Private Equity Capital for Commercial Real Estate: Understanding and Navigating the Options Primer on Private Equity

2. Objectives Understand the real estate private equity universe Discuss investment strategies and vehicles used by private equity Become familiar with the capital raising process and timeline Understand the workings of a joint venture, including fees, waterfalls and major terms Learn how to define your value proposition for investors Gain insight into current investor appetite from active capital providers

3. Real Estate Private Equity Investors

4. Real Estate Private Equity Investor Universe Owner / developer personal resources Friends & family HNW investors Family offices Commingled dedicated real estate equity funds Hedge Funds Pension funds, endowments, foundations Sovereign wealth funds Life insurance companies, banks, corporate investors Listed and unlisted REITs

5. Investment Criteria Real estate private equity investors will consider the following in making investment decisions: Returns Structure Strategy (Acquisition, Development, Land Banking, Debt, Capital Allocation) Property Type Geography Hold Period One size does not fit all Certain investors constrained by very specific investment mandates dictated by their investor base Investor cost of capital will determine strategy

6. Investment Return Characteristics Class A assets or premier multi-tenant buildings Primary markets High occupancy/credit tenants/long-term leases Stable cash flow investment Modest leverage <50% when used Unleveraged IRRs ~ 7.5% - 8.5% Class A and B assets Recovering Primary markets or Secondary / tertiary markets Mid-high vacancy / releasing risk / obsolescence / rents below market/repositioning Balanced mix of cash flow and appreciation Moderate leverage 60-70% Unleveraged IRRs ~ 9.5% - 13% Variation on core investing Primary markets Fewer credit tenants Some vacancy or releasing risk Cash flow with some potential for growth through increased cash flow Slightly higher leverage 50-60% Unleveraged IRRs ~ 8.5% � 10% Class A, B, or C Assets Secondary/tertiary markets or new developing markets Land/Development/Redevelopment/Repositioning/ Turnaround potential New or innovative product types Dramatic increase in cash flow Growth-oriented investment Higher levels of leverage 70-80% Unleveraged IRRs ~ 10% - 13%

