Investing in real estate is a lucrative strategy that attracts many entrepreneurs, which is why there are so many different types of real estate business models. People chose to find the deals and do the work themselves OR they choose to passively invest in REITS, hedge funds and real estate funds and syndications.
Today we will focus on real estate funds and syndications. These are investment vehicles that enable sponsors to raise capital for deals and give investors the alternative to stocks, options, crypto and other investments to earn passive income based on the assets held in the portfolio. Sponsors structure a fund or syndication to legally raise capital for a broad range of real estate assets in an attempt to generate high returns, protect against potential losses, pay their investors and scale the portfolio.
DEFINITIONS
A real estate syndication is when a group of investors pools together their capital to jointly purchase a large real estate property. Apartments, mobile home parks, land, self-storage units and other real estate assets are some of the investment opportunities available through real estate syndications. A syndication is usually focused on one deal at a time.
An investment or real estate fund is an entity formed to pool investor money and collectively purchase securities such as commercial and residential real estate. Thus, a real estate investment fund is a combined source of capital used to make real estate investments. A real estate fund may have a variety of projects under management at the same time.
HOW DO REAL ESTATE FUNDS WORK?
Real estate funds are a relatively new addition to the real estate market. Generally speaking, RE funds are pools of money — sometimes tens of millions or billions of dollars — managed by investment professionals. Unlike mutual funds, which must be registered with the Securities and Exchange Commission (SEC), RE funds are exempt from most standard securities regulations. However, they are filed with the SEC and are managed with Rules and Regulations that the SEC sets.
There’s no single definition of what qualifies as a RE fund, but they typically share these four characteristics:
- They’re not registered with the SEC. They are filed.
- They must follow Blue Sky Rules.
- They may only accept accredited investors. Although there are exceptions with the Regd 506b; whereas if you have a preexisting relationship with the potential investor(s) you can accept up to 35 unaccredited. However, they must be sophisticated and the process to invest must be met.
- They use some combination of advanced investment strategies to maximize returns, such as short selling, leverage and derivatives.
These real estate investment vehicles may invest in commercial properties, such as office buildings or apartment complexes, or residential properties. The fund may also invest in shares of publicly traded companies that specialize in real estate, such as homebuilders or mortgage lenders.
Some real estate funds invest directly in property, whereas others use derivatives or other strategies to express their view on the real estate market. Some may combine these approaches within a single fund.
Like any other fund, a real estate fund may charge management fees and performance fees depending on the type of structure used. Management fees are usually assessed on assets under management and are typically 1% to 2% annually. Performance fees are often charged at 20% of the profits generated by the fund above a certain hurdle rate such as 8%.
WHAT IS THE DIFFERENCE BETWEEN REAL ESTATE FUNDS AND MUTUAL FUNDS?
Real estate funds and mutual funds are two similar forms of investing that come with distinct differences. There are a few key differences between funds and mutual funds.
Real estate funds have less regulation than mutual funds. They do not have to register with the SEC, and there are no requirements for how often they have to report what they own or how they’re doing so long as the total capital invested in the fund is under 20 million dollars. Obviously normal management, compliance and accounting processes must be in place. The only requirement is that fund managers must register with the SEC if they manage more than $100 million in assets and they must register with the Commodity Futures Trading Commission if they trade certain types of derivatives.
Those who invest in funds must be accredited investors and have a net worth of at least $1 million.
Funds typically have higher fees than mutual funds.
Real estate funds are more liquid than mutual funds, allowing investors to enter or exit an investment faster. The sponsor or syndicator sets that timeline in their offering documents.
Mutual fund managers have more constraints on how much risk they can take on, which limits their ability to generate big returns when markets are rising but also limits losses in bear markets. Mutual funds are required to report holdings every quarter, so investors know what the manager owns at any given time.
Individuals can invest in mutual funds by buying shares directly from the mutual fund company or through brokers. There’s no minimum net worth requirement.
HOW DO I INVEST IN A REAL ESTATE FUND?
The rules for investing in real estate funds are rather different than those of other investments. To invest in most real estate funds, you must be an accredited investor. This means that you must meet one of the following criteria:
- You have an annual income of at least $200,000 (or $300,000 together with a spouse) for the past two years and expect to make the same or more in the current year.
- You have a net worth of more than $1 million, either alone or together with a spouse (excluding the value of your primary residence).
- Additionally, real estate fund investors typically must contribute at least one share to the fund itself. There are some funds that allow smaller contributions, but it’s unusual for these to be less than $25,000 to 100,000.
