No

Pensions Unaware Hidden Real Estate Fees Dwarf Those Disclosed

No

In recent years, following a decade-long gorging on hedge and private equity funds by government pensions, the massive hidden fees and expenses related to these "alternative" investment funds have attracted greater scrutiny. Despite initial skepticism, it is now widely acknowledged that undisclosed fees and expenses as high as 8 percent may dwarf hedge and private equity disclosed fees of 2 percent. With monumental total (disclosed and undisclosed) fees and expenses, it's no surprise that the net performance of these funds has been unimpressive.  

Given that real estate is regarded as the oldest alternative investment asset class commonly held by pensions, and many pensions invest 5 percent or more in real estate, the dearth of information regarding the all-in fees and expenses related to investing directly or indirectly through funds, in real estate is hard to explain.

Pension fiduciaries clearly have a legal duty to understand and monitor the reasonableness of all of the investment fees paid by the plan.

If fiduciaries don't know the nature and amounts of the fees they pay, they obviously cannot opine as to the reasonableness of those fees.

Adding to the mystery is the fact that virtually all pensions that invest in real estate retain professional investment consultants who either know or could easily ferret-out the all-in costs.

In connection with a current forensic investigation, I contacted a number of leading real estate advisory, consulting and investment fee benchmarking sources and was told that the all-in fee data either did not exist, or could not be shared with a third party.

Real estate funds are highly opaque and susceptible to the imposition of many substantial fees and costs—some of which may be paid to affiliates of the manager and/or appear to be duplicative, or improperly allocated to investors.

To my knowledge, the most in-depth recent forensic investigation into a public pension’s real estate investments was produced in connection with litigation between MayfieldGentry Realty Advisors and the Police and Fire Retirement System of the City of Detroit.  MayfieldGentry was an investment advisor and fiduciary to two Detroit pension funds overseeing a real estate investment portfolio worth more than $200 million of pension fund assets. (My firm briefly provided expert services in connection with this litigation.)

Chauncey Mayfield, the principal owner and chief executive officer of the firm, pled guilty to conspiring with former Detroit Treasurer Jeffrey Beasley to pay him bribes in exchange for new business from the pension funds. According to Mayfield, Beasley agreed to maintain business for Mayfield’s company and to give Mayfield new pension fund business in exchange for cash and others things of value. In particular, Mayfield gave $50,000 to the Kilpatrick Civic Fund. In addition, Mayfield paid for Beasley and others to take a trip to Las Vegas costing $60,000; paid for another private plane trip to Tallahassee, Florida, costing $24,000; paid for a private jet flight to Bermuda; and hired Beasley’s paramour to work at MayfieldGentry at Beasley’s request. The SEC charged Mayfield for stealing nearly $3.1 million from the police and firefighters pension fund that the firm managed so he could buy two strip malls in California.

According to the Forms ADV filed with the SEC by real estate asset managers I recently reviewed, the following fees and expenses may be imposed:

  1. An acquisition fee based on a sliding or a fixed percentage generally ranging from no fee to 1.50 percent of the amount invested, which may include debt related to the acquisition of the property. Alternatively, the firm may negotiate a fixed acquisition fee.
  2. An annual portfolio management fee based on a percentage of contributed capital, aggregate original investment costs, carrying values and/or a percentage of net operating income (before or after debt service). When such fees are based on contributed capital, original investment cost or carrying values, the fees generally range from 0.50 percent to 1.50 percent per annum.
  3. A disposition fee based on a sliding or fixed percentage generally ranging from no fee to 1 percent of net proceeds, which may include proceeds used to retire debt. Alternatively, the Firm may negotiate a fixed disposition fee.
  4. Performance or incentive fees negotiated on an individual basis with the client, generally ranging from no fee to 20 percent.
  5. A financing fee, which generally ranges from no fee to 1 percent, based on a percentage of the amount borrowed or refinanced. Alternatively, the Firm may charge negotiated fixed financing fees.
  6. A development supervisory fee, which generally ranges from no fee to 1 percent, based on a percentage of actual gross construction costs.
  7. Property management fees, which range from 3-4 percent of revenues for apartment buildings and 1-2 percent of revenues for office buildings.
  8. Underlying partnership or comparable venture management and performance fees, as well as underlying fund operating expenses such as offering, organizational and operating expenses of such underlying fund or other investment vehicle, and expenses related to the investment of such assets, such as brokerage commissions (including soft dollar payments, if applicable), expenses relating to short sales, clearing and settlement charges, custodial fees, bank service fees, interest expenses, borrowing costs and extraordinary expenses.
  9. Fund operating expenses, including, for example, costs and expenses incurred in connection with the formation and organization of the fund (and its general partner) and the offering of interests in the fund; tax and financial statement preparation fees; costs of communications with investors and ongoing legal, accounting, auditing, administration, appraisal, bookkeeping, consulting and other professional fees and expenses, including for litigation and preparation of financial statements and reports; costs, expenses and charges incurred in connection with monitoring, identification, evaluation, negotiation, structuring, due diligence, underwriting, development, acquisition, ownership, sale, valuation, hedging or financing of the fund’s investments or potential investments; premiums for insurance protecting the fund, its general partner, and other indemnified parties and any litigation; costs of the fund travel expenses and other expenses or costs incurred in connection with the business or investment activities of the fund and the investment due diligence process (which may include the cost of first or business class travel, meals, lodging, entertainment and incidentals).
  10. Custodial and administration fees.
  11. Brokerage fees and expenses.

In my June, 2015 crowdfunded forensic investigation, Double Trouble: Wall Street Secrecy Conceals Preventable Pension Losses in Rhode Island report, I estimated that the $7.5 billion Employee Retirement System of Rhode Island’s undisclosed real estate investment-related expenses may amount to an additional 3 percent, above and beyond the limited fees disclosed by the pension. The fees mentioned in the pension managers’ Forms ADV, such as those listed above—many of which amount to 1 percent or more—confirm that my 3 percent estimate may have been too conservative.

In connection with my current crowdfunded investigation focusing upon the state pension’s real estate investments, I have asked for but have been provided with no documents indicating the State Investment Commission overseeing the fund is aware of the all-in fees and expenses related to the pension’s real estate investments. I have seen no evidence that the State Investment Commission has assessed whether the  expected rate of return related to real estate assets is reasonable, given the significant costs.

Further, it seems that the majority of the pension’s real estate investments are non-core funds which charge significantly higher fees than core funds. All of the pension’s newer investments charge higher fees than the core funds. That is, fees are going up, not down.

In my opinion, Rhode Island’s severely underfunded state pension cannot afford to pay rich fees to real estate tycoons who manage funds that have underperformed for decades. All pensions, including those well-funded, should take a hard look at the all-in fees related to real estate investing.

 


Edward Siedle is a guest contributor for IFA Articles.  He is also the founder of BenchmarkAlert.com.  See his full bio here.