7. Investment Structure

8. A Closer Look at Joint Ventures

9. Structuring Joint Ventures Joint Venture: Partnership between a private equity investor and real estate sponsor to invest directly in real estate Involves formation of new, special-purpose entity to own the properties of the joint venture Acquisition JV Disposition JV Development JV In a disposition JV, sponsor contributes assets at agreed upon value while institutional investor contributes cash Profit sharing based on value of equity contributed by the parties to the joint venture Increasingly popular alternative source of equity capital for public and private real estate operating companies (REOCs) Historical model for many real estate owners/developers has been raising capital from friends and family and high net worth individuals. Became the norm for some investors that continued to invest during the financial crisis. Institutional investors may prefer this model for new relationships or developers without an institutional track record. Provides flexibility to test the relationship on a limited basis and modify the arrangement based on the experience. May be a gateway to establishing a longer term relationship (e.g., programmatic joint venture or commingled fund). Provides the owner/developer more flexibility to use multiple equity funding sources (i.e., no exclusivity given to investors, ownership structure can vary by asset). More cumbersome to raise capital on a deal by deal basis and provides the developer less long term certainty of funding sources. Entity Level Investment: Capital investments by one or more investors into the operating company of the owner/developer. Differs from other forms of private investment that generally involve selling only an interest in certain assets; entity level investment involves a sale of a portion of all lines of business and the operating company, including all fee streams. Investments can take different forms (e.g., common or preferred equity, control or non-control transactions, many variations of approval rights, etc.). Can provide permanent capital and potentially a longer term and more global solution than other private options � generally in exchange for greater loss of control and ownership. Valuation of existing portfolio/pipeline and approval issues (existing investors and partners) will need to be addressed. As compared to going public � No public reporting, public investor relations, quarterly EPS pressure and associated public company overhead and time commitment. Potentially more flexible governance � decisions made by a small number of parties without public company litigation overlay. However, no publicly traded stock (prior owners� stakes remain illiquid; publicly traded stock not available as currency for acquisitions or management compensation). Requires a close relationship with investors � even more stress on picking the right partner. Joint ventures carry specific risk; each partner enters into the deal and negotiates the specific terms and conditions. Contributions � What will each partner bring to the deal? (i.e. entrepreneurial partner vs. money partner) Preferred returns and �Claw-backs� � �Promotes� � ��beyond the hurdle rate, the cash flow split is differentiated so as to provided the entrepreneurial partner with a proportion grater than its capital contribution.� (Geltner & Miller, 2007) Governance � Who is responsible/in charge of what? Winding-up, Buy/Sell REOCs are real estate companies that own operate and/or develop property. Historical model for many real estate owners/developers has been raising capital from friends and family and high net worth individuals. Became the norm for some investors that continued to invest during the financial crisis. Institutional investors may prefer this model for new relationships or developers without an institutional track record. Provides flexibility to test the relationship on a limited basis and modify the arrangement based on the experience. May be a gateway to establishing a longer term relationship (e.g., programmatic joint venture or commingled fund). Provides the owner/developer more flexibility to use multiple equity funding sources (i.e., no exclusivity given to investors, ownership structure can vary by asset). More cumbersome to raise capital on a deal by deal basis and provides the developer less long term certainty of funding sources. Entity Level Investment: Capital investments by one or more investors into the operating company of the owner/developer. Differs from other forms of private investment that generally involve selling only an interest in certain assets; entity level investment involves a sale of a portion of all lines of business and the operating company, including all fee streams. Investments can take different forms (e.g., common or preferred equity, control or non-control transactions, many variations of approval rights, etc.). Can provide permanent capital and potentially a longer term and more global solution than other private options � generally in exchange for greater loss of control and ownership. Valuation of existing portfolio/pipeline and approval issues (existing investors and partners) will need to be addressed. As compared to going public � No public reporting, public investor relations, quarterly EPS pressure and associated public company overhead and time commitment. Potentially more flexible governance � decisions made by a small number of parties without public company litigation overlay. However, no publicly traded stock (prior owners� stakes remain illiquid; publicly traded stock not available as currency for acquisitions or management compensation). Requires a close relationship with investors � even more stress on picking the right partner. Joint ventures carry specific risk; each partner enters into the deal and negotiates the specific terms and conditions. Contributions � What will each partner bring to the deal? (i.e. entrepreneurial partner vs. money partner) Preferred returns and �Claw-backs� � �Promotes� � ��beyond the hurdle rate, the cash flow split is differentiated so as to provided the entrepreneurial partner with a proportion grater than its capital contribution.� (Geltner & Miller, 2007) Governance � Who is responsible/in charge of what? Winding-up, Buy/Sell REOCs are real estate companies that own operate and/or develop property.

10. Structuring Joint Ventures Single asset or programmatic joint venture Ability to attract programmatic capital largely determined by investor appetite, sponsor track record, investment parameters and visibility of pipeline Each joint venture is idiosyncratic; there are no pre-set terms and conditions Terms to be negotiated include: Contributions Preferred returns and �Claw-backs� �Promotes� Governance, guarantees (if any), fees, and transaction costs and expenses Hold period Winding-up, Buy/Sell Joint ventures agreement to provide capital for more than one investment over time. In exchange, joint venture partners often require significant governance/approval rights and other commitments (e.g., exclusivity). In contrast to commingled funds, tend to involve smaller number of investors, less discretion for the owner/developer and more frequent investor contact. May create significant dependence on the joint venture partners for capital. Can be used to establish institutional track record/precursor to a commingled fund or entity level investment. All of the terms of each joint venture are done on a deal-by-deal basis. Each deal is a new partnership to be negotiated, even though the terms of joint ventures can be similar or standardized across deals. Joint ventures agreement to provide capital for more than one investment over time. In exchange, joint venture partners often require significant governance/approval rights and other commitments (e.g., exclusivity). In contrast to commingled funds, tend to involve smaller number of investors, less discretion for the owner/developer and more frequent investor contact. May create significant dependence on the joint venture partners for capital. Can be used to establish institutional track record/precursor to a commingled fund or entity level investment. All of the terms of each joint venture are done on a deal-by-deal basis. Each deal is a new partnership to be negotiated, even though the terms of joint ventures can be similar or standardized across deals.

