PLANADVISER -May/June 2022 - 40

compliance consult
David Kaleda
Real Estate Fund Investments
An REOC lets asset managers avoid ERISA limits
REAL ESTATE asset managers will often pool capital for
purposes of investing in real estate. One substantial source
of such capital is investment by employee benefits plans
subject to the Employee Retirement Income Security Act. Yet,
if a manager intends to invest ERISA plan assets, it should
understand whether and how ERISA's
fiduciary duty and prohibited transaction
provisions apply to the management of the
capital pool and the underlying real estate
assets. A way to avoid applying ERISA is to
establish a real estate operating company.
e.g., performance fees. There are a number of managers who
invest in real estate and do meet these requirements.
On the other hand, a manager can still avoid plan asset
... any person
who exercises
Plan Asset Issues
As a threshold matter, the manager
should consider ERISA plan-asset issues.
When assets of investors are pooled into
a fund-e.g., a real estate investment
trust-and one or more of the investors is
an ERISA-covered investor, the manager
must determine whether the fund assets
will be treated as plan assets for purposes
of ERISA. The assets of the fund will be
deemed plan assets, pursuant to a Department
of Labor regulation, if the benefit plan investors-e.g.,
ERISA-covered plans or individual retirement accounts-
own 25% or more of any class of equity in the fund. If that
entity's assets are therefore deemed plan assets, each of
the benefit plan investors is deemed to own an undivided
interest in every asset-the real estate and the rest-owned
by the fund. Therefore, any person who exercises discretion
over the management of such assets acts as a fiduciary in
respect of such management activities. The asset manager
would inevitably be a fiduciary.
So, the manager should consider at the time it creates the
fund whether it intends to, or would like to, leave open the
possibility that benefit plan investors can invest in excess
of the 25% threshold. If this is the case, the manager must
then decide whether it can manage the fund in accordance
with ERISA. This can be challenging but can be accomplished
through carefully organizing and operating the fund
in a manner that allows for compliance with ERISA's fiduciary
duty provisions; compliance with several key prohibited
transaction exemptions, including the DOL's qualifiedprofessional-asset-manager-or
QPAM-exemption; and the
addressing of conflicts of interest such as those that arise
in connection with certain compensation arrangements-
discretion over the
management of
such assets acts
as a fiduciary in
respect of such
management
activities.
status without placing limits on benefit plan investors. It
does this when it structures the fund as a real estate operating
company. An REOC, according to the
DOL's plan assets regulation, must, as an
entity, pass two tests: 1) 50% or more of its
assets, valued at cost on a date set by the
fund, must be invested in real estate that
is managed or developed, and as to which
the entity has the right to substantially
participate directly in the management
or development activities thereof-the
50% test-and 2) In the ordinary course of
its business, the REOC must be engaged
directly in real estate management or
development activities-the management
test.
A Favorable Exception
The DOL's plan assets regulation vis-àvis
the REOC provides a favorable exception
from plan asset status to funds that invest substantial
assets in real estate-e.g., interests such as certain kinds of
debt-vs. traditional equity investments. But, in order to be
an REOC, the fund must do more than passively invest in
the real estate. It must be actively involved in the development
or management of its real estate assets as the plan
assets regulation describes. Thus, the fund and its real
estate investments must be carefully crafted to comply with
the REOC requirements.
In conclusion, ERISA-covered plans, IRAs and other
benefit plan investors can be an important source of capital
for managers that invest in real estate. But such managers
should be familiar with the assets regulation and understand
the implications of plan asset status and possible alternatives,
including establishing an REOC. In any case, a manager
should consider the implications of the regulation at the time
it forms the fund because complying with ERISA or the REOC
requirements can be difficult once the fund begins accepting
capital contributions and making real estate investments.
David Kaleda is a principal in the fiduciary responsibility practice
group at Groom Law Group, Chartered, in Washington, D.C.
40 | planadviser.com May-June 2022
Art by Tim Bower
http://www.planadviser.com
PLANADVISER -May/June 2022

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