Representing pensions funds in real estate transactions can  sometimes raise unique and challenging issues. Pension funds  come in basically two flavors--public and private. Public pension  funds hold pension monies for state and municipal employees  like teachers, fire and police officers and governmental workers.  Private pension funds benefit employees of corporate entities,  especially large companies. Due to sensible investment strategy  as well as the legal requirements to diversify, many pension  funds acquire and hold real estate assets. Following are some of  the more common issues that such investment raises:

  • Decision Making. Fund investments are handled through  advisors, whose relationship to the fund is governed by  an investment management agreement. Balancing the  needs and desires of both the fund and the advisor can be  difficult, but a familiarity with the management agreement  is often useful, as it may speak directly to an issue at hand.  Regardless of whether it is the advisor or the fund who  selects counsel, the actual client and counsel’s ultimate  duty is to the fund. In any difference of opinion between  the two, the fund has the last word; however, in many  situations, experienced counsel can facilitate a solution.  For example, the two may disagree over the amount of a limitation of damages provision. The fund is sensitive  to limiting its liability to the greatest extent possible  while the advisor may believe that the market requires  more exposure. Counsel can guide a resolution based on  experience in other deals with other funds or with the same  fund but a different advisor, thus achieving a “market”  deal and still giving the fund comfort that it is acting  as a responsible fiduciary in protecting its beneficiaries.  Even where the advisor has authority to act under the  investment management agreement (such as approval  of the closing statement), counsel still acts to insure the  interests of the fund are protected.
  • Guaranties. Typically, each fund property is held in a  single-purpose entity without other assets or, occasionally,  with a few other assets not exceeding a pre-determined  maximum value. When such an entity is selling or financing  the asset or entering into a development agreement  which requires significant future contributions, this can  create problems because the purchaser, the lender or the  developer will have no other assets to look to in the event  of a default. Many funds have organizational documents  or statutory authority which absolutely prohibit the  parent fund (as opposed to the ownership entity) from  guaranteeing ANY obligation and even those that do not  are concerned that taking on such liability would be a  breach of their fiduciary duty. Some funds are willing to  guaranty against default which they can control, such as  “bad boy” carve outs from loans, but are unwilling to cover  any loss from “market risk” situations, such as a reduction  in income due to a failure to lease the property or a  reduction in market rents or property value. This may make  some transactions with some third parties much more  difficult. In the case of post-closing liability or required  construction contributions, escrows or letters of credit  may solve the problem. In the case of loans, a fund may  have to settle for a lower LTV than what would have been  available with a more robust guarantor. Especially where  the fund is absolutely prohibited from giving a guaranty,  it is critical that this issue be identified as early as possible  in the process, so that the parties can address whether  there is a possible “work around” or whether the lender  must be eliminated from consideration, thereby avoiding  unnecessary costs. Such early identification is particularly  important with some regional or local lenders or developers  who are doing their first deal with a pension fund.
  • Tax Issues. Many of the biggest differences between  transactions with pension funds as opposed to other  entities revolve around tax issues. The funds and their  title-holding entities are exempt from Federal taxes, but  the Federal exemption does not necessarily translate to an  exemption from state taxes, so the fund’s counsel must  investigate the possible impact of both state income and  franchise taxes. Eliminating or minimizing such taxes may  require a restructuring of the ownership (changing from  a corporation to a partnership, for instance, or reducing  the amount of paid-in capital as much as possible), which  changes may then result in guaranty issues (see above).  Also, having a Federal tax exemption does not end the  concern about such taxes. Private pension funds are subject  to tax on “unrelated” income (UBTI) and, although public  funds are probably not (there is some disagreement), they  usually want to avoid it as well. Thus, in any acquisition  with pension funds, counsel must review the income  sources to insure no UBTI is present. Typical instances  of UBTI are hourly or daily parking lot income, rental  of personal property and re-sale of utilities for a profit.  Often, counsel can restructure these income sources to recharacterize them as non-UBTI.
  • Partnerships. Private pension funds are subject to ERISA  and public pension funds often have similar, state-imposed  requirements. Of particular concern in the real estate  context is the requirement that the funds act as a fiduciary  with respect to its beneficiaries, a categorization which  carries with it a number of statutory and common law  requirements, some of which must be passed on to thirdparty providers. This can create issues with developers in  construction agreements and property managers, but it is  often solved by providing some additional information so  that they understand that the “additional” responsibilities  thus imposed are actually the same or very similar as those  the management relationship would impose in any event