Plenty of investment opportunities exist today for people looking to grow their wealth and maximize their returns. Whether you’re a veteran or a new general partner looking to start an investment fund, it’s important you brush up on your trade to instill confidence in your prospects so they choose to invest with you.
We’ll touch on how funds work, their different types, how they’re structured, the benefits and risks of being involved with one, what legal issues to consider, and of course, how to start a real estate investment fund in just 10 steps.
What is a real estate investment fund?
A real estate investment fund is a resource pool that’ll store your investor’s money. When you’re setting up an investment fund, your investors trust you to use this pool wisely, providing them with great ROI at reduced risk – when purchasing securities like real estate and stocks.
How do property investment funds work?
Property investment funds work by having a GP (general partner) collect a pool of capital from other (limited) partners for the purpose of buying real estate properties (or shares).
What are the different types of real estate investment funds?
Three main types of real estate investment funds are available to investors:
- Real estate exchange-traded funds (ETFs) are passively-managed investment vehicles that track an index – enabling investors to earn market-matching returns. They’re open to public trading on most major stock market exchanges.
- Real estate private equity funds are actively-managed and target institutional investors and HNWI (high net worth individuals). Usually, private real estate funds are only available to accredited investors.
- Real estate mutual funds are professionally-managed investment vehicles. They expose money pooled from investors to a diversified portfolio of real estate opportunities, including real-estate publicly-traded companies, REITs, and physical real estate like residential buildings. They’re open to the public and could be accessed via financial advisors or online brokerages, but investors must meet minimum requirements to participate.
What’s the main difference between REITs and real estate funds?
Real estate investment funds and REITs (real estate investment trusts) have some similarities. They’re both pooled sources of capital used to invest in real estate.
However, there are some key differences between them, but the biggest one will be important to your investors: REITs are obligated to distribute 90% of their taxable income back to shareholders in order to maintain their tax-advantaged status with the IRS. But real estate funds don’t have to comply with those rules, making them favorable to investors preferring returns via capital appreciation instead of dividend payments.
Unlike a trust, a fund accepts money from investors at any time in exchange for issuing “units” to investors, often called “open-ended fund”, since the fund is “open” to new investors at any time.
How is a real estate investment fund structured?
Usually, real estate investment funds are set up as a corporation (LLC) or Limited Partnership to allow a group of people to pull their money together and invest in real estate. Also, the investor’s initial investment is paid first, with the fund’s manager or sponsor being entitled to a larger portion – based on the agreed preferred return structure – splitting the remaining profits between themselves and lower-tier investors.
How a fund is structured (whether or not it’s close-ended) determines how the profits are then distributed. Most investors value a real estate investment fund’s structure by how quickly can liquidity be reached, and by how it schedules payments of its profits.
Real estate investment funds can be generally broken into two types:
- Set end date (closed), like REITs, are structured to distribute profits quickly via dividends, sometimes even on a monthly basis.
- Open date, like a real estate investment fund. They’re structured to yield long-term appreciation, which can take years, and even decades.
These two are related, but not always directly. For example, appreciation can happen as a result of investing in property development, but also due to changing real estate market conditions.
Who runs a real estate investment fund?
Just like a mutual fund, a real estate investment fund can have passive or active management. Some funds have commission-based fees, while some are managed by an online brokerage that requires a yearly flat rate in order to invest.
Leading a fund as a GP, you have to be a knowledgeable expert who can effectively manage investments. It’s also crucial you stay up-to-date on the latest real estate market trends, so you can best maneuver market shifts—knowing where the next big investment is.
Today, technology is playing a larger role in the management of investment funds and has begun to revolutionize the industry.
How can technology help you start a real estate investment fund?
Technology is changing our world, shifting one industry after another. Our space is affected as well. Starting a real estate investment fund is easier if you’re using the right tech.
Covercy will help you organize your fund, manage finances, and communicate with your investors by letting you:
- Create and manage your capital calls.
- Auto-calculate, manage and execute your capital distributions.
- Slash the risk of phishing and wire-fraud with our secure platform and payments.
- View the positions of your investors in all assets & funds. Slice and dice as you wish.
- Give your investors access to their account and view the portfolio’s info, transactions, documents, and reports via an Investor Portal.
- Call capital in your investment currency; while letting your investors fund them in their selected currency. International Capital Call Payment Processing.
What are the benefits of a real estate investment fund?
Creating a real estate investment fund will create a win-win for you and your investors.
- Expose your investors to a healthy portfolio diversification
- Enable preferred return for your investor, letting them get paid first
- Produce stable profits in the long-term. Real estate appreciation is proven
- Help them save on taxes as they become part of your pass-through corporation
- Give people an opportunity to invest in real estate without having to qualify for financing.
