Marketing Investment Returns of a Discretionary Commingled Real Estate Fund to Potential Investors
August 16, 2019
By Gautham Deshpande and Philip DeRosa
Real estate investment managers continue to focus on building a fully integrated institutional investment platform covering all functions from acquisition to construction, asset management and investment management. As they transition from engaging in real estate investments on a deal-by-deal basis—with capital raised from other managers, institutions or private wealth through their own personal networks to a discretionary commingled investment fund with institutional investors—the issue arises as to how to present a track record that can pass institutional investor due diligence. The ability to accurately portray the results achieved with any pre-fund investments is critical to raising institutional investor capital for a discretionary commingled fund.
In addition to the operating due diligence of the investment manager and their infrastructure, typical investment due diligence focuses on the strategy and the relative and absolute portfolio performance and returns. Performance information relevant to institutional investors is return on invested capital, typically measured by internal rate of return (“IRR”), and the multiple of equity returned to investors, calculated as cash returned to investors divided by equity cash invested.
The process of marketing performance information to potential investors begins with obtaining and organizing data related to pre-fund investments, including acquisition costs, expenditures for capital improvements incurred over the life of the investment, equity and debt financing details, refinancing data, data relating to the sale of the investments, and the amounts returned to investors. Typically, such information goes back several years and is used to calculate accurate performance and return information. Before presenting past returns to potential investors, ask yourself if these investment returns have been verified by a credible independent source and if they could survive due-diligence by sophisticated investors.
Independent Verification Report
The schedule or statement of performance statistics information typically includes details of all pre-fund investments, such as the property address, acquisition date, purchase price, amount of equity and debt used to finance the property, sale date, sale price, cash returned to investors, and the resulting IRR and equity multiple. The performance schedule or statement is typically accompanied by a report provided by an independent accountant and can take one of these forms:
- Report on performance results calculated and presented in compliance with Global Investment Performance Standards (“GIPS”) – This is an independent accountant’s verification report that provides an opinion that the investment manager has complied with all the composite construction requirements of the GIPS and that such investment managers’ policies and procedures are designed to calculate and present performance results in compliance with the GIPS for the period such information is presented. The responsibility for designing and implementing policies and procedures designed to calculate and present performance information in accordance with GIPS rests with the investment manager and usually requires preparation and a full understanding of the robust GIPS framework.
- Attest Verification Report – Investment managers who may not have implemented the GIPS framework may engage independent accountants to provide an opinion on the performance information presented. Such a report is accompanied by footnotes that provide information to the readers about the basis of calculation of the investment returns.
- Agreed upon Procedures – Agreed upon procedures (“AUP”) are decided by the investment manager and the independent accountant and can be customized based on the information available and specific circumstances of the manager. The independent accountant issues a report presenting the procedures performed and related findings. An AUP report provides certain flexibility in designing and customizing procedures. This type of report, however, provides no level of assurance and is restricted to users who agree to the sufficiency of the procedures.
The type of report or optimal solution is based on the facts and circumstances of each particular situation. As such, it is imperative that you consult with your trusted business advisor to obtain a full understanding of the intricacies in this area.