11. Structuring Joint Ventures Example: Capital contribution: 95% investor / 5% sponsor Sponsor returns subordinated to investor receipt of preferred returns Sponsor handles day-to-day operations; paid market rate fees (which increase return on investment) E.g., asset management, property management, leasing, development, construction, acquisition, disposition or financing fees Exit may include buy/sell provisions where properties are liquidated through acquisition by one JV partner or sale to a third party

12. Entity / GP Investments

13. Entity Level Investment Considerations Equity infusion at the operating company level is akin to selling a portion of the firm Sale of majority or minority stake in the company entitles investor to share in corporate level cash flow May include net property income, fees, and carried interest Investor would pay its pro rata share of expenses Investor would expect control / governance rights commensurate with its ownership stake in the company May provide sponsor with global solution Capital raised typically used to recapitalize existing assets, provide corporate working capital or fund future growth

14. Entity Level Investment Considerations Enterprise valuation will take into consideration Value of existing portfolio (legacy assets) Value of existing and future fee streams Underwriting of corporate assets and liabilities Future value creation Company benefits from long term strategic alignment of interest Requires a close relationship with the investor, with �fit� crucial Important to vet strategy, governance, mechanisms for conflict resolution and potential exit

15. GP Level Investment Considerations Equity infusion at the GP level is focused on future opportunities only No valuation issues with respect to legacy assets GP level returns are enhanced Sharing of GP level carried interest enhances underlying deal IRRs by 250 � 500 basis points for the investor. Need to address key man provisions and management time commitments to legacy assets Investor will need to be comfortable with limited governance inherent within GP structure

16. Commingled Funds: Investment Structure

17. Commingled Fund Structure Pooled investment vehicle with defined strategy used for making investments in various debt and equity positions Funds are typically limited partnerships (or LLCs) with a fixed term of 7-10 years Typically raised and managed by investment professionals of a specific private equity firm (the general partner/sponsor/investment advisor) Sponsor has greater discretion over deployment of capital Increasing institutional appetite for funds sponsored by established operators Private REITs (vs. non-listed REITs) are one form of commingled fund that offer tax benefits that are attractive to certain investor classes in certain asset classes. Similar in form to a joint venture, but typically involve larger number of investors and fund managers have a much greater degree of discretion. Favored form of capital raising for many managers: a larger capital and investor base and greater flexibility without giving up ultimate control. (often with annual extensions). At inception, institutional investors make an unfunded commitment to the limited partnership, which is then drawn over the term of the fund. Typically, a single private equity firm will manage a series of distinct private equity funds and will attempt to raise a new fund every 3 to 5 years as the previous fund is fully invested. Term of the partnership � the partnership is usually a fixed-life investment vehicle that is typically 10 years plus some number of extensions Transfer of an interest in the fund � private equity funds are not intended to be transferred or traded, however they can be transferred to another investor. Typically, such a transfer must receive the consent of and is at the discretion of the fund's manager Restrictions on the General Partner - the fund's manager/sponsor often has significant discretion to make investments and control the affairs of the fund. However, there are often certain restrictions and controls to limit the type, size or geographic focus of investments permitted and how long the manager is permitted to make new investments Private REITs (vs. non-listed REITs) are one form of commingled fund that offer tax benefits that are attractive to certain investor classes in certain asset classes. Similar in form to a joint venture, but typically involve larger number of investors and fund managers have a much greater degree of discretion. Favored form of capital raising for many managers: a larger capital and investor base and greater flexibility without giving up ultimate control. (often with annual extensions). At inception, institutional investors make an unfunded commitment to the limited partnership, which is then drawn over the term of the fund. Typically, a single private equity firm will manage a series of distinct private equity funds and will attempt to raise a new fund every 3 to 5 years as the previous fund is fully invested. Term of the partnership � the partnership is usually a fixed-life investment vehicle that is typically 10 years plus some number of extensions Transfer of an interest in the fund � private equity funds are not intended to be transferred or traded, however they can be transferred to another investor. Typically, such a transfer must receive the consent of and is at the discretion of the fund's manager Restrictions on the General Partner - the fund's manager/sponsor often has significant discretion to make investments and control the affairs of the fund. However, there are often certain restrictions and controls to limit the type, size or geographic focus of investments permitted and how long the manager is permitted to make new investments

