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Lowering the hurdle

BLACKSTONE'S MAMMOTH NEW FUND FEATURES A LOWERED PREFERRED RETURN

Just as The Blackstone Group is outpacing its peers on the fundraising front, it is seeking to be just another fund on the terms-and-conditions front.

The firm's fifth fund, currently in the market and seeking as much as $12 billion, features a preferred return, or ?hurdle rate, of 8 percent, according to sources. Blackstone's previous private equity fund, the $6.5 billion Blackstone Capital Partners IV closed in 2002, had a 10 percent hurdle rate.

Eight percent is seen as the industry standard for hurdle rates, although one LP source says she has seen hurdle rates in new PPMs lower than this.

As market participants are keenly aware, GPs do not get paid carry if their fund fails to clear the hurdle rate. In setting this rate at 10 percent for Fund IV, Blackstone was perceived by many as attempting to show confidence in the firm's ability to generate double-digit returns with a very large fund. The bet paid off – by one LP estimate, Fund IV has a roughly 100 percent unrealized IRR. Carry will be paid, and how.

Now that Fund V may be double the size of the previous pool of capital, Blackstone is showing confidence mostly in its ability to raise the money while sticking to market terms. The LP source says she is not aware of any institutions objecting to the lowered hurdle rate.

Mega-fund returns have been lofty of late, but their managers are working hard to lower expectations going forward. An 8 percent, or lower, hurdle rate makes more remote the possibility that a GP team won't see carry, which would be a disaster for LPs, as well – funds managed by perversely motivated GPs are in danger of going in strange and/or unappealing directions.

The downward trend in hurdle rates is more pronounced among private equity real estate funds, where return expectations are even lower, given the current froth of the US real estate market. An investor in private equity real estate funds says he has seen hurdle rates on new opportunity fund PPMs as low as 6 percent, although this term varies widely, he notes.