Key Takeaways

• Check the fund documents before a year-end real estate closing. Real estate fund managers closing Q4 deals should confirm the deal fits the fund’s strategy limits, investment period and consent requirements, since a deal that slips past a December 31 investment period end may need advisory committee or investor consent.
• Some real estate deal structures can make a fund manager an investment adviser. Owning property outright is generally not a securities activity, but passive joint venture stakes, mezzanine debt, preferred equity, REIT shares and CMBS can be securities under the Investment Advisers Act of 1940.
• Year-end deals can trigger SEC registration and Form ADV obligations. Securities holdings can change a manager’s regulatory assets under management, with SEC registration generally required at $110 million, and affiliate transfers between funds may require client consent under Section 206(3) before closing if the interest being transferred is a security.

In the world of real estate investing, the last six weeks of the fourth quarter bring the same rush every year. Sellers want to close before December 31. Buyers want to put capital to work before an investment period ends or a fee step-down kicks in. Everyone wants the deal done before the holidays. Moving quickly is fine. The trouble is that rushed deals tend to be built around what gets them closed, not what the fund documents allow or securities laws require. Two questions deserve a hard look before anyone signs to avoid unintended consequences:

• Does the deal fit the fund?
• Did the deal make the manager an investment adviser?

Does the Deal Fit the Fund?

Most closed-end real estate funds still run on familiar terms. They have a term of about ten years with extensions, and charge a management fee on committed capital during the investment period that steps down to invested capital afterward. The usual promote is 20% of profits over an 8% preferred return, with a full catch-up. Fees are under real pressure. Preqin, a private markets data provider, puts the median management fee for 2025-vintage funds at 1%, down from a long-running median of 1.5%. Investors making new commitments this quarter know those numbers, and managers should expect the fee to be the first point raised. Beyond the baseline, the fund’s strategy changes what a year-end deal puts at risk.

Income Funds

Core and core-plus funds buy stabilized, leased property and earn most of their return from rent. Many are open-end, with investors coming in and going out at appraised net asset value, usually quarterly. Fees are charged on that value, at a median of 0.96% for core real estate equity funds in Callan's 2024 Real Assets Open-End Funds Fees and Terms Study, and many of these funds charge no performance fee at all. For these funds, a December purchase raises valuation and liquidity questions. A deal that closes on December 30 goes into the year-end value that sets redemption prices. Redemption queues reached an estimated $52 billion at the end of 2023, and although they have eased, managers should know how a new purchase affects the queue and whether the gate and suspension provisions work the way investors expect. Core-plus funds typically keep 60% to 80% of their assets in stabilized property, and a rushed transitional deal can push a fund past its own limits.

Value-Add Funds

These funds buy property that needs leasing, repositioning, or capital work, and they earn returns from both income and sale. Their terms usually follow the baseline, with management fees of 1.5% to 2.0%, a preferred return of 7% to 9%, and a catch-up in 76% of funds according to data from the Pension Real Estate Association (PREA). Here the year-end pressure usually comes from the investment period. If it ends on December 31, a deal that slips to January may need advisory committee or investor consent, and the fee base may already have stepped down. Managers should confirm whether signing, closing, or a binding commitment counts as making the investment under the fund agreement.

Opportunistic and Development Funds

These funds take on development, entitlement and lease-up risk and earn most of their return when they sell. Current cash flow is often thin, and the preferred return, often 8% to 10% and compounding, carries a lot of weight with investors. Deal-by-deal waterfalls and catch-ups of 50% to 100% are common, and every opportunistic fund in the PREA data had a catch-up. When a December exit triggers a promote, investors should understand how it interacts with deals that have not yet been sold, and how much protection the clawback actually gives them.

Did the Deal Make the Manager an Investment Adviser?

A manager that buys and operates property generally is not an investment adviser, because fee simple real estate is not a security. The Investment Advisers Act of 1940 (Advisers Act) covers anyone who, for compensation, is in the business of advising others about securities, and fund managers nearly always meet the compensation and business parts of that test. The question is the asset. Year-end deals are where structures tend to slip, because the quickest way to closing is often a structure the manager has not used before.

Is a Joint Venture Interest a Security?

