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Streamlining Construction and Property Accounting in Private Equity Fund Portfolios

Dec 6, 2022

Real estate private equity firm leaders are dealing with a significantly different economic landscape than a year ago. The rapid rise in interest rates and the resulting slow-down in transactions has forced management to re-evaluate market opportunities and risk tolerance, as well as recalibrate expectations for investor returns and promotes. Many prospective deals that looked robust last May no longer pencil out, nor do planned refinancings that would have returned capital to investors to boost their rate of return.

In periods of volatility and potential distress, fund managers are laser-focused on monitoring the performance of each investment, managing capital flows, making critical decisions, and communicating with their investors. They need real-time, accurate data and don’t have time to worry about the efficacy of back-office functions. As economic conditions worsen, many managers will be looking to cut costs.

Despite the need, reliable and timely information isn’t always available when the fund manager wants it. The problem is that not only are there many investments to monitor but property accounting is often performed by a fund’s operating joint venture partner who manage the properties. This decentralized approach to property accounting often results in delays in receiving the data (and often questionable reliability, consistency and accuracy of such data) needed to both make decisions and provide investors with timely financial and tax reporting. These dynamics create an environment where outsourcing select back-office functions to a qualified service organization could provide both stability and confidence in making strategic and operating decisions.  

Centralizing Investment, Construction and Property Accounting Through Outsourcing

During the past few years many fund managers have successfully outsourced fund administration – fund accounting, investor relations, capital calls and distributions, and tax services. Outsourcing property accounting services is common among real estate companies but less so by funds, perhaps because of the decentralized nature of the accounting function. As noted, construction and property accounting are often performed by the fund’s operating joint venture partner who also manage the properties. These property managers each have their own processes and systems resulting in inconsistent charts of accounts, accounting principles, report formats, and the timing of report delivery to the fund. This approach puts the onus on the fund to chase down the financial information from many sources and standardize that information for internal performance monitoring and investor reporting.

The inefficiency of the decentralized model forces fund managers to consider an outsourced, centralized approach where an accounting firm works with the fund for properties it manages as well as each external property manager to create accounting standards across the portfolio, taking into considerations the provisions of joint venture operating agreements. The accounting firm can also provide more real-time information to the fund manager, and together they can customize performance dashboards for each investment and the portfolio. It also becomes the job of the accounting firm to work with the fund’s joint venture partners maintain the schedule so that quarterly financial reports for each investment are delivered on time and fund investor reports can be prepared.

Another issue faced by fund managers is that the financial reporting across the portfolio may be produced using different presentations, for example, cash, tax, modified accrual, or generally accepted accounting principles (GAAP). Moreover, it is likely that external property managers use different property management systems to generate the financials. These varying approaches make it more difficult to aggregate the data when assessing portfolio or fund performance. The outsourced accounting firm can work with the various managers to create a more consistent presentation that would make financial reporting more standardized and delivered in a more timely manner If necessary, a data warehouse can be created to accumulate, reformat, and then report out the results to the fund. Additionally, lenders or banks may require the financial statements to be audited for certain transactions, requiring full disclosure GAAP financial presentation. Outsourcing to an accounting firm facilitates that process.

Building the processes and systems to accumulate and report on data from multiple sources in a consistent manner adds to the fund’s internal control infrastructure. The accounting firm will have sufficient resources to maintaine segregation of duties and review all work prior to finalization of reports. The fund and their outsourcing partner can create policies and procedures that will be reliably implemented. Additionally, the outsource firm is more likely to have strict confidentiality conventions and data protection and cloud-based back-up systems, including cybersecurity protocols.

Human Resource Considerations

The current tight job market has made attracting and retaining the best talent increasingly difficult and expensive. Outsourcing takes that burden off the fund by providing a bench of professionals available to support the fund’s accounting needs. Outsourcing often results in lower costs because the fund no longer provides benefits to the employees whose responsibilities are being outsourced, and the fund no longer use space, IT, and other equipment dedicated to those employees. Alleviating fund management of a portion of its human resources enables senior executives to focus on more strategic and transactional matters.

Not only property accounting processes may be outsourced, but specific roles in the fund’s finance team, such as the controller or chief financial officer. A property accounting firm with a particular specialty in real estate and private equity brings expertise in fund and transaction structuring that facilitates integration with the fund’s back-office functions, including fund administration. In so doing, outsourcing provides scalability as the fund grows, as well as the ability to efficiently process more complex transactions. The accounting firm can also alert the fund of any upcoming changes to accounting and tax rules that may impact the fund’s strategy or the reporting on specific transactions.

Getting Started

Fund management should consult with real estate accounting firms on the benefits of outsourcing property accounting, focusing on current pain points and the data and reporting required to enhance decision-making. The fund should have clear goals for what they want to accomplish through outsourcing, and which roles should be outsourced and which remain inside the fund. Management and their outsourcing partner should also consider the optimal approach for implementing new processes with the various joint venture partners. A detailed implementation plan helps to set expectations of all parties and enable performance monitoring.


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