18. Real Estate Commingled Fund: How It Works

19. Three Types of Fund G.P.s Long standing relationships with high net worth clients who can help capitalize these funds These banks, serving as frequent intermediaries, have access to proprietary deal flow Skillful at corporate finance and complex structuring Examples: Morgan Stanley, Goldman Sachs, Credit Suisse, and UBS Volcker rule will limit participation by banks in the future

20. Most private equity is invested via partnership of a limited duration

21. Investment Strategy

22. Open-ended Funds No limits on the number of properties in which the fund can invest No limit on the number of investors No limit on the duration of the investment Unit certificates in the fund may be redeemed at any time at a set price, usually at Net Asset Value. Closed-ended Funds Raise a fixed amount of capital Have a specified duration Exits from the fund are limited Exit prices can be predetermined Mutual funds are an example of open-end funds. Net Asset Value is defined in the REIT module, i.e., market value of the assets less the value of the liabilities. Mutual funds are an example of open-end funds. Net Asset Value is defined in the REIT module, i.e., market value of the assets less the value of the liabilities.

23. Fundraising Statistics

24. Fund Size

26. Joint Venture Indicative Process

27. Diligence Request List

28. Explore Structural Alternatives Corporate and Legal Due Diligence Articles of incorporation, board minutes, ownership structure, legal entity list, etc. Business Due Diligence Financial model(s) and detailed rollup Financing � debt abstracts / loan documentation Estimate of defeasance and yield maintenance costs for in place debt 2011E and run-rate G&A detail All executive employment agreements Change of control analysis - tenant rights summary, ROFO�s, ROFR�s, etc. Lease abstracts Vacancy guidance Other Tax returns Employee benefit plans Third party reports Ultimate Deliverables Confidentiality agreements and process documents Dataroom Purchase and sale agreement(s) Updated Management Presentation

29. Merchant Development Model - Illustrative

30. Crafting the Investment Thesis

31. Investment Highlights

32. Two Scenarios � Diligence & Underwriting

33. Teaser Outline Teaser Overview 3-5 page summary of joint venture investment Provided to interested, potential joint venture partners along with Confidentiality Agreement Enables potential joint venture partners to quickly determine preliminary interest Teaser Outline Transaction Overview Corporate Overview Company History Track Record The Opportunity Selected Investment Highlights Market Highlights Portfolio Overview Process & Timing Contacts

34. Process Alternatives 34

35. Sample Investor Universe

36. Description of Typical Fees

38. Return Requirements by Investment Strategy Chart obtained from RealPac: Real Property Associate of Canada Go over the various investment strategies. Equity funds pick a strategy or two to follow and also determine the return target that they expect to achieve.Chart obtained from RealPac: Real Property Associate of Canada Go over the various investment strategies. Equity funds pick a strategy or two to follow and also determine the return target that they expect to achieve.

