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Definition Hurdle Rate in Real Estate

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Definition Hurdle Rate in Real Estate

The hurdle rate is most often used in property-fund settings and denotes the annualized percentage return above which the fund manager is entitled of a pre-determined share of the net investment returns achieved by the fund (net of fees and fund expenses). This share is not high and usually does not exceed 20%.

If the realized net investment return by the fund is lower than the hurdle, then there is no payment of performance fees to the fund manager and profits are distributed among the investors in the fund. The hurdle rate is set by the fund manager generally at a level that reflects achievable market returns (net of fees and fund expenses).

Within this context, a well established property investment performance index, believed to represent market returns, may be used as the basis for setting the hurdle rate level. In such a case, the hurdle rate is not constant but varies as the performance of the index varies. In the United States, the index generated by the National Council of Real Estate Investment Fiduciaries (NCREIF) is often used as the hurdle rate, with the fund manager entitled of a percentage of returns, when fund realized returns exceed NCREIF Index performance.

In order to attract investors, property fund managers usually target a performance above market returns. In this sense, the targeted return of a property fund is higher than the hurdle rate. In some cases there may be several hurdle rates, with an increasing percentage share of profits distributed to the fund manager as fund performance exceeds higher hurde rate levels.

For the purposes of distributing performance fees, fund performance maybe measured periodically or at the expiration of the fund. Funds with indefinite termination date of closed-end funds with long duration tend to measure fund performance periodically.

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