CRE Investment Through Private Equity Can Cost More Than You Think

A lesson that the average retail investor has heard time and again is that even a fraction of a percentage in higher fees can kill your returns. The personal finance site Nerdwallet calculated the 30-year difference in a personal retirement account of $13,200 between an index fund at 0.09% fees and a mutual fund that charges 0.82%.

That may have played out on a consumer level, but for accredited and institutional commercial real estate investors, the principal—and the interest—hold true as well. A new analysis by alternative assets data provider Preqin shows that when it comes to investments through private equity, management fees hide the true dollar cost.

As the analysis notes, fees are a point of contention between general and limited partners in private equity funds. “LPs’ calls for greater transparency have become increasingly loud as they look into what exactly they are paying for and how that is impacting bottom-line, net returns,” Preqin says. “GPs counter this by arguing that their funds’ outperformance of public markets justify fees to yield-hungry investors. Regardless, investors’ demands are likely to get louder as private equity and venture capital assets approach the $7tn assets under management (AUM) milestone.”

The inherent problem limited partners point to is that, given how fees affect ultimate results, outperformance of public markets doesn’t matter if the ultimate return is smaller than the cost would seem to justify.

While management fees have hovered roughly between 1.5% and 2% across the 408 PE funds in the study, the sizes of the funds have increased markedly, meaning that the total sums they general partners receive have grown substantially. Is that unreasonable if each investor is getting charged what they would have been?

Perhaps not, but there is another mechanism in play, according to Preqin. Some costs once included in management fees have been broken out separately by some funds. For example, GP administration fees, deal-involved travel fees, and, in some cases, even salaries and office overhead. Other additional fees can include regulatory filings and compliance, insurance costs, broken deal costs, and even fund formation costs.

Firms are moving from a “2 and 20” structure—2% management fee on total assets under management and 20% on profits beyond a set threshold, to a “’2 and 20 plus’ arrangement.”

The result is an absolute increase in fees, meaning lower returns even as the funds make more money from additional investors entering.

The SEC has proposed changes to increase transparency, which would make it easier for investors and regulators to see exactly what is going on.