- For a Regd 506b you must have a preexisting relationship with the sponsor prior to investing. With a Regd 506c there is no relationship needed; however, you will be required to go through a 3rd party verification process on your net worth. These are SEC regulations real estate fund managers must stay compliant with in case of an audit or inquiry. Very important.
Many funds require investors to keep their money locked up for months or even years at a time. Investors may not be able to withdraw their money from the fund until they give 30, 60 or 90 days’ notice to the fund manager. Some funds may even require investors to wait as long as five years before they can get their money back out of the fund.
Institutional investors such as pension plans and university endowments often invest in funds to diversify their portfolios and generate alpha (also called “risk-adjusted returns”) beyond what they can get from public markets. In uncertain times, funds may be able to reduce risks or even generate positive returns when markets decline.
HOW CAN FUNDS MAKE BIG PROFITS IN REAL ESTATE
Real estate funds are in the business of making big profits, which leads to a question: How does this play out in real estate?
Real estate funds are private funds that pool the money of investors and invest in a variety of investments. These funds can be either open-ended or closed-ended and come with a minimum investment of $1 million for non-accredited investors.
Real estate funds are private investment vehicles that are typically only open to accredited investors, high net worth individuals, pension plans and endowments. In exchange for locking up an investor’s capital into the fund for a period of time, fund managers earn performance fees — usually 20% of profits — in addition to management fees — usually 2% of assets under management. Investors’ money is pooled together and invested in stocks, bonds, currencies, commodities, derivatives and other asset classes.
Advantages and Disadvantages of Real Estate Funds
Advantages of real estate funds
Funds have some advantages over mutual funds, which are subject to far greater government regulation. Funds are under the jurisdiction of the Securities and Exchange Commission (SEC), but they aren’t bound by the same rules as mutual funds. This allows fund managers more flexibility in investing their clients’ money and, possibly, more opportunities to generate high returns.
Disadvantages of real estate funds
Funds require investors to be wealthy, accredited and or sophisticated. In order to invest in a fund, you must have a net worth of at least $1 million. This makes funds only available to high-income individuals and institutional investors like pension plans. The SEC requires that all prospective investors meet this threshold before they can invest in a real estate fund.
Funds may charge high fees so it’s important to ask the right questions and review the Offering documents. Real estate funds often charge both management and performance fees, which can reduce your returns significantly if the investment doesn’t perform well. You’ll pay a management fee of 1% or 2% of your total assets under management (AUM) plus 20% of any profits generated on your investment each year. To find a real estate fund with no fees is an anomaly and you should take that fund very seriously if you are shopping for investment opportunities.
INVESTING IN REAL ESTATE FUNDS
Funds invest in real estate for different reasons, sometimes to make money and sometimes just to own a beautiful piece of history, but there will be cash flow and/or an upside on the exit strategy. Investing in real estate funds is not the same as investing in a private equity (PE) fund or other types of real estate investment trusts (REITs).
The majority of funds do not take investors’ money and buy apartment buildings, office complexes or industrial parks, although that is quickly changing in the world of funds and syndications. Instead, they focus on making money by engaging in arbitrage or short-selling opportunities. It is possible to invest funds that do own property but these are not ordinary funds. That said, there are three main ways to invest in this type of asset class:
By investing in a fund that focuses on real estate-related opportunities
By investing in one or more REITs that specialize in commercial or residential property
By purchasing individual properties and managing them yourself
CONCLUSION
Real Estate Fund Investing has exploded in popularity over the past several years. The market is growing quite rapidly, and there are now more sophisticated investment options available than ever before. As an investor make sure you do your due diligence and verify the sponsor or syndicator’s track record over the past 12-24 months. The fund manager MUST have a proven track record.
As we speak the residential and commercial opportunity is exploding, but money is only to be made by putting creative deals together and working the money with speed. You decide if you want to be finding deals and working hard or finding the right real estate fund and not working but earning passive income.
If you want to FIND the deals and scale your portfolio the best way is to set up a real estate fund. If your plan is to structure a real estate fund it is important to work with a reputable service provider and Securities Attorney who will have the knowledge and experience to structure a tailored Offering to protect you, the real estate and most importantly your INVESTORS!
Start with your business plan and decide what types of assets you will focus on– preferably assets and projects you have experience with. It’s hard to raise capital with no track record unless the deal is so sweet and solid that it’s impossible for everyone involved not to win.
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