Reduce discrete linear voltage regulator dropout
To turn an N channel MOSFET on you need to have the gate voltage higher than the source voltage by a certain amount. Turn this the other way around; the source has to be lower than the gate by a certain amount for the FET to start conducting. 

In your circuit, the gate voltage can be no higher than the drain voltage therefore, the source has to be lower that the drain for the device to start conducting. How much you may ask. It all depends on the FET; some have a gate-source threshold voltage that is several volts. On your device it is between 0.4v and 1.3V - this voltage will cause the device to start conducting a current of 100uA - read the data sheet page 2. If your FET model has the parameter \$V_{GS(THRESHOLD)}\$ then try altering that to see what effect it makes.