Private Equity - Fund Equity vs Deal Equity; Gross vs. Net Property Level Returns w/ Sub Line
I recently did and diligence request for a potential LP that asked questions differently than usual. This relates to peak equity, reinvesting cash flows, and using a subscription line in a closed end RE fund. If I take what I invest in a deal day one (x), take cash flow (y) to pay fund fees and expenses or distribute, and then fund more into that deal (z), my "invested equity" should be "x+z". I understand my net invested capital would be x-y+z, but that is somewhat irrelevant since management fees are paid on invested capital. Now to fund x, I put it on my subscription line and called the money later, also x. So if I take cash flow from a different deal and invested it (as z) into the deal, I have invested capital that is not from a capital call. So now I am in a situation where I have deal level invested equity of x+z and fund level equity of x.
At the same time, lets say I funded the deal from my line in June, books close, and then call the equity in August. At 6.30 I will have invested equity in a deal that is from the subscription line. That is 1) ok, right? and 2) any property level returns should not include any sub line activity? What if I wait 6 months to call that equity? Is the property 100% levered? The acq guys are trying to sneak in using the sub line into their underwriting and I am pushing back but need more ammo. I have always been under the impression that subscription line activity should never be in deal level returns.
Frankly, in past roles I was lucky to work with fabulous accountant that knew the fund world like the back of their hand. Now its a little bit different and I am getting different answers and there are (plenty) of times when looking at the fund level vs sum of the property level I cannot keep track of what is going on or what is right.
Does anyone have any tips on how to manage this from a deal level and fund level perspective? Or how LPs digest this information when evaluating a manager?
Maybe the most unique comment I've seen on WSO RE in a WHILE.
Bump, would also like to know.
I’ll mention first that there is an ILPA standard regarding deal and fund level returns (gross, net, etc). Deal level returns do not care what the source of the equity is (actual equity or sub line), they start at the moment cash comes in from the fund and ends when cash comes out. In practice, fund level gross returns should be higher than deal level returns, because your sub line is cheaper than your equity (this will depend on how efficient your cash management operations are). Usually closed end funds have a recycling provision during the investment period in which cash pulled out of a deal can be reinvested, profits will contribute to an increase in net invested capital (as you noted). However, the scenario in which you hold an asset on a sub line for 6 months is unlikely. For a ~$1b fund, you might be able to get a sub line for 100-250mm, if you have to deploy that 1b in 18 months, it will be difficult to keep one asset on a line for 6 months at a time.
This is how I have always understood it to be but when things stray due to the LPA or the fund is making big capital investments pots investment period it gets murky. Its tricky when a fund still has a large amount of uncalled commitments at the end of the investment period slated for development/redevelopment. This means the line can still be outstanding because of the uncalled commitments and its 2020 and banks love it. I guess one way to interpret your response is: when the investment period ends, you cannot recycle cash flow/sale proceeds. If I have an investment throwing off cash and a development project I can't take some of that cash flow and put it into my development because I am essentially investing profits post investment period. The equity I have reserved at the end of the investment period must be from LP capital call. Right?
Now if I am managing my multiple and still have room on my line after the investment period and I make a disposition, I could in theory pay down my line, then draw on the line down the road to fund some equity on a development project. If I am able to extinguish the line from sales before ever calling that capital, haven't I just indirectly recycled capital after the end of the investment period?
This is where I am wondering - where/what is the check? It is not necessary explicitly disclosed what the deal level equity is at the end of the investment period and the line may still be outstanding. So what do LPs look at to make sure the activity the GP is doing post investment period is not recycling capital or crossing deals? Do they look at deal level invested equity (which should include all equity funded from the line), reserved capital (which must come from capital calls), and then basically say if you go over this amount you would need advisory committee approval? Some LPAs I've seen are worded as if the line can't be open after the investment period but in the world today that is not always the case.
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