What’s so Great About a Real-Estate Fund?
By Kathy Fettke | RealWealthNetwork.com
You had a tough time getting to sleep. Then, the phone rings. You think it’s the doorbell as you stumble out of bed, in your dreams, and suddenly realize your cell phone is doing it’s ringtone vibrating dance on the nightstand.
“Hello? … The heater. … Right now? … Your kids are crying? … Let me call you back in five.”
Okay, that’s one possible scenario in the life of a landlord, if you manage your own properties. Or, you could have a property manager. In that case, the phone call would come the next day telling you of a difficult night with tenants, and requesting permission to spend a certain amount of money to remedy the situation.
Option number two is a whole lot easier than option number one. But there’s an option number three that’s even easier. In this case, you would invest in a real estate fund created by a group of investors who pool their money to buy multiple rental properties.
It’s like a mutual fund only it’s tied to hard assets instead of the whim of Wall Street investors. The fund itself is professionally managed along with the properties. You get returns and tax benefits on your investment but you don’t have any of the typical landlord responsibilities.
Direct Ownership vs. Real Estate Fund
There are big benefits to any kind of real estate ownership. When you have direct ownership of a rental property, you have complete control of how that rental is used and the flexibility to make changes. You also have big tax benefits, and you get all the profit.
A real estate fund can provide other benefits that may be better suited for someone who is too busy to manage properties or even a property manager. It’s also great for people who are new to real estate and don’t want to take the time to learn about the nitty gritty details.
When you put your money into a real estate fund, the first thing you are getting is “diversification”. You are pooling your money with other investors to buy multiple properties and getting the diversity without spending the time or money it takes to do that yourself. The fund may have 150 properties of different assets classes in different locations. That gives the fund strength if some of those properties, or markets, flounder.
With a fund, you don’t have to qualify individually for financing. That’s a really important part of the deal. Positive leverage is one reason we are in this business. That happens when you borrow money to decrease the amount of the initial investment and bring in higher returns than the cost of the loan. So if you are tapped out on financing, have bad credit, or don’t want to go through the hassle of getting a loan, a fund will take care of that for you.
Another big benefit of owning income-producing real estate is the tax savings. Most funds are set up as a pass through entity such as an LLC so any of the tax benefits you get from “direct ownership” are also available for fund investors. And, that structure is professionally managed so you don’t have to deal with a lot of paperwork or bookkeeping. You will get periodic statements that are often sent quarterly, along with your paycheck.
The icing on the cake — fund investors will typically get a “preferred rate of return”. That means that investors get paid first from the profit pool. Fund managers get paid after that. So whatever percentage you agree on as your rate of return, you will get that money first. This is a great benefit. It puts the investor “first”.
Other advantages of a fund include the buying power of a big team. The people putting the properties together for the fund will having relationships with industry insiders. They will have expertise at recognizing great deals quickly and the ability to buy those properties before they disappear. And, they will be able to negotiate lower prices if they are buying in volume.
The Role of a Fund Investor
First of all, any tips offered in this article are not to be construed as advice. The first rule of thumb for any investment is to speak with your accountant and get your advice there. This article only attempts to help explain the idea of a real estate fund so you are better informed to find one that works for you.
Preliminary research and follow-up are always important for any great investment. Here’s a checklist:
1 – Research fund managers & their investment history/track record
2 – Understand the fund’s return structure, timeline & exit strategy
3 – Read the offering documents & run it by your CPA and attorney
4 – Don’t be afraid to ask lots of questions
5 – Find out how and when you will receive updates & distribution statements
The background and experience of the managers is the most important factor. It’s better to turn down a great opportunity with inexperienced managers, than become a part of their learning curve. Experienced managers know how to choose the right investments and navigate through challenges that are certain to pop up along the way.
Understanding the timeline or the “life of the fund” is also very important, including when you are allowed to exit the fund. If the fund requires a 5-year investment obligation, you should know that ahead of time, and what it requires to remove your money from the fund when that timeframe expires.
Beware of a fund with no “end date”. There’s more of a chance the fund could turn into a Ponzi scheme if it’s open-ended. A closed fund, with a specific timeframe, is usually safer.
Accredited Investors Need Only Apply
Most funds require that investors are “accredited”, meaning that you must earn a certain amount of money or possess a certain “net worth”. To be accredited, you must have an income of $200,000 a year for two straight years, or $300,000 if you are a couple. Or, you must have a net worth of one million dollars, excluding the equity in your primary residence.
You’ll see lots of buy & hold rental funds on crowdfunding sites these days. In most cases, you must be an accredited investor to participate in those. However, if a private company only reaches out to people with whom they have a prior existing relationship, 35 non-accredited or “sophisticated investors” may participate.
According to Investopedia: “A sophisticated investor is a type of investor who is deemed to have sufficient investing experience and knowledge to weigh the risks and merits of an investment opportunity.” Sophisticated investors (or accredited, for that matter) should never invest more than 10% of their net worth into any one fund or investment. Diversification is key.
A prior existing relationship requires “three touches” with the organization or three different ways that you’ve had contact with that company. It’s not well-defined, and is basically up to the fund managers to determine if that criteria has been met, but it could mean a combination of phone conversations, in-person meetings, email correspondence, or event attendance.
To find out more about buy & hold rental funds, private lending, and direct investment in cash-flowing turnkey rentals, join our network at www.RealWealthNetwork.com. It’s free and will give you access to quality investor education from real estate attorneys, CPA’s, property managers, insurance agents, and much more.
Tags: Property Management, Real Estate