The Securities and Exchange Commission’s freshly implemented regulations around private fund adviser disclosures are expected to have an outsized impact on small and emerging commercial real estate debt managers.
Additionally, private fund advisers will have to obtain and distribute an annual financial statement audit of each of the funds. “The problem, however, is that this information is difficult for smaller firms to compile efficiently and report,” said Yasho Lahiri, a partner at New York-based law firm Kramer Levin.
“Smaller firms will bear the brunt of the regulations because they don’t have the infrastructure in place to provide this information easily,” Lahiri said. “What you’re going to have, five years from now, will be a cottage industry of outsourced providers of this reporting. But it doesn’t exist today.”
Lahiri gave a hypothetical example of a firm that is managing about $200 million of capital, a level that translates into gross revenue from management fees of less than $4 million annually.
“Chances are, revenues are lower than that, and it is not a lot of cash to pay everyone,” Lahiri said. “If I added two senior, expensive people to deal with the reporting required, that is a significant cost. And you’re managing a fund of about $100 million, that will tip the balance and make it much more difficult for someone who is not ultra-wealthy to start a fund.”
Lahiri noted there is a sense that while the SEC is asking for incredibly detailed information, this is also the kind of reporting that does not fit well with funds that hold illiquid assets.
“Managers will be spending more time and, thus, employing more people, to provide fund-level reporting, even if some of the work is outsourced to third parties, and these internal costs are borne by the manager and not the fund,” he said. “If you’re running a small fund, it is the case that management fees are not typically a profit center for you and these requirements will make running a fund a lot harder to do.”
The requirements will affect commercial real estate debt managers because real estate debt funds are generally viewed as private funds for the purpose of these regulations by the SEC, Lahiri said.
“The letter said that if there are two layers between an adviser and the dirt, the adviser is exempt from the private fund provisions. But if you’re a debt manager, this is not the case – you’re a private fund for the SEC’s purposes.”
Over the longer-term, Lahiri believes there will be a market reaction to provide third-party solutions for the reporting, and private fund managers will be able to outsource that with relatively little internal supervision required. “But at the moment, no one has built that for every size of fund and fund manager,” he added.