fee of 2.25% or more, whereas no 2009-2010 vintage funds charge this higher amount.