Hazelview Investments, a private money manager that specializes in commercial real estate, has halted redemptions on its $1.4-billion Four Quadrant fund, a move that prevents its retail investors from cashing out, even as Hazelview’s new private equity backer earns a fixed 7.95-per-cent annual return.
Hazelview raised $200-million from Ares Capital in late 2022 by creating a new class of preferred share units for the global private equity firm. Unlike the fund’s ordinary units – which target an annual yield, meaning their returns vary – the preferred units promise Ares 7.95 per cent annually for three years, cash that Hazelview could otherwise have used to fund redemptions or distributions. Hazelview has the option to extend the investment for two more years, but must pay a fee to do so.
Until recently, retail investors in the Four Quadrant fund earned a yield similar to the one earned by Ares. Their average annual return has been 8.1 per cent since inception. But, with the commercial real estate market wobbling, the fund has lost 1.1 per cent in 2023, leaving investors with negative returns so far this year. They gained only 0.8 per cent in 2022.
The Four Quadrant fund, which Hazelview has managed for 12 years, offers investors exposure to a mix of private and public real estate investments. It owns commercial properties, lends to real estate companies, buys public debt and corporate bonds, and invests in shares of publicly traded companies. Despite this mix – which makes up the “four quadrants” of investments – the fund is largely illiquid. Roughly 80 per cent of the portfolio is made up of assets that are hard to sell in a flash when investors want out.
Previously, redemptions were limited to 5 per cent of the fund’s total value each quarter, but in October all pending redemption requests were suspended until the end of March, according to an investor presentation. That means retail investors are now not only making much less than Ares, but they also can’t get their money out for 120 days, the maximum length of time for which Hazelview can suspend redemptions, according to the fund’s terms.
Hazelview has faced surging redemption requests for much of 2023. In June, the company told investors that the requests had jumped to $188-million, according to a client memo obtained by The Globe and Mail, and by early July they were hovering around $250-million, according to someone familiar with the company’s operations. The Globe is not identifying the source because they were not authorized to speak publicly.
Multiple private debt and real estate funds have halted or limited redemptions over the past year, often because their borrowers are grappling with higher interest costs on variable rate debt, or because investors are looking to cash out and buy ultrasafe investment products that now pay around 5 per cent annually. But Hazelview has the added difficulty of managing two investor classes that earn different returns – and also have different rights.
Under the financing terms for the $200-million fundraise from Ares last year, Ares ranks senior to all other investors “with respect to rights on distributions, liquidation, winding-up and dissolution,” according to Four Quadrant fund documents. Existing investors, despite their subordination, were not given the option to vote on bringing Ares on as an institutional backer.
In an e-mailed statement to The Globe, Hazelview said no vote was required because the fund’s limited partnership agreement provides the general partner – Hazelview – with the right to create new classes of units and fix the provisions attached to those units without the prior approval of the limited partners – that is, the retail investors.
Hazelview said it is only required to provide notice to existing investors after an amendment. It said in this case that notice was sent.
As for the redemption halt, Hazelview said the decision was made because of responsibilities “relating to liquidity management.”
Hazelview said increased volatility in Canadian government bond yields has “caused a wide-spread pause of capital flow in the real estate market and these market conditions have restricted Four Quadrant from exiting private investments in order to fund redemptions.”
The bulk of the Four Quadrant fund’s assets – $1-billion – are invested in what Hazelview calls private equity, which includes investments in real estate development projects. Eighty-three per cent of the assets are invested in Canada, and the projects include the T3 commercial office campus in Toronto. Within this private-equity portfolio, 52 per cent of the debt incurred by the projects has fixed interest rates, and 48 per cent has floating-rate interest.
The fund’s second-largest quadrant is made up of public equities, with $255-million invested in publicly traded real estate companies, the majority of which are in the United States. Rising interest rates have hurt real estate company valuations. The MSCI U.S. REIT index, which tracks the performance of real estate investment trusts in the U.S., is down 6.3 per cent this year.
The third quadrant is private debt, often direct mortgages, with $195-million in assets. Fifty-six per cent of these assets are loans with floating rates, and the weighted average interest rate across the entire private debt portfolio is 10.4 per cent. The fourth and final quadrant is public debt, with only $8.9-million in assets.
Investors in the fund pay a 1.5-per-cent annual management fee, plus a performance fee of 20 per cent on any earnings above a certain threshold. Retail advisers who invest their clients’ money in the Four Quadrant fund earn a trailer fee of between 0.5 per cent and 1 per cent each year.