Features English And US Private Equity Real Estate Funds: Key

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English and US private equity real estate funds: key features, Practical Law UK Practice.English and US private equity real estate funds: keyfeaturesby Andrew Wylie and Nathaniel Marrs, DLA PiperPractice notes Maintained United Kingdom, United StatesAn overview of the key features of UK and US private equity real estate funds and the differences between them.Closed-end or ‚Äúprivate equity-style‚ÄĚ funds which invest in real estate are one of the most significant sources forprivate funding in the real estate sector in the United States of America and, increasingly, in the United Kingdom andmany continental European jurisdictions. Over the last quarter of a century, as the private equity real estate modelin the USA has become more familiar and real estate investment opportunities for funds more readily apparent, theEuropean investor base has grown considerably and private equity real estate (PERE) is now recognised in Europeas an important alternative asset class in its own right.This practice note provides an overview of the basic structure of a typical PERE fund, highlights some differencesbetween English and US PERE funds and outlines some of the UK and US issues involved in forming and marketinga PERE fund.This practice note addresses certain aspects of Scottish limited partnerships. The laws that govern limitedpartnerships formed under the laws of the British Virgin Islands, the Cayman Islands, Guernsey or Jersey fall outsidethe scope of this note. REITs and open-end funds also fall outside the scope of this note.What is a private equity real estate fund?A PERE fund is an actively managed closed-end collective investment vehicle that invests almost exclusively inreal estate and real estate related assets. Those assets may include debt (such as portfolios of performing and nonperforming loans secured by real estate), equity in real estate-focused companies (whether wholly owned or majorityor minority holdings) and majority and minority investments in joint ventures. The purpose of the fund is to providea return to its investors over the life of the fund, which will typically be around ten to twelve years and during thatperiod the fund will manage its investments to maximise their value on disposal or exit.PERE funds derive from the private equity leveraged buy-out fund (LBO fund) industry which burst upon the USAin the late 1970s and early 1980s. As investors became increasingly aware of the attractive features of LBO funds,sponsors responded by seeking to acquire a broader variety of investments, including real estate. Starting in theearly 1990s, private equity funds focused exclusively on real estate began to appear. Today, such funds represent asignificant source of private funding for the acquisition, ownership and operation of real estate.Many PERE funds are product and/or geographically specific. The size of PERE funds themselves may vary fromas little as tens of millions to billions of dollars, which reflects the appetite of investors for the track record of theprincipals and the purpose of the fund.Types of PERE funds 2019 Thomson Reuters. All rights reserved.1

English and US private equity real estate funds: key features, Practical Law UK Practice.Depending on their relative risk/return profile, PERE funds are often labelled core, core plus, value add, oropportunistic, with each succeeding category indicating an increasingly risky and higher return, as illustrated in thediagram below.Of course, higher levels of risk and returns can be achieved through a variety of methods, including through theuse of higher debt levels and investment in assets with less certain returns or that require greater levels of effort orcapital investment (such as ground-up development). In general, however, the following characteristics are seen inthese different categories: Core: fully developed assets requiring very little additional capital investment; long-term leases to investment grade tenants; and moderate leverage (no more than 50%, typically closer to 40%).Core Plus: assets similar to core assets but requiring additional capital investment or, potentially, somedevelopment or redevelopment; an initial tenant base that may not be as creditworthy as a core tenant base; and 2019 Thomson Reuters. All rights reserved.2

English and US private equity real estate funds: key features, Practical Law UK Practice. potentially higher leverage.Value Add: assets that typically require moderate levels of additional capital investment, development orredevelopment and/or significant lease-up or repositioning; and typically higher levels of leverage.Opportunity: assets that usually require significant amounts of work, whether in the form of lease-up, repositioningor substantial development or redevelopment; often high levels of leverage (potentially up to 90% with respect to individual assets); and pursuit of a variety of strategies to leverage returns, including significant use of joint ventures,portfolio acquisitions and disposals, debt strategies, and public to private or private to public companyacquisitions and disposals.In addition to categories based on risk/return metrics, PERE funds can be divided based on sponsor strategy,including so-called allocator funds and operator funds, whereby allocator funds focus on investing in assets wherelocal joint venture partners act as the operator of the assets (by virtue of being the property or developmentmanager), and ‚Äėoperator‚Äô funds directly provide operating services to the assets in which they invest.Since operator funds seek to add value with respect to the funds‚Äô assets on a more focused and local basis thanallocator funds, such funds often concentrate on specific geographic regions and/or property types and consequentlytend to be smaller than allocator funds. In addition, allocator funds investing alongside local operators are usuallyrequired to pay the local operators a profit element (commonly referred to as a carried interest or promote), inaddition to other fees, thus resulting in a "double promote" to fund investors who are also required to pay the fundsponsor a carried interest or promote. In practice, the line between operator and allocator funds is often blurredas some larger opportunity funds, typically formed by institutional sponsors, may act as operator or allocator withrespect to their assets, depending on the particular investment strategy for those assets.Finally, PERE funds may be distinguished on the basis of geographic focus or asset type such as office, hospitality,multifamily, retail, industrial and logistics.PERE fund structureThe primary PERE fund vehicle will usually be a limited partnership. The wider fund structure may, however, involvea number of other fund vehicles, such as feeder funds and parallel funds, which, in turn, may include corporationsor private REITs (particularly for US PERE funds that desire to limit ‚Äúunrelated business taxable income‚ÄĚ for UStax exempt investors and tax payable under the Foreign Investment in Real Property Tax Act of 1980 for non-USinvestors). A fund also comprises numerous other parts, involving a cast of players that includes the fund‚Äôs advisers,managers and investors (see Typical European PERE fund structure and Dramatis personae).Limited partnership 2019 Thomson Reuters. All rights reserved.3

