Catch up is a term relevant to private real estate funds, and describes the manner in which managers of such funds are compensated upon a property sale. The “catch up” refers specfically to a situation in which a manager is fully compensated at the agreed-upon rate once investors receive their expected returns. Under such a fee arrangement, the investor may receive profit in addition to their expected return, but only once the maanger has received its cut.
Q. An earlier guest was talking about private real estate funds and this is a hot topic for investors in these vehicles. What is it?
A. This describes a key element in how the managers get compensated for running the fund, and goes hand in hand with “carried interest”. Now, we know that carried interest is percentage of fund profits — often, 20%– that the manager gets as his incentive, above his 1.5 or 2% management fee. But exactly how you calculate that carried interest can get tricky, and that’s where “catch up” comes into play.
Q. So, in these cases, the “catch up” relates to how the proceeds from the sale of a property in a real estate fund are allocated between the investors and the manager.
A. Right. The resulting distributions of profits go like this: first, to investors until the capital allocable to that investment is paid back to them; and second, additional money to investors until an agreed “hurdle rate” on that capital is met, say 8% over their original capital. So now the investors have their money back plus 8%. OK, time for the manager to start getting paid his 20% of profits, his carried interest, right? But here’s the big question: does he start by getting a lump sum, a “catch up, ” equal to 20% of the profits on the deal?
Q. Oh, so the investors have their capital plus a preferred return, but maybe the manager now grabs his 20% carried interest before the investors get any share of the remaining profits?
A. Right, the argument is: hey, you got your preferred return, maybe a pretty high one, so I get my 20% of profits before you get any more. It’s caused a lot of angst with investors, and became an issue in attracting new capital. So some RE managers have said: forget the catch up. After the hurdle rate, we’ll just split all subsequent dollars 80/20. That’s an attractive feature for investors to look for when considering private real estate deals.
Q. Anything else investors should look for here?
A. If a deal does has a catch up, it should also have a claw-back provision, allowing the investors to recover money from the manager if it turns out, in retrospect, that the catch-ups have allocated too much profit to him.