Presenting a live 90-minute webinar with interactive Q&A
Private Equity Real Estate Fund Formation: Capital Raising, Regulatory Issues and Negotiating Trends Navigating Capital Contributions, Allocation of Profits/Losses, Clawbacks, Return of Capital, Fees, Conflicts of Interest and More TUESDAY, NOVEMBER 15, 2016
1pm Eastern
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12pm Central | 11am Mountain
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10am Pacific
Today’s faculty features: Richard M. Morris, Partner, Herrick, Feinstein LLP, New York Eamon Devlin, Managing Partner, MJ Hudson, London Louis Tuchman, Partner, Herrick, Feinstein LLP, New York
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Private Equity Real Estate Fund Formation: Capital Raising, Regulatory Issues and Negotiating Trends November 15, 2016
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Meet the Presenters
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Meet the Presenters
Richard (Rick) Morris
Eamon Devlin
Louis Tuchman
Partner Herrick, Feinstein LLP
Managing Partner MJ Hudson
Partner Herrick, Feinstein LLP
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Meet Richard (Rick) Morris Herrick, Feinstein LLP •
More than 25 Years of Transactional
[email protected]
Experience •
Commercial and Regulatory Issues, Acquisitions, Financings and Exit Strategies, Public Company Offerings, Public and Private REITs
Expertise: Corporate Finance, Corporate Real Estate, Institutional Investment, M&A, Funds, Corporate Governance, Executive Employment and Benefits
Richard (Rick) Morris Partner Herrick, Feinstein LLP
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Tel 212-592-1432 http://www.herrick.com/
Meet Eamon Devlin MJ Hudson •
More than 15 years of Investment Funds
[email protected]
Experience •
Advises on Equity Investments and Investment Funds, with Experience in M&A, Spin-outs, Secondaries, Co-investments, GP Restructurings and Formation of Investment Funds
Expertise: Corporate and M&A, Private Funds, Secondaries and Primary Closed-ended Fund Investments
Eamon Devlin Managing Partner MJ Hudson
9
Tel +44 20 3463 3207 http://www.mjhudson.com/
Meet Louis Tuchman Herrick, Feinstein LLP
•
More than 30 Years of Tax Transactional
[email protected]
Experience •
Tax Implications of Investments, Financings,
Tel 212-592-1490
Restructurings, Tax Controversies and Contracts, REITs, REMICs, Tax-free Exchanges and Transfer Taxes Expertise: Tax, Private Equity, Private Investment Funds, Real Estate Joint Ventures and Restructurings
Louis Tuchman Partner Herrick, Feinstein LLP
10
http://www.herrick.com/
Agenda
Introduction to Real Estate Funds Considerations of the RE Fund Stakeholders Key US Tax Issues Key UK / US Differences and Similarities Commercial and Capital Raising Issues Brexit Q&A
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Introduction to Real Estate Funds
General (and alternative) structures of the private fund
Difference classes of real estate Mortgage or Equity Hybrid Structures “Blocker Corp” structure “Portfolio Interest” structure
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Considerations of the different stakeholders in a Real Estate Fund
Investors
Sponsors
Types: US, taxable, tax exempt, ERISA, Non US Certain differences regarding tax aspect or profile ESG sensitive or focused only on returns Time line: availability of funds and required exit Active managers, investor relations or contributors of assets
Placement Agents
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Summary of Certain Material Tax Issues
With respect to each stakeholder Certain “typical” structures
Blocker Corp as a feeder Portfolio Interest Exemption REIT
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Overview of UK and EU to US Issues
Regulatory aspect or profile Permanence and Stability of Capital
Time line for investment and returns
Scope of fiduciary issues Ability to leverage assets and capital commitments Forum and venue for resolution of disputes Expectations and typical access to records and influence on valuation and fundamental decisions through the Advisory Board or otherwise
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Certain Initial Points - Planning Stage
Sponsors
ID of sponsors including investment committee members Regulatory aspect of sponsors Compensation and responsibilities Terms for "kick out" or termination of a Sponsor Responsibility of each Sponsor / member
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Certain Initial Points - Planning Stage cont.
