Starting a Real Estate Private Equity Fund in New York-- Unique Structural and Regulatory Issues

New York houses many of the world's largest real estate private equity funds and is among the most cities for real estate fund managers. Nearly one-fourth of the largest 100 real estate fund managers globally are headquartered in New York City (PERE June 2019 Report).

New York provides a well-paved regulatory structure and access to a large concentration of capital sources. On the other hand, New York, at both the state and city level, presents several regulatory and tax nuances, which fund managers must navigate. These include requirements imposed on managers located in New York as well as non-US managers targeting New York investors.

This article briefly looks at a number of specific provisions applicable to New York managers and investors, which can affect the structure, tax, regulation, and compliance.

New York Real Estate Fund Structure

A private equity real estate fund structure encompasses the following:

(i) fund-level entities (investment vehicles based on strategy and investor needs);

(ii) sponsor-level entities (management company and general partner entities owned by sponsors), including blocker structures when necessary).


A real estate fund will also have portfolio holding companies to hold individual properties or other assets, which vary significantly based on the strategy and participation by other parties, such as joint venture partners. A fairly unique aspect of real estate private equity funds is that managers often operate affiliated operating companies to provide related services to the funds, such as developers, property management companies, and others. Portfolio holding companies and affiliated operating companies will not be discussed in this article, but some of the principles below will apply to these entities.

i. Fund-Level Entity Structure

Real estate private equity funds are typically established as Delaware limited partnerships. Limited liability companies are becoming a common alternative to limited partnerships, particularly for hedge funds. Private equity funds, however, are rarely established as limited liability companies unless needed to accomplish specific tax-related objectives. Limited partnership fund entities are usually the appropriate choice for private equity real estate funds with sponsors located in New York City. The limited partnership structure, with a dedicated general partner for each fund, allows a simpler division of management fee and carried interest in order to cleanly divide management fee income and carried interest under New York City's Unincorporated Business Tax (the "UBT"), as discussed below.

• • • How will New York's UBT Tax Affect Structure?

The New York City UBT tax (not to be confused with the similarly named federal UBTI--unrelated business taxable income, "the UBTI") creates a unique municipal tax structure that taxes income from flow-through entities, such as limited liability companies and limited partnerships, currently taxed at a 4% rate. The UBTI taxes income generated from unincorporated businesses that operate a trade or business wholly or partially within the City of New York, including Manhattan, Brooklyn, Queens, the Bronx, and Staten Island. However, the UBT is imposed only on the management fee and not on carried interest. Accordingly, fund sponsors located in New York City need to structure the management company and general partner as separate entities (or create a structure with similar tax attributes) to avoid UBT on the sponsors' carried interest.

ii. Sponsor-Level Entities

Sponsor-level entities typically include a management company and a separate general partner. The management company earns a management fee, which is subject to ordinary income, while the general partner is allocated a carried interest, which may be treated as long-term capital gains depending on the tax characteristics and holding period of the portfolio assets. The role of the management company is expansive, encompassing nearly all of the fund's capital raising, asset allocation, and asset disposition roles.

The role of the general partner, by contrast, is quite narrow, acting as a passive entity that delegates its role to the management company and receiving carried interest. The general partner entity facilitates compensation to the fund sponsors, seed investors, and other passive general partner investors.

The separation of manager and general partner functions, among other benefits, allows a manager to form multiple funds with separate general partners for each fund to silo fund-specific risk. In some cases, the sponsors elect to have the general partner combined with the investment manager, as a single entity. Combining entities for hedge fund managers is common (though in our view not a good practice). However, private equity funds, which generally anticipate multiple funds should generally avoid combining entities, as each fund should have a dedicated general partner for tax and liability purposes, and to facilitate sponsor-level passive investors.

• • • New York Newspaper Publication Requirement for LLCs

The management company and general partner are nearly always organized as LLCs. New York is one of a handful of states that have maintained the archaic requirement for newly formed limited liability companies to publish an announcement of formation in local newspapers. Known as New York's Limited Liability Company Law, the LLC is required to publish the announcement for six weeks in two local newspapers in the county where the LLC is located. This applies both to LLCs formed in New York, as well as LLCs qualifying an out-of-state entity (such as a Delaware management company or general partner) for managers operating in New York.

• • • Should the Management Company and General Partner Be Organized in Delaware or New York?

Private fund sponsors in New York generally organize their management company and general partner entities in either New York or in Delaware. The decision to form as a New York or Delaware entity has little practical effect on New York's UBT tax. Rather, UBT depends on the actual commercial activity of the fund managers. There is not a strong consensus among securities counsel on whether to form a management company in Delaware versus New York, and both are commonly used. In large part, the decision comes down to marketing and precedent. Historically, most large managers have organized sponsor-level entities in their home state, and although this is still the prevailing practice, Delaware organized managers are becoming more popular.