39. Return Requirements by Investment Strategy

40. Returns and Leverage Leverage Ratio (LR): at the time of purchase = Acquisition Price/Equity thereafter = Value/Equity

41. Levered Returns Table

42. Median IRRs

43. Venture Cash Flow Sharing Arrangements

44. Joint Ventures Two types of partners that combine expertise with capital Cash flow sharing arrangement made between these two partners

45. Joint Ventures: Cash Flow Sharing Sharing Cash Flow � Operating Cash Flows Typically pari passu or at predetermined percentages Sharing Cash Flow � Property Sale/Refinance Repay any debt Return of initial investment (return of invested capital remaining) Remainder Distributed (return on capital) Split of Cash Flow (often a waterfall arrangement) Predetermined portions/percentages Preferred returns and return hurdles Hard Hurdle Soft Hurdle IRR lookback (clawback) or catch-up with soft hurdle Pari Passu: a phrase that literally means "equal footstep" or "equal footing" Proportionally, without preference. This term is also often used for cash distributions to be paid in accordance with the amount of capital contributed Pari Passu: a phrase that literally means "equal footstep" or "equal footing" Proportionally, without preference. This term is also often used for cash distributions to be paid in accordance with the amount of capital contributed

46. Example JV Waterfall Distribution First, to repay capital contributions made by each partner (typically 90%/10%) pari passu Second, to pay each partner a 9% cumulative annual return on capital Remaining proceeds split 50% to Institutional Investor and 50% to Developer/Sponsor Target IRR 18% to Capital Investor

47. Hard vs. Soft Hurdles The difference between a hard hurdle and a soft hurdle is like the difference between a deductible and a threshold.

48. Hard Hurdles A hard hurdle functions like a deductible: Operator would not receive any promote unless and until capital investor were to receive IRR hurdle and then operator would received a predetermined percentage of the incremental cash flow. In effect the profit distributions required to achieve the hurdle would be deducted from all profit distributions in determining the portion that is shared by Operator.

49. Soft Hurdles The soft hurdle is a threshold that must be reached as a condition to operators retention of any promote: If the profit distribution is sufficient to achieve the IRR hurdle, then The threshold would be reached Operator would get a predetermined percentage of all profit distributions Catch up if preferred returns are met first In that sense, the soft hurdle would go away If the profit distributions are not sufficient to achieve the IRR hurdle, then The threshold would not be met Operator would not get a predetermined percentage of all profit distributions Operator must forfeit distributions (lookback or clawback if preferred returns are not met first) to the extent necessary to meet the threshold A hard hurdle always reduces the amount of profit distributions that may be shared by Operator (if there are profit distributions to share), whereas a soft hurdle is contingent and may not result in any reduction at all. A hard hurdle always reduces the amount of profit distributions that may be shared by Operator (if there are profit distributions to share), whereas a soft hurdle is contingent and may not result in any reduction at all.

50. Uncertainty of Soft Hurdles A hard hurdle always reduces the amount of profit distributions that may be shared by Operator (if there are profit distributions to share), whereas a soft hurdle is contingent and may not result in any reduction at all.

51. Look back vs. Catch-up Look-back for Investor: one approach is to give Operator 50% of the profit distributions from the outset with a so-called �Look-back�: The parties look back at the end of the deal and to the extent Investor hasn�t achieved a 9% IRR, Operator must turn over to Investor its promote distributions (in this case, all of Operator�s distributions) Catch-up for Operator: another approach is to give Investor 100% of the profit distributions until Investor achieve IRR hurdle, and then give Operator its share with a so-called �Catch-up�: After Investor achieves a 9% IRR, Operator gets 100% of all subsequent profit distributions until profit distributions are in 50/50 ratio

52. Return Multiples

53. Net Multiple The net multiple return is used by investors to determine how much they have received in cash relative to how much they paid in It does not take into consideration the timing of capital call-ups and distributions It does provide a good indication of fund performance Calculated as a Ratio: Total Cash Inflows/Total Cash Outflows

54. Net Multiple (cont.)

55. IRR Multiple Table

56. JV Waterfall Examples Typical JV Promote Structure: The Sponsor invests a small portion of the equity, with a Limited Partner (�LP�) providing the balance. The Sponsor is generally entitled to received performance incentives in the form of promotes (a greater portion of the cash flow) upon achieving certain return hurdles