What are the risks of a real estate investment fund?
This might be worrying your LPs, and it’s important you know how to best address it because while a real estate investment fund has many benefits, it doesn’t come without risks.
Here are the two most common pitfalls you’ll need to communicate to your investors:
- Real estate funds are structured in a way that avoids having investors withdraw capital early. Make it clear for them it’s a necessary part of how you operate. If liquidating fast is a priority for them, a fund might not be their best route.
- With the rise of digital assets flipping at light speed, and SPAC deals replacing traditional, slow IPOs, some investors are looking to cash in quickly. Explain that real estate funds are usually structured to make money over time, which means delayed gratification for the opportunity to reap great rewards.
As for you, on the legal side, it’s important you know:
- Legal business entity
When starting out, small real estate investment companies (funds) usually don’t form a legal entity. But once you grow, it’s important you protect yourself and your personal assets by incorporating them, with the most common form/structure being an LLC. It’ll provide you with flexibility when markets fluctuate or your needs change.
It’s vital to insure properties correctly once deeds pass into your fund’s control, so getting the right kind of insurance as an investment property fund is paramount.
Make sure you research and talk to experienced RE attorneys and insurance agents to nail down coverage that best suits your fund. Additionally, work with a lawyer to make your tenant contracts waterproof, clearly stating what are they responsible for, what your limit of liability is, and what’s beyond reasonable coverage.
What are the first steps to starting a real estate investment fund?
Starting a real estate investment fund as a general practitioner (GP) requires careful planning, legal considerations, and the ability to attract investors. Here are the general steps you would need to take:
- Define your investment strategy: Determine the specific focus and strategy of your real estate investment fund. Will you invest in residential properties, commercial properties, or a mix? Will you focus on specific geographic locations or property types? Clarify your investment goals and risk tolerance.
- Form a legal entity: Establish a legal entity for your investment fund, such as a limited liability company (LLC) or a limited partnership (LP). Consult with an attorney to understand the legal and regulatory requirements in your jurisdiction and to ensure compliance with securities laws.
- Develop a business plan: Create a comprehensive business plan that outlines your investment strategy, target market, financial projections, and fundraising goals. This document will serve as a roadmap for your fund and will be useful when attracting potential investors.
- Secure regulatory compliance: Familiarize yourself with the securities laws and regulations governing investment funds in your jurisdiction. Determine whether you need to register with the relevant regulatory authorities or qualify for any exemptions. Comply with all necessary filing requirements and disclosures.
- Assemble a team: Surround yourself with professionals who can support your real estate investment fund. This may include attorneys, accountants, real estate experts, property managers, and administrative staff. Their expertise will be invaluable in managing the fund effectively.
- Raise capital: Reach out to potential investors who may be interested in investing in your fund. This could include high-net-worth individuals, family offices, institutional investors, or even friends and family. Develop a compelling pitch that highlights the unique value proposition of your fund and clearly articulates the potential returns and risks.
- Structure the fund: Decide on the fund structure that aligns with your investment strategy and investor preferences. Common structures include open-end or closed-end funds, as well as different classes of shares or units that cater to various investor profiles.
- Acquire properties: Once you have raised sufficient capital, identify and acquire suitable real estate properties that align with your investment strategy. Perform thorough due diligence on potential properties to assess their financial viability and potential returns.
- Manage the properties: Oversee the day-to-day operations of the properties, including tenant management, property maintenance, rent collection, and financial reporting. If necessary, hire property management professionals to assist with these responsibilities.
- Provide investor updates: Maintain regular communication with your investors by providing periodic updates on the fund’s performance, property acquisitions, and any other relevant information. Transparency and accountability are crucial to maintaining investor trust.
Remember, starting a real estate investment fund involves complex legal and financial considerations. It is strongly recommended to consult with professionals such as attorneys, accountants, and financial advisors who specialize in fund formation and real estate investments to ensure compliance and maximize the chances of success.
We covered lots of ground today. We discussed what is a real estate fund, its different types, how they’re structured, operate, and make money. We also learned how technology can help propel you forward should you choose to start a fund, or improve upon your existing one. Lastly, we covered some of the benefits, risks, and legalities involved, and provided a 10-step list to starting a real estate investment fund of your own.
Your safe and tech-empowered real estate fund starts here.
Investing in commercial real estate can be risky. It is not a fit for everyone. While we aim to provide general information to help you better understand CRE investments, we are neither providing any investment advice nor advising for or against any particular investment.