Blackstone Returns Fees in First Clawback Triggered at Firm

Blackstone Group LP is refunding some performance fees earned during the commercial real estate boom, the first time fund investors have clawed back cash from executives at the world’s largest private-equity company.

Blackstone and some of its managers returned $3 million in carried interest to investors in Blackstone Real Estate Partners International LP during the second quarter, said a person with knowledge of the payments. They may pay back an estimated $15.7 million this quarter to another fund, Blackstone Real Estate Partners IV, according to the person and a regulatory filing.

Blackstone’s property buyout funds recorded performance fees totaling $1.74 billion, some of which was allocated to the firm’s partners, as the market for office towers, hotels and apartments soared from 2004 to 2007. Prices have slumped about 39 percent since then, leaving New York-based Blackstone and its rivals in a position similar to that of venture capital firms about a decade ago, when the collapse of technology stocks forced them to return profits earned on Internet companies during the 1990s.

“The acute situation for clawbacks is when you have had a very successful period of gains and then the remaining deals don’t do well,” said Michael Harrell, co-head of the private funds practice at the New York-based law firm Debevoise & Plimpton LLP. “That is what happened when the Internet bubble burst and there is certainly the potential for that with the sharp downturn in the real estate market.”

Photographer: Nelson Ching/Bloomberg

Stephen Schwarzman, chairman and chief executive officer of the Blackstone Group LP. Close

Stephen Schwarzman, chairman and chief executive officer of the Blackstone Group LP.

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Photographer: Nelson Ching/Bloomberg

Stephen Schwarzman, chairman and chief executive officer of the Blackstone Group LP.

Clawback Provisions

Private-equity funds, which raise money from institutions including pensions and endowments, pay a share of profits from investments, usually 20 percent, to the firm and its investment managers. If the fund’s remaining holdings suffer a permanent decline in value, clawback provisions can require the executives to rebate cash distributions in order to prevent their share of profits from exceeding the 20 percent.

Blackstone’s repayments were included in an Aug. 6 regulatory filing that didn’t name the funds.

Blackstone’s $38.7 billion purchase of Sam Zell’s Equity Office Properties Trust in February 2007 marked the pinnacle of a bubble inflated by easy financing. The firm sold $60 billion of real estate assets before the market slumped in 2008, Chief Executive Officer Stephen Schwarzman said during a July 22 conference call with analysts, according to a transcript.

Profits from some of those sales have helped Blackstone’s funds outperform rivals. The carried interest paid on the profits also exposed Blackstone managers to possible clawbacks when the market fell and dragged down the value of the remaining holdings in their funds. Potential clawbacks at the firm’s property funds more than tripled to $299.8 million last year from $77.2 million at the end of 2008, according to regulatory filings. The figure shrank to $280.3 million at the end of June.

First-Half Gains

Blackstone real estate buyout funds averaged gains of 33 percent in the first half as commercial property values reached a bottom or begun improving in most of the world, Schwarzman said during last month’s call. The funds recorded about $37.4 million of performance fees during the second quarter, reversing a $47.4 million decline during the same period last year, Blackstone’s financial statements show.

“We anticipate that all of our funds will be profitable and any final clawbacks will be insignificant,” Peter Rose, a Blackstone spokesman, said in an e-mailed statement.

Rebates by individuals will be spread among more than 100 people who receive carried interest. Blackstone requires individuals to put some of their cash performance fees in segregated accounts that it can use to meet clawbacks.

Equity Office Properties

While Blackstone sold $27 billion in assets acquired in the Equity Office deal, there weren’t any potential clawbacks from gains on those transactions, according to the person familiar with the funds. That’s because Blackstone used the proceeds from those real estate sales to pay down debt rather than make carried interest payments to itself and managers.

Publicly traded Blackstone, Fortress Investment Group LLC and KKR & Co. disclose information on clawbacks, which are designed to prevent money managers from exceeding their cut of profits over the life of a fund. Blackstone, while reporting potential refund obligations for several years, had never been required to make a “cash clawback payment” since its 1985 founding by Peter G. Peterson and Schwarzman, filings show.

That changed in the second quarter, when the firm’s Blackstone Holdings management unit and current and former personnel repaid $1.7 million and $1.3 million, respectively, to the international fund, according to the quarterly filing with the U.S. Securities and Exchange Commission. The fund, which invested $757 million from January 2001 to September 2005, has generated internal rates of return averaging 28 percent annually, Blackstone said.

Blackstone Real Estate Partners IV is scheduled to receive an estimated $15.7 million in clawbacks on Sept. 30, including $9 million from current and former personnel, according to the SEC filing and the person familiar with the situation. The fund, which invested $2.74 billion from April 2003 to December 2005 in companies such as Extended Stay America Inc. and La Quinta Corp, has averaged annual returns of 14 percent.

The repayment may be smaller than estimated in the filing because holdings have risen in value since then, said the person, who was briefed on the funds’ performance and asked not to be named because the information isn’t public.

Property buyout funds raised about $262 billion from 2005 through 2009, more than double the total from the previous five years, according to London-based Preqin Ltd., a research and consulting firm focusing on alternative assets.

Market Sours

In some buyouts, debt reached 95 percent of the price as buyers assumed that rents and cash flow to service the borrowings would rise with the real estate market, said James Corl, a managing director at Siguler Guff & Co. who oversees the New York-based investment firm’s distressed strategies.

Instead, the economy weakened in 2008, leading to defaults among developers such as Harry Macklowe, whose properties were overburdened with debt, Corl said.

Funds that began investing after 2004 have lost money on average, Preqin data show. Funds that entered the market in 2007 have averaged annual declines of 33 percent.

“All of these guys invested in trophy properties at the top of the market,” said Thomas Capasse, a principal at Waterfall Asset Management LLC, a New York firm that invests in high-yield structured debt. “Many of these real estate opportunity funds ended up down 30 to 75 percent.”

In April, Morgan Stanley told investors that the firm expected an $8.8 billion international real estate fund would end up losing about 61 percent of its assets. Whitehall Street International, a property investment fund run by Goldman Sachs Group Inc., lost almost all of its $1.8 billion in equity, CNBC, Reuters and the Financial Times reported the same month.

Morgan Stanley, Goldman

The banks, based in New York, haven’t disclosed any clawbacks in their quarterly filings. Alyson Barnes, a Morgan Stanley spokeswoman, and Andrea Rachman, a spokeswoman for Goldman Sachs, declined to comment.

KKR and Fortress, also based in New York, haven’t reported paying any clawbacks.

Private-equity firms begin to earn performance fees once their fund’s annual returns exceed a threshold promised to clients, typically 7 percent to 10 percent. Real estate funds record carried interest as they mark up the value of their holdings. The fees don’t get paid until gains are realized through property sales.

Traditional corporate buyout funds wait until their lifespan, usually about 10 years, is completed to make this calculation. Real estate funds sometimes require interim clawbacks, such as those being made by Blackstone.

“Some managers have had to write checks and some managers have had difficulty writing checks,” said Geoffrey Dohrmann, chief executive officer of Institutional Real Estate Inc., a San Ramon, California, publishing and consulting firm that specializes in the commercial real estate market.

To contact the reporter on this story: Miles Weiss in Washington at mweiss@bloomberg.net

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