Converting a Closed-End Real Estate Fund to an Evergreen NAV (Open-End) Structure, Part 2: Liquidity

Liquidity

A fundamental feature of an evergreen or open-end fund is that it is intended to provide limited liquidity to its investors on an ongoing basis, rather than a single liquidity event for everyone at the same time.  As was mentioned in Part 1, an evergreen NAV structure, if properly designed, can offer investors greater flexibility in managing the timing of their exit and associated tax planning.  Most evergreen vehicles permit periodic redemptions, typically monthly or quarterly. However, those redemptions are subject to notice requirements and caps on the amount that can be redeemed during a given period. Funds also typically retain the ability to defer or suspend redemptions if liquidity becomes constrained. These limitations are not incidental; they are a core design feature.  Real estate assets take time to sell, and transaction markets can change quickly. Redemption limits are intended to allow a fund to provide some level of investor liquidity while avoiding forced asset sales, thereby protecting the portfolio and remaining investors.

Illiquidity Is Not Always a Problem

The limits described above are the reason evergreen funds and non-traded REITs are often described as “semi-liquid.”  Semi-liquid means there will always be some level of risk that an investor will not be able to exit exactly when they want.  Investors must understand and accept that redemption requests may be limited or deferred in whole or in part.

Sponsors cannot promise full liquidity.  We are not going to eliminate the risk of illiquidity from time to time. No one can do that. 

For an evergreen fund, what sponsors are really saying to investors is: “Trust me.”   Trust the sponsor to deliver a reasonable amount of liquidity, in a reasonable amount of time at a reasonable valuation.  What does that mean? 

The answer depends on the particular situation and it can vary tremendously.  This is where the sponsor needs to understand its investors and their needs and expectations. Sponsors need to be able to describe their approach to liquidity for redemptions to new and existing investors, and they need to have honest conversations with investors if and when redemptions are limited.  At the same time, sponsors should also be able to clearly articulate the benefits investors receive in exchange for accepting a semi-liquid structure. Evergreen funds are designed for long-term investment in an asset class that is inherently illiquid. By limiting redemption pressure, the structure can allow the fund to hold assets for longer periods, avoid forced sales, and provide more stable NAV-based pricing. Many investors are willing to accept limited liquidity in exchange for long-term exposure to private real estate and the potential for more stable investment performance.

For large, established evergreen vehicles that are widely sold to retail investors, a relatively high level of liquidity would generally be expected on the “semi-liquid” spectrum.  However, for a smaller fund sold to friends and family or family office investors, the expected level of liquidity may be lower.

I used to believe that a sponsor had to have new sources of capital lined up before converting a closed-end fund to an evergreen fund, but that is actually not the case.  If a sponsor wants to convert a closed-end fund or a REIT to an evergreen structure with no immediate sources of liquidity expected in the near future, that is not necessarily a problem.  Much depends on the investor base.  Some investors may be ready for liquidity now, while others are perfectly comfortable remaining invested, particularly if a liquidity event or redemption would trigger taxes.  In many situations, only a portion of the investor base is seeking liquidity.  When that dynamic begins to emerge, sponsors often start considering whether an evergreen NAV structure could provide a solution.  At that stage, liquidity pressure is beginning to appear, but it has not yet overwhelmed the vehicle or forced suboptimal asset sales. This can actually be a good time to convert to an evergreen structure. The conversion can give investors a credible path to liquidity while giving the sponsor time to manage the situation through an initial lock‑up and structured redemption program, with capital raising planned for the future.

Why Liquidity Is Complicated

In practice, liquidity dynamics vary widely across funds and are driven by several interacting factors:

• Existing investor dynamics. Some investors may actively seek liquidity, while others may prefer to remain invested, particularly where redemption would trigger taxes or disrupt a successful investment. Investor concentration and coordination also matter.

• The lifecycle of the fund. Early‑stage funds, mature vehicles, and funds approaching the end of their original term often face very different liquidity expectations, even when the underlying assets are similar.

• The lifecycle and performance of the assets. Properties under development, newly stabilized assets, and mature assets nearing disposition present very different liquidity profiles. Asset performance and NAV volatility can also materially affect redemption behavior.

• Sponsor performance and credibility. A sponsor’s track record, transparency, and history of managing redemptions meaningfully influence investor confidence and liquidity pressure.

• Market conditions. In strong transaction markets, assets may be sold relatively easily. In weaker markets, liquidity may be far more constrained.

• Fund‑level liquidity needs. The fund’s capital requirements for new investments, capital expenditures, debt service, and its overall balance sheet and financing profile all affect available liquidity.

• Access to new capital. The ability to raise capital from new investors is often critical, as evergreen funds generally rely on ongoing inflows to support ongoing redemptions.

When considered together, it becomes clear that liquidity in a real estate fund is not a single issue, but the result of several dynamics interacting at the same time.

The Other Side of the Equation – Capital Raising

Where sponsors may get into trouble is assuming that an evergreen structure solves liquidity. It does not. Converting a vehicle to an evergreen structure does not magically create redemption capacity. It simply creates a framework for managing inflows and outflows.  The underlying constraint remains the same: liquidity coming into the vehicle must equal or exceed liquidity going out. If redemption requests exceed available liquidity, the fund must either defer redemptions or generate liquidity through other means.

In the long run, a conversion to an evergreen fund must be structured to facilitate the raising of new capital. Capital is needed both for redemptions and for growth. Properly structured, evergreen fund vehicles can offer sponsors a variety of ways to access capital that may not have been available in a traditional closed-end structure. These may include new distribution relationships with financial advisors and other intermediaries whose clients are seeking an allocation to real estate through a semi-liquid investment vehicle, as well as structural mechanisms such as UPREIT structures, Section 721 contributions, or structured real estate programs such as Delaware Statutory Trust (DST) offerings. We will discuss these capital formation tools in more detail in Part 3 of this series.