57. JV Waterfall Examples JV Promote Structure with Minimum Equity Multiple Hurdle: The scenario below is similar to the previous structure, with an added return hurdle. The investment must generate a minimum equity multiple for the LP before the second promote can be paid out to the Sponsor

58. JV Waterfall Examples Preferred Return: In the scenario below, the Sponsor�s return is subordinated to the LP�s (the Sponsor does not receive any cash flow until the investment generates a set return for the LP). After this hurdle is achieved, the Sponsor may be entitled to a catch up payment sufficient to generate the return already received by the LP. Afterwards there may be additional promotes or a set cash flow split

59. JV Waterfall Examples Cash Flow Split after Return of Capital: In this scenario, once the total invested capital has been returned to the Sponsor and the LP (on a pari passu basis), all of the profits are distributed based on a pre-determined split

60. JV Waterfall Examples Each scenario produces similar returns IRRs ranging from 20.03% to 20.74% for the Investor and 51.05% and 52.41% for the Sponsor Equity Multiples ranging from 2.37x and 2.42x for the Investor and 7.38x and 7.87x for the Sponsor Profit ranging from $18.45m to $19.19m for the Investor and $9.56m and $10.30m for the Sponsor

61. More on Commingled Funds

62. Commingled Fund Customary Terms Minimum investment commitment in these funds is at least $1 million A typical return target for these funds is a 20% IRR and a 2x equity multiple over the life of the investment However in light of the financial crisis, these returns have crept down significantly Fund sponsors hope to raise new funds seamlessly and are generally permitted to raise a new fund after 85% of the fund�s capital is invested The sponsor also invests its capital in the fund The amount invested by the sponsor can range from 1-3% for first time fund managers, to 25-50% of total equity commitments

63. Commingled Fund Customary Terms A return waterfall details how cash is split between the investors and the sponsor These preferred returns range from 8 to 10% If the returns exceed the preferred return than these additional profits are split 80/20 With 80% of the profits going to the investor The 20% of the profits given to the sponsor is called a carried interest or promote In addition to their promote, fund sponsors also receive an annual management fee

64. Commingled Fund Customary Terms Management fees � an annual payment made by the investors in the fund to the fund's manager to pay for the private equity firm's investment operations (typically .50% to 2% of the committed capital of the fund) Management Fees are fees paid to the fund�s manager based on a variety of measures which include: Total equity commitment Total equity invested to date Gross or Net asset value Percentage of income Or combinations thereof Go over the fees earned by the fund sponsor/manager. Note that any other services provided by the sponsor would also be specified, e.g., property management, brokerage, acquisition or disposition fees, etc. Go over the fees earned by the fund sponsor/manager. Note that any other services provided by the sponsor would also be specified, e.g., property management, brokerage, acquisition or disposition fees, etc.

65. Carried Interest or Promote Carried interest - a share of the profits of the fund's investments (typically up to 20%), paid to the private equity fund�s management company as a performance incentive (also called a promote). The remaining 80% of the profits are paid to the fund's investors Hurdle Rate or preferred return� a minimum rate of return (e.g. 8 - 10%) which must be achieved before the fund manager can receive any carried interest payments Fees are calculated based on a set hurdle rate (IRR) and often include claw back provisions if funds hurdle rate is not achieved Carried interest, also known as promote, is how the investment sponsor shares in the profits of the fund. Clawback - A provision that ensures that a general partner does not receive more than its agreed percentage of carried interest over the life of the fund. So, for example, if a general partner receives 21 percent of the partnership's profits instead of the agreed 20 percent, limited partners can clawback the extra one percent. Carried interest, also known as promote, is how the investment sponsor shares in the profits of the fund. Clawback - A provision that ensures that a general partner does not receive more than its agreed percentage of carried interest over the life of the fund. So, for example, if a general partner receives 21 percent of the partnership's profits instead of the agreed 20 percent, limited partners can clawback the extra one percent.