English and US private equity real estate funds: key features, Practical Law UK Practice.The limited partnership is the traditional US fund vehicle and is highly familiar to investors. Limited partnershipsare also commonly used by UK and European fund houses, often with modified features to reflect local tax andregulatory requirements.The key features of a limited partnership are: Two categories of partner: the general partner. There will only usually be one general partner that will have control over themanagement of the limited partnership and unlimited liability to third parties for the debts andobligations of the limited partnership; limited partners. There will often be many, and they are essentially passive investors without activemanagement rights. A limited partner‚Äôs liability to the partnership and its creditors is generally limitedto the amount of capital that it agrees to contribute to the partnership. A limited partnership agreement that governs the relationship between the partners, the content of whichis only lightly regulated and that is a matter of negotiation between the partners (see Limited partnershipagreement). Freedom from many of the legal constraints and formalities usually applicable to corporate entities. Thisflexibility is a significant attraction. Recognition as a partnership, not a corporation, under domestic tax law and, as a consequence, ‚Äúfiscaltransparency‚ÄĚ, meaning the partners are treated for tax purposes as having invested directly in theunderlying partnership assets, with no (or limited) taxation at the entity level.A PERE fund will generally seek to use a legal form that is tax efficient, marketable and familiar to investors in itstarget jurisdictions. As there is no single fund type that fits all, if a fund seeks to target investors in a number ofdifferent countries, it may use a number of fund vehicles tailored to specific jurisdictions as feeder funds or parallelfunds (see Fund descriptions).As a rule of thumb, PERE funds which are targeted principally at US investors will tend to use limited partnershipsestablished under the laws of the State of Delaware, USA. Funds that are targeted principally at investors in the UKand investors in non-member states of the European Union will tend to use limited partnerships established underthe laws of the Cayman Islands, England, Guernsey or Jersey. The English limited liability partnership, introducedby the Limited Liability Partnerships Act 2000, has not generally been adopted as a vehicle for PERE funds as analternative to the traditional limited partnership (for various reasons, including regulatory and tax considerations).In the USA, limited liability companies are used for hedge funds, and generally not for PERE funds. This is due tomarket practice, the existence of a larger body of developed US case law for limited partnerships than is the case forlimited liability companies and the fact that a number of jurisdictions do not treat a US limited liability companyas transparent for tax purposes.DelawareIn the USA, the formation of business entities is a matter of state, not federal, law. The majority of US PERE funds areformed as limited partnerships under the Delaware Revised Uniform Limited Partnership Act (Delaware Act). This 2019 Thomson Reuters. All rights reserved.4

English and US private equity real estate funds: key features, Practical Law UK Practice.is a matter of choice and the promoters of the fund are not required to have any substantive connection with Delawareto form a limited partnership under Delaware law. A Delaware limited partnership is not required to disclose theidentity of its limited partners to any governmental or regulatory authority so as to become a matter of public record.Delaware takes seriously its status as the pre-eminent US state for the formation and incorporation of businessentities and the Delaware Act is revised frequently, usually annually. The Delaware courts are also regarded asamong the most business-oriented in the USA and there is a developed body of Delaware case law about limitedpartnerships. Most of the limited partnership statutes of the other US states are similar to the Delaware Act, althoughthere can be substantive differences.England and ScotlandEnglish and Scots law that applies to limited partnerships stems from a combination of: The common law of partnership, mostly based on case law. The Partnership Act 1890, as amended (PA 1890), which sets out a broad code for English and Scotspartnerships generally (and which was intended to bring together the general common law on the topic andhas not been amended to any material extent since 1890). The Limited Partnerships Act 1907, as amended (LPA 1907), which gives statutory recognition to limitedpartnerships and provides for their registration as well as modifying the PA 1890 to afford limited liability tolimited partners.A fund need not be permanently established in England to be treated as an English limited partnership. An Englishlimited partnership formed under the LPA 1907 must, however, carry out some business in England at the time of itsformation. Thereafter, it is possible to migrate an English limited partnership offshore, although care is often takento preserve some connection with England to bolster the choice of English governing law.Salient features of a Scottish limited partnershipThe principal difference between an English partnership and a Scottish partnership (whether general or limited) isthat the latter has legal personality separate from that of its partners (by virtue of section 4(2) of the PA 1890). Thismakes a Scottish limited partnership attractive for use as a carried interest vehicle and as the primary fund for aPERE fund of funds (not least due to simpler filing requirements at Companies House). A Scots limited partnershipis not a body corporate for the purposes of Scots law.Scots law appears to require a Scottish limited partnership to observe various requirements in order to ensure that itis respected as a Scottish limited partnership. These include the requirement for its general partner to be a Scottishlimited company and for its general partner to hold meetings of its board of directors in Scotland. These requirementscan be burdensome.Private fund limited partnership regimeAn English private fund limited partnership (PFLP) is an English limited partnership that has been designated as aPFLP (see Practice note: overview, Private fund limited partnerships (PFLPs)).The PFLP regime was introduced in the UK on 6 April 2017 for private investment funds structured as limitedpartnerships. 2019 Thomson Reuters. Al