START A REAL ESTATE FUND
Powerful and Attractive Investment Vehicles
We represent and advise our clients when they are ready to start a real estate fund.
Real estate investment funds provide investors with the ability to invest in large, diversified portfolios that typically hold, improve, manage, and develop illiquid real estate assets. Real estate funds are generally sponsored by experienced real estate developers, property managers, brokers, or investment advisers and can be structured according to specific investment strategies or asset types. These funds typically begin with an investment strategy that fits within one of four categories; Opportunistic, which is likely to be a development or rehabilitation strategy; Value-add, which generally takes an existing use and improves it in a significant manner to collect rents or sell when the property reaches a market-maturity level for profitability; Core plus, which is similar to the value-add strategy, but requires less work to improve the property and usually has fewer landlord responsibilities; and Core, which is to purchase and hold existing, leased space until the point of maturity - usually with long-term, triple-net, NNN, or absolute net leases in place.
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Investment fund managers typically start a real estate fund that will likely use one of the strategies mentioned above combined with a particular asset class that investors will find appealing. Asset classes can be categorized as residential projects, such as development, rehabilitation, fix-n-flips, multifamily housing projects, apartment complexes or condominiums, or other residential projects; commercial projects, such as office, warehouse, industrial, distribution, hospitality, retail; or specialty projects, such as golf courses, recreational vehicle and mobile home parks, amusement parks, nature conservatories, airports, marine facilities, ski resorts, vacation resorts, community development projects, religious facilities, projects involving water or mineral rights, non-profit projects, or other real property projects.
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Many successful sponsors will start a real estate fund that tends to have a focused strategy in one particular asset class with which the sponsor has previous experience. Although the past, personal experience cannot be used as part of the track record when starting a real estate fund, such person experience can still be an effective personal background of a real estate fund's sponsor and investment management team.
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We work with sponsors and investment fund managers to assist them in defining a strategy and opportunity for each investment fund that will be beneficial to the fund and its investors. Each new strategy and opportunity is typically segregated into a separate and distinct investment fund that is used to attract specific investors to that particular strategy, especially when a sponsor is preparing to start a real estate fund.
We assist sponsors with an end-to-end solution to address all issues involved in starting a real estate fund.
Most often, the first place to start a real estate fund is to organize as Delaware limited partnership. Investors in the fund typically make capital commitments in specific dollar amounts (or sometimes other property) when they are admitted to the partnership. Each investor is then obligated to make capital contributions when called upon by the fund, that will generally be used for investments and to pay the fund's expenses. To start a real estate fund can be a very complex process, and even more so when the structure may involve multiple uses of leverage, triggering rules of distribution, additional debt and equity investment fund vehicles, a real estate investment trust, and other entities that can require creative and big-picture structuring. Fund managers who are preparing to start a real estate fund should seek out competent legal counsel to assist in forming a real estate investment fund so that they remain legally compliant and protect the sponsor, fund and investors from unnecessary liabilities.
Preferred Retun
Real estate investment funds are typically distinctive from hedge or some private equity funds in that they are most often closed-end funds and offer a preferred return. A preferred return is similar to an annual minimum or promised rate of return on invested capital after an investor has contributed a capital investment. Preferred return rates vary, but are typically adjusted for risk, and range from 5-12%. The preferred return is used as an incentive to invest in the closed-end fund because the investor will have no redemption rights or any right to demand that the fund sell any asset to make distributions.
Fund-Level Fees
Many real estate investment funds will pay the investment manager a management fee (1-3%) and may also pay other fund-level fees such as a loan origination or guarantor fee (although less common), property brokerage and management fees, and property-level fees, such as lease-up fees, eviction and other fees for legal matters, insurance and maintenance costs, marketing, common area costs, taxes, and more. Many of these fees can be paid for by the income produced from the investment properties, but when the income is insufficient to cover these costs, the investors may be required to make additional contributions as expenses. Offering documents must be carefully drafted to ensure all fees and risks are properly disclosed and investors are adequately informed before making any investment decision.
General Partner Incentive, Carried Interest, or Performance Fees
Assuming the real estate investment fund is profitable after the properties have been sold, the general partner will typically be paid an incentive allocation, which may be called the carried interest or a performance allocation. After the properties are sold and the investors are paid all of the preferred return owed to them plus their original investment amount, the general partner will typically receive a catch-up amount (an amount that is likely the same percentage as the split of the profits as applied to the cumulative profits above the original investment amount) and then receive a split of all remaining profits. Performance allocations typically range from 20% - 50% or may be set up in a tiered structure so that the general partner may receive greater incentive amounts based on greater profits generated.
We typically see a correlation between risk of loss and any incentives, such as profit splits, that are paid to the general partner. That is, the greater the risk of loss, the greater the incentive allocations the general partner will be entitled to, according to the fund's offering and governing documents.
For more information on how we can assist you start a real estate fund or with your specific legal matters or questions, reach out to us here.
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