Studies by INREV and PREA reveal significant differences in fee structures between European and US non-listed funds, as Lonneke Löwik reports
For the past five years INREV, the European Association of Investors in Non-Listed Real Estate Vehicles, has conducted a Management Fees and Terms study to examine fee structures and levels of European non-listed real estate funds. Last year, the Pension Real Estate Association, PREA, carried out a similar study in the US. Both studies followed a similar approach, which for the first time made a comparison between European and US non-listed property fund fee practices possible.
The studies showed that most funds in Europe and the US charge annual management fees, including acquisition fees, asset management fees, commitment fees, dead deal fees, debt arrangement fees, development fees, disposal fees, fund management fees, project management fees and property advisor fees. Fund management fees, which might include most of these, are the most common.
However, fee structures can change during a fund's life. During the investment period, funds whose fee structures change typically charge management fees as a fixed percentage of commitments during the investment period. After that, the INREV study, which is weighted toward core funds, found that most of these funds charge annual fund management fees based on gross asset value (GAV). In the PREA study, with more higher-risk funds, management fees based on commitment invested equity were most common during the investment period for funds whose fee structures changed.
Core funds in the US charge significantly lower annual management fees than value added and opportunity funds. In contrast, in Europe there is little difference between core and value-added funds, while opportunity funds typically base their fees on drawn commitments, limiting comparison. Core funds in Europe typically invest in different sectors and regions and therefore may have higher management costs, which might explain this result.
Comparison between value-added funds is limited to fees charged on the same basis. Fee levels of European value added funds, however, appear quite comparable to fee levels of the PREA funds.
Multi-country European funds charge higher fees than single-country funds, probably because of the asset management resources required. In the PREA study, however, funds investing in only one country charge higher annual management fees than those investing in several. However, multi-country funds also pass on more fund expenses and costs to their investors, which is not captured by the study, making conclusions difficult.
The fee rates charged by single-country funds vary widely by target region; however, funds targeting the US report the lowest management fees. Single-country funds investing in the UK, which like the US has a long real estate fund tradition and is highly competitive, have lower fees than other European countries.
The PREA study asked fund managers if the fund was the first in a series. Fee rates of funds that are the first in the series are lower than subsequent funds, possibly because of the more complex structure of some follow-on funds, which affects costs, or the fact that managers with a proven track record can charge higher fees.
Performance fees, called incentive fees in the US, are charged by most funds in both studies. Although structured differently, a comparable percentage of closed-end funds in the two studies charge performance fees. In contrast, more open-ended funds in Europe charge performance fees than in the US.
Performance fees in both studies are primarily based on realised gains, but a minority of the funds in each base them on unrealised gains. Most hurdle rates are absolute return hurdles, either defined as an internal rate of return ( IRR) or total return hurdle. Floating benchmarks are rare, although a few funds in both studies use them together with an absolute return hurdle.
Closed-ended funds in the US have lower first hurdle rates than in Europe and have a wider spread with their target return. In both markets, however, managers are rewarded for performance well before target IRR is met. The performance fee rate, which is the share of the fund return exceeding the hurdle rate paid to fund managers, is slightly lower in the US than in Europe, although it also varies more widely.
The use of multiple hurdle rates and catch-up clauses in performance fee structures also differs significantly between the US and Europe. Multiple hurdle rates are more common in European funds, while catch-up clauses are used more often by funds in the US. In the PREA study, 44% of the funds with an incentive fee have a catch-up clause, compared with only 13% of INREV funds. Opportunity funds use them most, along with some value-added funds, and a 50/50 split between general partner and the limited partner with a 20% carried return is most common. In the US, catch-up clauses have increasingly been used by funds launched since 2006.
Many other fees are charged by funds in both markets, with acquisition and property management fees being the commonest. On average, European funds charge higher acquisition fees but lower property management fees than US funds.
Further comparison is limited because of the different structures of the samples and questionnaires due to different market practices. However, a rough comparison can be made by looking at the difference between net and gross target IRRs of funds, a simple proxy for measuring the total leakage in a fund.
This comparison shows that the higher a fund's risk profile, the more fees and costs reduce returns. The difference between gross and net IRRs of value-added funds in the US is significantly larger than in Europe, while the opposite holds true for opportunity funds. Different style definitions applied by the fund managers might partly explain the disparity.
Although the two studies do not allow direct comparison of all fee structures in both markets, they offer interesting insights into how fees are structured in Europe and the US. It will be left to future studies to further develop comparability of property funds' use of management, performance and other fees, but a step forward for the transparency of fee structures on both sides of the Atlantic has already been achieved.
Lonneke Löwik is director of research and market information at INREV