Raising capital
Type of capital (institutional or retail) Location of capital (US or non US) Use of placement agents
Investment Strategy
Certain considerations regarding mortgage, equity, hybrid
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Certain Business Issues
Economic terms for the fund
Management Fee Pref Rate Sponsor / investor split or "carried interest"
Minimum investment amount Capital Call and remedies for failure to fund Escrow of capital commitments or other assurances
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Certain Business Issues cont.
Term of the investment period Term of the Fund Extension rights Fees
3rd parties such as leasing agent Co fee arrangements Management Agent Property managers Asset acquisitions and dispostions Outside of Scope fees (e.g., testimony)
Leverage restrictions or expectations Affiliate relationships Redemption or PE lock up
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Certain Legal Issues
Securities Laws
Investment Company Act
Exemptions under 3(c)(5)
Investment Adviser Act
SEC registration
Form D State Filings Other Registration Exemptions
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Raising Capital in Europe: a Roadmap for US Private Equity Real Estate Funds
What is the Alternative Investment Fund Managers Directive (AIFMD) Relevance to US Fund Managers seeking to raise funds in Europe Alternatives for US Fund Managers raising European capital BREXIT: What are the implications for US Fund managers? Key Takeaways
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What is AIFMD? Relevance to US Fund Managers seeking to raise capital in Europe
What is AIFMD?
AIFMD provides a framework for harmonising the management and marketing of Alternative Investment Funds (AIFs) (ie, all “collective investment undertakings” other than EU UCITS funds) in the European Union (EU) Most US managers will be marketing non-European funds (such as Cayman Islands and Delaware) to European Investors and AIFMD will impact such fundraising operations in the EEA (ie, the European Union, Iceland, Liechtenstein and Norway). Note - Switzerland which has its own rules is not an EEA country AIFMD applies to managers of “alternative investment funds” (AIFS). It is not the fund that is regulated by AIFMD, only the manager of the fund (AIFM)
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AIFMD – definition
AIFs are defined as any collective investment undertaking which
raises capital from a number of investors with a view to investing it in accordance with a defined investment policy for the benefit of those investors is not already regulated under the UCITS Directive
Real estate structures qualifying as operative business
Developing and operating properties vs. only buying, holding, selling Single investor structures 23
AIFMD – definition
Explicit and implicit exemptions Holding companies Joint venture structures Operational requirements
Transparency & reporting
Valuation of assets Risk management Outsourcing requirements AIFM offering document Annual report Disclosure to regulator
Remuneration requirements 24
Options for US Funds and Managers seeking to raise capital in Europe
Alternative 1: Rely on “Reverse Solicitation” Alternative 2: Register country by country under the national private placement rules (NPPRs) Alternative 3: Set up an EU AIF and an EU manager (or use a 3rd party AIF and/or AIFM ‘platform’) in order to obtain a right to “passport” such funds in all 28 EU jurisdictions
Before looking at the above options it is worth briefly noting that paradoxically, the marketing framework under AIFMD (a piece of legislation designed to harmonise/simplify the marketing regime throughout Europe) is now relatively complex.
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AIFMD – Reverse Solicitation – A Practical Strategy?
“Marketing” means a direct or indirect offering or placement at the initiative of the AIFM or on behalf of the AIFM…” This Directive should not affect the current situation, whereby a professional investor established in the Union may invest in AIFs on its own initiative...” Ideal case: an investor, who has had no previous contact with the manager/distributor approaches them – eg, investor or pension/other consultant has a mandate and actively searches out managers with suitable strategies/funds 26
AIFMD – Reverse Solicitation
Interpretations vary across the EU:
Clear guidance in only a few countries and generally restrictive Only possible for professional investors AIFM has the burden of proof (written confirmation) and getting it wrong is a criminal offence/gives investors a ‘free put’ Some countries require the specific fund product (not ‘any product’ or the strategy only) be mentioned by name by the investor (France, Holland, Austria) Some require a separate enquiry per transaction/investment (Belgium, Germany, Netherlands & Norway) Complex to administer (record keeping, monitoring for each transaction, ensuring you now exactly what your and your distributor(s) sales people are doing) Unlikely to work for smaller or “start-up” managers, and not in line with marketing campaigns of larger asset managers Not to be used to circumvent the AIFMD Reverse solicitation is not a marketing strategy!
