Real estate investment has been a trusted means of building wealth. However, for the masses, the complexities of understanding the legal, financial, and construction side of development opportunities can be overwhelming. For individuals who want the profit from real estate without immersing themselves in detailed complexities, partnering with a real estate development fund may be a great solution. These investments provide exposure to multi-family and mixed-use development, usually high-return sectors. This doesn't involve the hassle of being on-site and facing the daily challenges of project management and construction.
Understanding Real Estate Development Fund
A real estate development fund is also known as a real estate private equity fund or real estate fund. It is an organized investment fund structure that pools money to purchase or develop real estate. Funds can be specialized by asset types like office, industrial, retail, medical, or residential. They can be specialized by strategy as well, including value-add, core, distressed, joint venture equity, or development. They can also be open-ended or closed funds.
Debt Vs. Equity Funding
Debt funding is when investors act as lenders to a real estate development. Investors lend the required funds to the developer at a pre-agreed interest rate. An example would be a mortgage loan from a bank. The developer would pay back this loan with the agreed-upon interest on a specified schedule.
Equity funding is where real estate investors take ownership of the development. Investors here invest in a real estate project and have an interest in the property. Generally, equity investors share the profit from the sale of the development (or a portion of the regular rental income if the asset is to be held long-term) rather than being paid a predetermined rate of interest.
Types of Fund
Closed-End Funds
Closed-end funds are appropriate when investing in assets with long hold periods and are not easily transferable. Due to the nature of real estate investments, most real estate funds are closed-end funds.
They usually have a definite term, like five or ten years, with the possibility of extension under specific conditions. Investors generally cannot withdraw or add capital during the existence of the fund and get a reallocation of capital when assets are being sold or some other type of capital event, like a refinancing.
Open-End Funds
Open-end funds are more suitable in the case of investments that are easily tradeable, which means investments are traded in an open market with a respectable amount of liquidity. They are also suitable for investments that are easy to enter and exit at any time. Contrary to closed-end funds, they do not have a fixed span.
Successive-Ended Funds
Successive-ended funds are a blend of both open-ended and closed-ended funds to provide a unique combination of flexibility and stability to investors. It permits continuous capital inflows and periodic outflows, as in open-ended funds. However, it provides fixed periods of investment, as in closed-ended funds. They give investors a sense of community by sharing common investment objectives and risk profiles.
Public and Private Funds
Public funds are regulated by the Securities and Exchange Commission, guaranteeing transparency and accountability. On the other hand, private funds don't have similar registration requirements. They may provide higher rewards but have higher risks.
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Public funds are regulated by the SEC, so they are less subjected to scams and provide a safe investment environment.
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Private funds draw higher returns but have higher risks due to a lack of regulatory supervision.
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The decision between the two generally depends on one's risk tolerance and investment goals.
Benefits of Investing in Real Estate Funds
1) Diversification
Most real estate investment funds provide investors with general exposure to the real estate market. With a low initial value of investment, investors are able to buy various types of assets in different markets at the same time.
2) Lower initial investment requirement
The initial investment requirements of most real estate funds are quite low. They are generally under $10,000 for a mutual fund and not more than $100 for most real estate ETFs. That gives investors a much lower entry point in comparison to purchasing individual properties.
3) Lower Risk
With the diversification that these funds offer, investing in a number of developments is easy. This reduces the risk of fluctuations in the amount paid as income and decreases the risk of the investment.
4) Passive investing
Real estate allows investors to earn passive income because tenants pay rent, yet active management is needed to be a landlord. On the contrary, real estate funds are significantly more passive investments because other people manage the active management of the properties.
Considerations Before Forming First Real Estate Investment Fund
Fund sponsors must consider the following before launching their first fund:
Structure: Most of the real estate investment funds are closed-end with a fixed term. But open-ended funds and continuation funds are also available.
Strategy: It is important to have a clear investment strategy to attract investors and fulfill their needs and expectations.
Cost: Sponsors cover initial organization expenses, such as legal, accounting, and marketing expenses, until they raise capital.
Investors: Institutional and individual investors may have different requirements and expectations in real estate funds.
How to Earn Money Through Real Estate Funds?
Real estate fund sponsors earn profits based on the type of investment involved. For example, rental income from owned property and dividends from stock in a rental property. However, real estate debt funds make a profit from interest receipts on loans. If the borrowers do not pay back the loan, then the fund can seize borrowers' collateral assets and sell them.
Usually, real estate fund sponsors have an equity share between 5% and 50%, and profits are shared based on this percentage. They also earn by collecting fees from other investors. These are the most popular real estate fund fees that sponsors can charge investors:
Asset Management Fees
Real estate fund owners generally demand up to 2% against investment capital or annual property revenue as an asset management fee. This fee is levied to cover any asset operation and management expenses, overheads generally accepted.
Property Management Fees
The real estate fund owners manage the purchased property, including security of the property, maintenance, cleaning, repairs, and other day-to-day operations. The property management fee range is between 2% to 6% of the invested capital.
Acquisition Fees
An acquisition fee of 1-2.5% of the capital invested in the specific property is usually charged to investors by real estate funds for acquiring direct property ownership. The acquisition fee is charged to reimburse the acquisition-related expenses in terms of both money and time.
Disposition Fees
Most of the fund owners' and investors' revenues come from enhancements in the value of the properties. The cleaning and general partners charge investors 1-2% of their income from the property sale for handling this work.
Marketing Fees
Marketing plays a vital role in the real estate industry. The real estate fund owners have to spend on marketing campaigns like attractive pictures, copywriting, and communication with interested buyers while looking for investors. The general partners may charge additional fees from investors to cover marketing costs.
Development Fees
There are cases when a real estate fund may purchase property for heavy redevelopment. General partners may charge limited partner fees to cover the development costs.
Legal Fees
Considerable legal work is involved in managing a real estate fund, including setting up investments, escrow management, and contract review. Generally, the funds charge the investors a small percentage of their provided capital toward these expenses.
