Matt GilbertDirector, Performance

nuveen A TIAA Company

Eric Mack, CPADeputy Senior Financial Officer

USAA Real Estate Company

March 20, 2019

Agenda:

Introduction Structures and Legal Agreements Waterfalls – Building a Model Accounting and Financial Reporting Performance Treatment and Implications Open Discussion

Introduction

Promote•Paid to a partner when a project exceeds “target(s)”•AKA – Carried Interest•Typically paid by LPs/Non-Managing Members to GP/Managing Member

•Taxed as a capital gain for individual tax payers

Incentive Fee

•Paid to a partner, affiliate or 3rd Party when a project exceeds “target(s)”

•Typically paid by all partners•Taxed as ordinary income

In addition to promotes and incentive fees there could be other fees with a similar impact or implications:

◦ Bonus fees (paid to fee developer; a certain % of available funds for distribution after debt, interest and equity is paid)

◦ Tenant/Lender participations◦ Participation to prior owner (typically land seller)

Structures and Legal Agreements

GP/Managing Member

LP/ Non-Managing Member

Fund

10% 90%

Promote

JV

90%

Operating GP

10%

Promote

GP/Managing Member

LP/ Non-Managing Member

Fund

10% 90%

Advisor

0%Incentive fee

Fee Developer

Tenant/Lender

Prior OwnerJV

Operating GP

10%90%Incentive fees

• Limited Partnership Agreement• LLC Operating Agreement• Management Agreement• Development Management Agreements• Leases• Purchase and Sale Agreement• Side Letter• Other

Tier 1•Any shortfall contributions and returns •Typically not applicable

Tier 2

•Return of capital with a preferred return (i.e. 9% IRR, Preferred Return, Equity Multiple, 3rd party benchmarks i.e. ODCE, Etc.)

•The preferred return is typically to the LPs and to the extent applicable to the GP/Managing Member

Tier 3•First Promote/Incentive Fee Level (i.e. 20% to GP with remainder prorata to Partners, 30% to

managing member and 70% to other member (when percentage interests were 10%/90%)•The Promote/Incentive Fee is to the GP/Managing Member/Advisor

The IRR hurdle to meet before a promote or incentive fee is paid may be levered or unlevered

Levered: ACTUAL - Cash flows including debt and interest payments. NAV includes debt obligations, lowers NAV

Unlevered: HYPOTHETICAL - Cash flow before debt and interest payments. NAV add back debt obligations, increases NAV and produces a higher return

Claw-backs◦ Impact on Revenue Recognition◦ After Tax Distributions◦ Security

Pooled Returns◦ Tranches of investments within a vehicle◦ Separate vehicles (Parallel Vehicles, Programs, Etc.)

Waterfalls – Building a Model

What Three Wise Philosophers

Don't go chasing waterfalls Please stick to the rivers and the lakes that

you're used to I know that you're gonna have it your way or

nothing at all But I think you're moving too fast

Do not have it your way… and don’t do these too fast!

Excel Model

Accounting and Financial Reporting

Usually no accrual of a promote or an incentive fee for historical cost due to the following:◦ Not in the money usually – would not exceed the

IRR hurdle etc.◦ NBV continues to decrease due to depreciation

Fund Level Venture / Investment Level

A promote is not recorded on the P&L; only an equity swap and is reflected on the fair value statement of equity as a swap between the LP and GP – DOES NOT REDUCE NAV

An incentive fee is accrued on the fair value income statement as an affiliate expense and is an expense of the fund and shared by all partners – REDUCES NAV

An incentive fee that is not an expense of the fund and is “outside of the fund” is not presented in the fair value financials because it is an expense of the individual partners

Performance Treatment and Implications

Unleveraged Investment and Fund Level Returns• Promotes are generally paid after the effects of

leverage• Waterfall structures are set up with underwriting that

reflects the effects of leverage

• Unleveraged is a “what if” scenario so why not adjust the associated hurdle?

Its more complicated than that…

Denominator Effect• Unpaid promotes decrease accounting NAV• Size of assets and related income does not

proportionately decrease

• Gross return is a “what if” scenario so why not adjust the 2 NAVs separately

Its more complicated than that…

Open Discussion