The explosive growth of Private Equity and Real Estate (PERE) funds since the 2008 global financial crisis (GFC) has been nothing short of spectacular – and it's a trend that seems to keep picking up speed, even when uncertainties from trade wars and weakening economies loom overhead.
According to the Preqin database, a record amount of capital (US$70 billion) was raised in the first half of 2018, and Q3 delivered the largest average fund size since 2015 at US$589 million. With 634 private real estate vehicles in the market in Q4 2018, the appetite for both value-added and opportunistic investment strategies in the real estate sector does not seem to be waning.
This trend is very much in line with the increased number of new PERE fund set-ups which TMF Group has supported. We've found the increased demand for investment and holding vehicles spans the globe, with jurisdictions such as the Cayman Islands, Jersey, Delaware, Singapore and Hong Kong preferred by limited partners (LPs) and fund managers.
With the launch of each new fund, the fund manager and their team are caught up in non-stop action, diving straight into acquisition mode and sourcing the best opportunities. Firepower is generally expended within the first three years, but the fund manager often does not realise the (realistic) size of their operations until the fund structure has grown to a morbid-sized structure of 100-odd vehicles. That seems fine until one looks at the energy and cost it takes to manage (the horror of) it all.
In this article, we attempt to provide an overview of the real underlying cost in managing these vehicles globally. In doing so, we hope to raise awareness of some potential blind spots, and to reduce the administrative headaches one gets when given the task to run the operations of such structures with a lean team.
Scenario: The true fund cost from the Asia perspective
There are a few common structures being used and favoured by investors globally. Let's consider a US$500 million fund using a common GP/LP structure through the lense of an Asia-based fund manager investing into APAC real estate - much of the literature published has been either US or EU centric, with not much focus on this part of the world to date.
Some background to our scenario:
- US$500million PERE Fund
- South East Asia-focused, growth-oriented (four countries)
- fund managers are based in Hong Kong and Singapore
- it's based on a Cayman structure with five institutional investors
- number of investments deployed is 5-15.
The fund's costs can general be categorised into the following:
- Annual Ongoing
Pre-launch and set-up costs
At the pre-launch phase for a new shop, fund managers are usually focused on fundraising and conducting roadshows while working closely with external legal counsels to have the fund document pack prepared. This forms the bulk of the set-up cost; in APAC this can cost a minimum of US$35,000 and the fees can easily reach US$100,000.
Setting up the fund structure comes next, and a standard Cayman Exempted Limited Partnership (ELP) with five LPs would cost around US$3,000 to US$5,000. Service providers such as legal counsels, banks and fund administrators have seen costs increasing in recent years, largely due to increased Know Your Client (KYC) and compliance requirements. Common additional costs that kick in are express filing costs and incidentals which can increase the set-up costs by up to 10%.
Annual ongoing costs
Once it's set up and is running, we must consider salaries for a team of four experienced portfolio managers to support the fund manager and standard overheads of a physical office space – these could cost around US$500,000 annually.
On the investment front, a typical deployment for a commercial or mixed-use development in Australia, for example, will warrant US$100,000 to US$150,000 annually for a Managed Investment Trust (MIT) structure. In Indonesia, a Perseroan Terbatas Penanaman Modal Asing (PT PMA) structure with two foreign corporate vehicles commonly used to hold real estate could cost a minimum of US$50,000 annually for the fund administration services of a reputable service provider. Countries such as Japan, Korea, Thailand and China – well-known for unique local compliance requirements and tax structuring - will have similar substantial cost structures annually.
Fund managers do not usually realise the total cost of ad-hoc charges until the invoices turn up. Unscheduled capital calls, drawdowns, additional committed capital and new investors are all good news, but when such changes are not managed in an efficient way, the cost of making changes to the fund structures and vehicles can cost upwards of US$50,000 annually. Factor in restructuring due to tax law changes and the fees can double.
Mitigating costs exceeding planned budget
With all the fees added up, the costs often exceed the original planned budget and fund managers would be hard-pressed for results while answering to increased operational costs.
Are there ways to manage such situations? Yes, indeed. Communication is key. We encourage fund managers to pull in their fund administrators to their structure planning as early as possible. Being part of the conversation means the fund administrator can provide an independent point of view, and an experienced professional will be able to highlight areas which may have been overlooked.
TMF Group's fund services
TMF Group's PERE team operates in a global network offering local expertise in more than 80 jurisdictions, which means we can simplify your operations, lower your risk and help control costs. Read more about our private equity and real estate investment or fund services, or get in touch to discuss how we can help drive efficiency for global operations.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.