The most common example is the manager that cannot win an asset outright and agrees to come in as the money partner beside a local operator. If the fund ends up with major-decision rights but no real control, its interest is likely a security. Limited partner and non-managing member interests ordinarily are securities. Even a co-general partner interest can be one if the fund has little real power, depends on the operator’s expertise, or can be removed without cause. The building may be one the manager would happily have bought outright, but the legal result is very different.

Are Mezzanine Debt and Preferred Equity Securities?

Another common example is the manager that fills a gap with mezzanine debt or preferred equity to keep a deal on schedule. The Securities and Exchange Commission (SEC) has treated commercial loans as securities under the Investment Company Act of 1940 (Investment Company Act), and many managers treat mezzanine and even mortgage debt as securities for Advisers Act purposes. Buying shares of real estate investment trusts (REITs) or commercial mortgage-backed securities, or taking an interest in another sponsor’s syndication, to get capital working before year-end raises the same issue. Tenancy-in-common interests and earn-outs in sale agreements can raise it too.

For a fund that relies on the real estate exception in Section 3(c)(5)(C), these assets can also put the exception itself at risk. SEC staff positions generally look for at least 55% of a fund’s assets in mortgages and other interests in real estate, and at least 80% in those assets plus real estate-related assets. Mezzanine loans qualify only in limited circumstances, and preferred equity, REIT shares and commercial mortgage-backed securities usually do not count toward the 55% test. A fund that falls outside the exception generally must rely on Section 3(c)(1) or 3(c)(7), with their limits on who can invest, and all of its assets then count toward its manager’s regulatory assets under management.

Do Transfers Between Affiliated Funds Require Client Consent?

Year-end is also when managers shift assets between their own vehicles to tidy up a fund before a final close or wind-down. Once a manager is an adviser, the antifraud rules in Section 206 of the Advisers Act apply whether or not it is registered. Section 206(3) requires written disclosure and client consent before each principal transaction, meaning a purchase or sale between a client and the adviser or an affiliate acting for its own account. It also regulates agency cross transactions, in which the adviser or an affiliate acts as broker for both the client and the other side, and treats trades by affiliates as the adviser’s own. Selling a joint venture interest from one fund to another, or having an affiliate broker the sale, may need consent before closing rather than after.

When Does a Real Estate Fund Manager Need to Register With the SEC?

One security can change the numbers. A fund that relies on Section 3(c)(1) of the Investment Company Act (the exception for funds with no more than 100 investors) or Section 3(c)(7) (the exception for funds sold only to qualified purchasers) is a private fund, and all of its assets, including uncalled commitments, count toward regulatory assets under management. A fund that relies on the real estate exception in Section 3(c)(5)(C), which covers funds primarily engaged in acquiring mortgages and other interests in real estate, counts its assets only if securities make up at least 50% of its value. SEC registration is generally required at $110 million, and advisers with less than $100 million generally register with their home state instead. An adviser solely to private funds with less than $150 million may be exempt, but it still must file Form ADV, the SEC’s adviser registration and disclosure form, as an exempt reporting adviser. An exempt reporting adviser whose private fund assets reach $150 million, and whose filings are current, generally has up to 90 days after filing its annual Form ADV update to apply for SEC registration. A registered adviser takes on much more, including compliance policies, a code of ethics, a chief compliance officer, custody and recordkeeping rules, limits on who can pay performance fees, and pay-to-play restrictions. The annual Form ADV update is due within 90 days after fiscal year-end, which for most managers means a December deal shows up in a filing due at the end of March.

What Should Managers and Investors Do Before Signing?

Managers should check each year-end deal against the fund’s strategy limits, investment period, and consent requirements. They should read joint venture control and removal provisions with the securities question in mind, confirm which Investment Company Act exception the fund relies on, and obtain any needed consent for affiliate transfers before closing. Investors should ask whether the manager has done this work. Many institutional investors prefer, and some require, an SEC-registered manager, and a manager that should be registered and is not is a diligence finding. A short conversation in November costs far less than unwinding a structure in March.

For more information, please contact the author, Matthew N. Bobrow, at mbobrow@foxrothschild.com.

This information is intended to inform firm clients and friends about legal developments, including the decisions of courts and administrative bodies. Nothing in this alert should be construed as legal advice or a legal opinion. Readers should not act upon the information contained in this alert without seeking the advice of legal counsel. Views expressed are those of the authors and not necessarily this law firm or its clients.