It’s that time of the year again. Real estate fund managers registered with the Securities and Exchange Commission are working on their Form ADV filings. I’m hearing a few questions about the right way to calculate Regulatory Assets Under Management.
The instructions to Form ADV Part 1 Appendix B provide three steps on page 9:
First, is the account a securities portfolio?
Second, does the account receive continuous and regular supervisory or management services?
Third, what is the entire value of the account?
Form ADV deems a “private fund” to be a “securities portfolio.” If you’ve gotten this far you’ve already given up on dealing with subtleties of the “private fund” definition and accepted that your real estate fund is a private fund. That gets you past the first step.
For fund managers, the second question is relatively easy since fund management falls squarely into management services.
That leaves us with the third step. The instructions provide:
In the case of a private fund, determine the current market value (or fair value) of the private fund’s assets and the contractual amount of any uncalled commitment pursuant to which a person is obligated to acquire an interest in, or make a capital contribution to, the private fund.
The first question is what to do about the subscription credit facility. As far I can tell: nothing. That leaves the likelihood that the fund RAUM is slightly high. Draws from the credit facility will be repaid with capital calls. So any investments still financed by the facility will be double counted. The value of the investment is in the value of the fund assets, but the capital has not been called to fund the investment and will be added as part of the uncalled capital.
The second question is what portion of the value of the real estate should be included as a fund asset. Some fund managers are using the gross value of all of the real estate. Others are using the net value after deducting the mortgage debt.
I’ve heard mixed messages from the SEC on which is the preferred method. One thing is clear is that the SEC wants consistency on how you come to the value and that you don’t act in a way that is deceptive.
The argument on using the net is that it better equates to the true fund value. The mortgage debt is generally isolated to the investment, so it is not fund-level debt. The fund is not leveraged.
As a comparison, it would seem strange for a private equity firm to use the gross value of a portfolio company in its fund valuation. I have not heard from any private equity fund managers that are adding the portfolio company level debt into the firm’s RAUM.
Many funds use the Investment Company Guidelines for real estate fund accounting. Those Guidelines call for the net value to be shown on the fund’s balance sheet. The Form ADV instructions say that if you calculate fair value in accordance with GAAP or another international accounting standard for financial reporting purposes you are expected to use that same basis for purposes of determining the fair value of your assets under management.
The SEC wants the registered adviser to use the same method in calculating assets under management that it uses to report its assets to clients or to calculate fees for investment advisory services. That would all seem to lead back to the equity capital in the real estate investments and not the gross value of all of the real estate investments. Investors generally look to the return on equity and capital, not the gross value of the real estate assets.
The third question is what to do about non-fund real estate investments, like direct investments, separate accounts and joint ventures. The general consensus seems to be that can they fall outside the scope of RAUM.
While there is still debate over whether a real estate fund is a “private fund”, these type of dirt investments generally seem to fall far away from that definition. There are few, if any, structural entities that would make one think that it is investing in a securities. There is little in the way of cash holding that may end up in a money market fund or other security investment. That means these “dirt” investments would not be a securities portfolio and don’t make it past step one in the RAUM analysis.
I’ve seen a few real estate managers address the RAUM mismatch in Form ADV Part 2. Item 5 states RAUM, then add in other measures of assets under management and how they got to those amounts. That extended assets under management would include the “dirt” investments.
I’m curious to heard what methods you are using.
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