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National Private Placement Rules – What exactly are they?
AIFMD does not implement a harmonised regime for privately placing AIFs in the EU Rather, each Member State is permitted to retain its own domestic rules which means it is necessary to consider and take advice country by country as to what forms and methods of marketing are permitted AIFMD does impose an obligation, however, to register non-EU AIFs (for example US AIFs) marketed by both EU and non-EU AIFMs (for example US managers) to investors in each EU state and to comply with various information and ongoing reporting obligations AIFMs will be able to use NPPRs until at least 22 July 2018 when it is envisaged they may be phased out. However, it is uncertain whether this will occur
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National Private Placement Rules – What exactly are they?
“Sub-Threshold” AIFMs unable to register under NPPRs in: Austria, Belgium, Finland, France, Ireland, Italy, Norway & Spain Nor can any pre-marketing be conducted in these countries even for “above threshold AIFMs”. Although France has recently introduced a relaxation of the restrictions on pre-marketing in certain circumstances So this is effectively a “no-go area” except with a passport and even then there are problems in France, Spain and Italy So potentially 10 major western EU countries are impractical leaving: Luxembourg, Netherlands, Sweden, UK and Ireland
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National Private Placement Rules – Are they working?
Problems with the NPPRs:
“Pre-AIFMD Marketing” – Certain Member States regard any initial contact with a prospective investor as “AIFMD marketing”, effectively precluding any contact until an offer document is available – this contradicts market practice Other Member States (e.g., UK) only consider ”AIFMD marketing" to take place only when a final offer (e.g., subscription document) is presented and correspondingly permit a certain degree of "pre-marketing” BUT even UK considers “pre-marketing” as a regulated activity (“financial promotion” under UK FSMA); and most require marketing to be undertaken by a regulated entity
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Alternative 3: Going onshore – Becoming an authorised EU manager or sign w/ a 3rd party platform provider
Subject to qualifying requirements, the AIFMD marketing passport is available to EU managers marketing an EU Fund. There are 2 alternative options for US managers considering going down this route:
Setting up a European Fund directly in Europe
An authorised European AIFM will benefit from the AIFMD marketing passport automatically in respect of the EU funds that it manages and wishes to market
Signing up with a Third Party Platform
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Will the US be granted the Passport in its own right?
Why is the AIFMD marketing passport potentially attractive?
Currently both the manager and the fund must be established in an EU country to obtain AIFMD passporting rights Other funds/managers must market under the NPPRs of each country The reason the passport is thought valuable is that complying with the NPPRs can be expensive and complex involving delays and compliance with local requirements, such as appointment of a depository and/or local paying agents. In practice, it is arguable that marketing under the NPPRs works seamlessly in only five EU countries at present: Belgium, Holland, Ireland, Luxembourg and the UK
BUT – the question remains: do US managers really want to subject themselves to EU type rules and regulations?
These would include: remuneration rules; reporting obligations; leverage; and asset stripping restrictions Arguably a strong case remains for private placement being the route of choice for many seeking to raise capital in Europe!