Registration and Filing

Real estate fund sponsors face two layers of securities regulation:

(i) fund-level regulation under state and federal securities law; 

(ii) adviser-level regulation under state and federal investment adviser law. Compliance with the registration provisions of adviser-level regulation is generally more burdensome than compliance with fund-level regulation.

i. Fund-Level Regulation

Fund-Level regulation governs the investment fund as an issuer of securities. Investors that subscribe to the fund are purchasers of securities, and enter into an investment contract when they make a binding capital commitment to contribute capital into the fund. Fund-level regulation includes registration requirements for securities issuers and investment companies (the Securities Act of 1933 and the Investment Company Act of 1940).

Note that exemptions from registration requirements do not exempt funds from state and federal anti-fraud regulation, including those of the federal Securities Exchange Act of 1934, and New York's Martin Act of 1921. In contrast, investment adviser regulation requires compliance with federal registration, record-keeping, and fiduciary requirements.

• • • Investment Company Act of 1940

The Investment Company Act requires non-exempt pooled investment vehicles that invest in securities to register with the investment company act. This act contains restrictions unsuitable for private funds, including various diversification requirements, limits on leverage, inflexible investment mandates, and prohibits registered funds to receive performance-based compensation, such as carried interest, and others. These restrictions prevent some of the core traits that define the alternative fund economic model for both sponsors and investors. Registered funds are often referred to as '40 Act funds, and include mutual funds and various other registered vehicles.

Private funds are excluded from the investment Company Act of 1940 under the following three sections, which provide self-executing exclusions from the statute's provisions:

3(c)(1)- for small, startup funds, which can have no more than 100 investors;

3(c)(7)- for established funds with institutional investors, all of which must be qualified purchasers ($5 million combined net worth for individuals, $25 million for entities);

3(c)(5)(C)- for funds holding interest, mortgage, or liens on real estate (and real-estate-related) assets.

• • • Securities Act of 1933

Private funds are generally exempt from registration as a securities issuer under Regulation D Rule 506 and need only file federal Form D filings, and state Form D notice filings, including Form 99 filings in New York. At the federal level, the Securities Act of 1933 requires investors to either register securities offerings or satisfy an exemption from registration. For private fund managers, this is typically accomplished under Rule 506 of Regulation D, a safe harbor for exempt securities offered to accredited investors. Regulation D Rule 506 is divided into two exemptions: Rule 506(b), for funds offering investments to investors with whom the fund managers and its agents have a substantive preexisting relationship, and Rule 506(c), for funds engaging in general advertising and solicitation. An offering made in reliance of Regulation Rule 506(b) or (c) is preempt from state-level registration requirements, other than Form D notice filings.

• • • Securities Act of 1933

Unlike most states, which require state regulatory notice filings (known as Form D Blue Sky Filings) only after an investor makes a capital commitment, New York requires fund managers to submit a state notice filing (in New York, the Form D filing is called a "Form 99") prior to any sale or "offer" to investors. The definition of an "offer" is broadly interpreted and can include pre-launch communications seeking pre-launch soft commitments. Moreover, a fund that files its notice filing in New York is required to accompany the Form 99 filing with presentation materials and supporting documents that will be provided to prospective investors.

ii. Adviser-Level Regulation

Fund managers that invest in assets deemed "securities" are subject to the federal Investment Advisers Act, and New York law. Adviser-lever regulation governs the investment manager as an adviser to the fund, to the extent the fund invests in "securities." Most private equity real estate fund managers are subject to the investment advisers act, even when they only invest in real estate assets. The definition of securities is broadly interpreted and depends not only on the nature of the assets, but how the assets are held and controlled. The investment advisers act has key implications for fund managers, depending on a fund manager's investment strategy, investor base, and assets under management.

• • • Investment Adviser Regulations

Generally, a fund manager must register with the SEC once it reaches an asset level that exceeds $150 million (provided it has no separately managed accounts and does not hold itself out as an investment adviser), and must file a truncated ADV filing once it reaches an asset level of $25 million. New York managers need not register with the state, provided they have no more than five clients. Note that a fund is counted as a single client.

New York is one of a few states in the U.S. that consistently and vigorously enforces its state securities laws, rather than relying primarily on enforcement actions by the SEC, and actions brought by private parties.

In addition to staying compliant with fund-level and adviser-level securities laws, managers should build compliance programs specific to and based on New York state law. New York regulatory programs that directly and indirectly apply to fund managers include New York's Cybersecurity Requirements for Financial Services Companies (effective as of March 2017), New York's Whistleblower Guidance, and Guidance for Preventing Elder Financial Exploitation.