Commercial Investment Real Estate January/February 2017 | Page 18

INVESTMENT
A N A LYSIS
Capital Conundrum
Does sponsor equity make sense to fund investments?
n attractive investment structure is gaining traction
in the world of private equity real estate, offering an
alternative way for sponsors of real estate projects to
fulfill their capital contribution obligations. Increas-
ingly, sponsors are offering investors the opportunity to con-
tribute a portion of the capital that would typically be directly
contributed by the sponsor or its affiliates — known as sponsor
equity — rather than investing as a limited partner. Risks and
benefits come from investing in sponsor equity.
For a typical real estate deal, a joint venture is formed for the
project, either a limited liability company or limited partnership,
with the sponsor or an affiliated entity serving as the manager
or general partner. In such capacity, the sponsor is expected to
raise capital for the project, manage the day-to-day operations
of the project, and contribute a meaningful portion of the capital
required for the project.
A
Sponsor Equity Structures
As compensation for the sponsor’s services, in the final tiers of the
waterfall distribution schedule, the sponsor is usually entitled to
receive a larger percentage of the profits beyond its capital contri-
bution percentage, which is called the promote or carried interest.
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January | February 2017
Since many sponsors are involved in multiple projects and
do not receive such promote distributions until the later stages
of a project, some sponsors do not have access to sufficient
capital to pursue all of the potentially profitable opportuni-
ties. With the current strength of real estate markets and
continued growth in transaction activity, capital-constrained
real estate private equity sponsors are increasingly offering the
opportunity to invest in sponsor equity. This added source of
capital allows them to pursue more investment opportunities.
If the sponsors are only seeking sponsor equity for one specific
project, they might approach a few investors and form the man-
ager and general partner entity for that project as a joint venture
with those investors.
Alternatively, the sponsor could form a sponsor equity fund
that would raise a larger amount of money through a more tra-
ditional private offering, which could then be used to contribute
portions of the required sponsor equity for multiple projects.
The key terms of these structures can vary, but some common
provisions are summarized below.
Distribution and Management Fee. If a sponsor establishes a
fund to contribute sponsor equity for multiple projects, investors
will likely pay a management fee to the sponsor based on the
COMMERCIAL INVESTMENT REAL ESTATE
by Jeffrey M. Friedman and Andrew M. Halbert