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BREXIT: Implications for US PE Real Estate Fund Managers
If the UK and EU do proceed to “divorce”, then there are two basic alternative scenarios:
Scenario 1 – The UK ceases to be a full member of the EU, but becomes a member of the European Economic Area (EEA) (like Iceland, Liechtenstein and Norway) or negotiates a parallel arrangement (similar to that enjoyed by Switzerland, which is neither in the EU or EEA but is part of the single market for certain purposes) with reciprocal passporting type rights Scenario 2 – The UK leaves the EU and does not join the EEA or succeed in negotiating similar passporting rights with the EU
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Key Takeaways
US managers should carefully investigate and periodically review the available options for raising funds in the EU. Changing environment Where is my target investor base in Europe? Will I be raising funds across multiple jurisdictions or just a select few? What resources do I have at my disposal? What is my proposed timetable? Do I have any deadlines? Is reverse solicitation a viable option? Do I want to rely on the national private placement regimes? Have I checked the private placement requirements in each target jurisdiction and whether or not the offer or marketing needs to be registered prior to the fundraise? Do I want to establish a permanent presence in Europe and set up an EU manager and EU fund/ use a 3rd party EU Platform for full EU compliance and be subject to the AIFMD regime?
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Investment Strategy and Operations
Class of real estate Leverage Joint ventures or co-investments Development issues Differences of RE Fund and other “typical” Private Funds
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Entity Structure
LP or LLC Would you ever use a corporation that is NOT a REIT?
Answer – yes in the Cayman Islands and yes as a “blocker corp”
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Basic Structure Issues
Most US taxpayers prefer investing through partnerships/LLCs (passthroughs) Upside is that there is no entity level tax (in contrast to a corporate vehicle)
Pass-through of both income and losses
Downside is the requirement that investors file returns in all jurisdictions in which the entity does business. Partnership pass-through rules do not apply to publicly traded partnerships (PTPs)
Usually means that partnerships with more than100 partners are taxed as corporations, not pass-throughs. Determination of number of owners entails looking through entities that own interests in the fund. Redemption plan? Exception for qualifying MLPs (master limited partnerships)
Qualifying assets – oil and gas, real estate
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Basic Structure Investors
Investment Fund
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Tax Rules for Foreign Investors
No tax on capital gains realized by non-U.S. sellers if not effectively connected to a U.S. trade or business
“Effectively-connected income” (or “ECI”) is taxed at ordinary rates
(But see last bullet point)
Character as ECI passes through to an investor in a partnership (or pass-through LLC)
So if foreign investors are ok filing in the U.S. and paying U.S. taxes, they can invest directly in a partnership/pass-though like U.S. investors 39
Tax Rules for Foreign Investors So foreign investors generally invest through corporate entities. However, Corporations do not benefit from capital gains rates that are lower than ordinary income rates Foreign corporations owe branch profits taxes on their ECI FIRPTA (Foreign Investment in Real Property Tax Act of 1980) treats real estate gains as ECI, so not exempt under first rule above
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Tax Rules for Foreign Investors
FIRPTA (Foreign Investment in Real Property Tax Act of 1980) treats real estate gains as ECI, so foreigners are subject to tax. FIRPTA also applies to sales of the stock of U.S. corporations that own U.S. real estate (more that 50% of the assets are U.S.) and to sales of interests in partnerships that own U.S. real estate. FIRPTA includes a withholding mechanism to ensure collection from foreign investors. Any U.S. buyer can be required to withhold from the consideration due on the purchase.
Partnerships must withhold with respect to gains/income that is allocated to foreign investors
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Foreign Investor Structure U.S. Investors
Foreign Investors
U.S. Blocker Corp
Investment Fund
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Loan Funds
Investing in and holding loans does not constitute a trade or business for U.S. income tax purposes. Originating loans does constitute a trade or business for U.S. income tax purposes.
Investors use “season and sell” mechanism to avoid origination – they purchase loans from a third party who/that originates them
Must avoid agency problem
Loans held by investors who do not own an equity interest in the borrower if properly structured, can be exempt from withholding (portfolio interest exemption)
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Richard (Rick) Morris
Eamon Devlin
Louis Tuchman
Partner Herrick, Feinstein LLP
Managing Partner MJ Hudson
Partner Herrick, Feinstein LLP
[email protected] +1 212-592-1432
[email protected] +44 20 3463 3207
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[email protected] +1 212-592-1490