The review of strategic alternatives can be a daunting task even for the most seasoned executives and directors of real estate companies and real estate investment trusts. This is particularly true in today’s real estate environment in which tax reform, concerns regarding the current stage of the real estate cycle and political turmoil all must be taken into account. The next five months of the K&S REIT Advisor will include a  high-level overview of the pluses and minuses of an individual strategic alternative for private real estate portfolios. This month’s REIT Advisor focuses on the conversion of a private real estate portfolio into an open-end investment vehicle.

An Overview of Open-End Vehicles

Open-end vehicles are continually offered private investment vehicles that seek to provide investors some degree of liquidity through the right to request redemption of equity in accordance with the vehicle’s governing documents. The open-end vehicle arose out of large separate accounts for institutional investors that desired to provide liquidity for investors. Fundraising for an open-end vehicle is generally ongoing. Interested investors submit irrevocable, binding subscription agreements to the vehicle, which the vehicle may accept in whole or in part. To the extent that investors have submitted subscriptions in excess of the vehicle’s current capital needs, the vehicle may accept only a portion of those subscriptions and the uncalled amounts will remain in a “subscription queue” to be accepted at future dates when the vehicle has need for the capital.

Benefits

Open-end vehicles offer the following benefits:

• Flexibility Across Asset Classes and Sponsor Types. The open-end vehicle works with traditional real estate investments – office, multifamily, industrial and retail. Importantly, the concepts and mechanics are open to non-traditional asset classes as well, including timber, healthcare and data center investments. The structure is appropriate for a wide variety of sponsors and situations, including newly formed vehicles by private equity sponsors and public REITs looking to monetize an existing portfolio or recycle capital.
• Control with Liquidity. Open-end structures permit the existing owner to retain control of the assets while offering liquidity to existing investors. New investors will want to ensure a minimum ownership position of the sponsor of the vehicle. 
• Lower G&A Expense Compared to Public Markets. The general and administrative expense of a privately operated vehicle is generally lower than that associated with a public vehicle over the long-term.
• Opportunity for Incentive & Management Compensation. The sponsor of the vehicle has the opportunity to receive incentive fees tied to performance of the portfolio across designated intervals and return thresholds. It is also customary for the sponsor to earn management fees with respect to the portfolio. 
• Widely Accepted by Institutional Investors. The open-end structure is widely accepted by institutional investors in real estate, including the quarterly redemption mechanisms based on the net asset value of the portfolio. This structure permits access to a wide array of institutional investors.

Considerations

The open-end structure also raises the following considerations:

• Complex Structuring. The structuring required to implement an open-end vehicle is often complex, particularly in instances where a portfolio is rolled into the structure from an existing business or vehicle. The jurisdiction and structuring requirements of institutional investors will also impact the complexity of the structure. 
• Liquidity Considerations. The redemption provisions that provide investor liquidity can cause investor relations and other issues if liquidity becomes an issue – in some instances, the fund could be forced to sell assets depending on the terms of its organizational documents. In addition, the redemption crunch can be exacerbated in the event that the market for institutional equity capital is closed. 
• Size and Scale Required. Investors in open-end funds rely on the quarterly redemption mechanics as a liquidity mechanism. For the open-end vehicle to have a properly functioning redemption mechanism requires significant size and scale for the vehicle. This is often in excess of $1.0 billion in net asset value. This scale can often be reached over a period of years during a temporary lockout on redemptions.