Compliance Challenges for Open-End Real Estate Vehicles

The ability to hold real estate assets for longer periods of time, coupled with the potential of reaching a broader investor base through increased liquidity, is driving real estate managers to take a fresh look at open-end vehicles. For investment advisers mainly familiar with closed-end vehicles, gaining an understanding of some of the key elements involved in operating an open-end real estate vehicle is pivotal to evaluating the risks and implementing sufficient compliance oversight functions.

Historically, the most commonly offered real estate vehicles have privately offered closed-end vehicles. Such vehicles often have life spans of 10-12 years and may derive much of their performance from the purchase and sale of real estate. The only real liquidity occurs at the end of the life of the vehicle.

In contrast, an open-end vehicle can have a perpetual lifespan, is more likely to derive performance from the revenue of operating companies, and offers some form of ongoing liquidity. However, offering an open-end vehicle does not mean the vehicle cannot restrict the timing of subscriptions and redemptions. Preliminary lock-up periods are common and redemptions can be scoped to be allowed semi-annually or quarterly. In addition, limitations on the size and total value of redemptions can also be specified in the governing documents.

With respect to an open-end vehicle, some of the key compliance considerations are:

Portfolio Management

• How will the portfolio be managed for potential style drift?
• How will liquidity be monitored?
• Will the vehicle use a liquidity sleeve consisting of cash, or cash like instruments, or will it consist of tradeable securities?
• Who will monitor and trade the liquidity sleeve?
• Will running a liquidity sleeve trigger registration as an investment adviser, for real estate managers not already registered?
• How often will best execution be reviewed?
• How will trade errors be treated?

Allocations

• If other vehicles will be investing in the same sector/property type, how will investment allocations be fairly implemented?

Valuation

• How often will assets be valued?
• What methodology will be used and will third-parties be engaged to assist with the valuation process?
• What changes to current valuation procedures will be needed in order to strike a relevant NAV?

Fees

• How often will fees be calculated and will they tie to a NAV rather than invested capital or other traditional measures?
• How will unrealized appreciation be accounted for?

Carried Interest

• How will unrealized appreciation be monitored?
• How will hurdles be monitored?

Subscriptions/Redemptions

• When will subscriptions and redemptions be accepted?
• Who will handle ongoing subscription and redemptions?
• Will a professional fund administrator be needed?
• Who will monitor know your customer (KYC) and ongoing bad actor provisions that will become relevant?
• Who will monitor the redemption requests, and if gates are imposed, how will they be determined?

Our guidance

Before you jump into an open-end real estate fund structure, coordinate with counsel and your trusted compliance advisers to ensure you have the infrastructure ready to deal with these changes and test them for relevant issues on an ongoing basis.

How we help

We have a number of solutions to help real estate fund managers build and maintain effective compliance programs.

Please reach out to your ACA consultant or contact the Private Markets Team if you have any questions about this article, or want to find out how ACA can help your firm meet their compliance obligations.

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