The Benefits of Real Estate Funds and How they Work

[Jorge Abreu]

Private equity real estate funds are becoming more and more popular in the last few years, but they're not exactly new. Real estate syndications have existed for decades, with some of the earliest examples dating back to 1926. Real estate funds come in two different flavors: REITs (Real Estate Investment Trust) and private investments. Private investment funds allow you to invest alongside a small group of other investors, while REITs offer publicly traded stocks that represent an ownership stake in a larger pool of properties around the world.

Commercial real estate has always been considered an "alternative investment," but it is fast becoming more mainstream. With housing prices skyrocketing, the increasing cost of raw components and lumber, and labor shortages, the idea of owning a piece of income property is just not in the cards anymore for many individuals. So, most investors are turning toward small multifamily or other hands-off type commercial real estate properties.

Aside from buying an entire storage facility or small multifamily complex on your own, another more affordable entry point into commercial real estate can be found through real estate investment funds. These funds appeal to investors who want to own commercial property but would rather be passive in their investing approach, meaning they do not want to directly partake in property management activities.

Investors pool money to purchase assets within the fund. The fund's sponsor then directs all of the fund's operations, including property management. If the fund purchases and renovates or buys and holds property for an extended duration of time, the sponsor team will need to make stronger efforts in property management. Real estate funds are a fantastic strategy for individuals who want to generate passive income by investing in real estate, but don't want to be responsible for the property.

Below, you will find everything you need to know about real estate investment funds, their benefits, the structure, profits, returns, and more!

What Is A Real Estate Fund?

Real estate funds are a mutual investment entity. Mutual investments allow investors to invest any amount of money they choose toward numerous properties at the same time, regardless of the property-to-capital ratio. This way, investors circumvent the need to have the entire capital amount that would be required to invest in whole properties as an individual. Investors can purchase a portion of several properties in the form of shares.

Real estate investment funds provide you the chance to invest in real properties with a variety of rules and regulations that are specific to each region. There are different kinds of funds, including dividend-paying real estate investment funds, which are similar to mutual funds. These funds combine money from investors and give them the opportunity to explore Investors may choose from a wide variety of funds, each with its own targets. For example, some real estate funds focus on large residential properties, while other funds might be focused on commercial properties that can be sold quickly.

Rules for each real estate fund vary. But generally, the funds offer investors the chance to invest in real estate at a lower price point, maintain liquidity since shares can be cashed out early, and, of course, the opportunity to earn passive income when rent is paid on the properties and when the value of the real estate increases.

Types of Real Estate Funds

As you look deeper into real estate funds, you will notice two main types of real estate funds. The first type is a private equity real estate fund. Private equity funds are not open to the public and have more restrictive membership criteria, such as high net worth or an institutional affiliation.

The second type is a Real Estate Investment Trust (REIT). Real estate investment trusts are publicly traded. Although there is a cost to the investor, REIT's offer liquidity and can provide diversification within your portfolio.

Real Estate Funds vs REITs

A real estate fund is pretty much another form of a mutual fund, except it is focused on investing in the securities public real estate companies offer. These real estate mutual funds differ from real estate investment trusts or REITs. Real estate mutual funds are exempt from registration with the Securities and Exchange Commission or the SEC, and they are exempt under what is known as Regulation D, Rule 506.

REITs are corporations that invest directly in commercial real estate, and when you invest in a REIT, it is like buying stocks, where shares can be purchased and sold. REITs and other securities have to be registered with the SEC. They can seek exemption from the SEC, but this process is costly, complex, and time-consuming, therefore not typically done.

How To Invest In Private Equity Real Estate Funds

Once you connect with a firm or sponsor who is offering an investment opportunity, you have a couple of choices as to how you can invest your capital. You can either send in capital you've saved in a highly accessible account or you can invest using your retirement savings.

Wire Liquid Funds

If you've saved your investment capital in a highly-accessible, highly liquid savings or other bank account, you can simply wire the entire investment amount to the sponsor, according to the instructions provided in the investment documentation. The sponsor will then buy shares in the fund on your behalf and list them in an account that is maintained at the transfer agent.

Self-Directed IRA Funds

The self-directed IRA is one of the most popular ways to access real estate investment funds. This version of an IRA isn't much different from a Roth IRA. Self-directed IRAs are more popular because they allow investors to invest in a wider range of assets, such as real estate investment funds.

Traditionally, brokerages do not allow investors to invest money in non-traditional investment possibilities from a Roth IRA, Traditional IRA, or 401K. As a result, investors interested in a real estate fund strategy may need to transfer funds from their existing, likely traditional brokerage account to an IRA custodian that offers self-directed investing choices.

The main benefit of investing in a real estate fund instead of buying and managing an investment property is it allows the investor to diversify their portfolio and still keep a hands-off approach. Investors should remember that self-directed IRAs are self-directed, which means it is 100% up to the individual to do their research and conduct thorough due diligence, find good sponsors, and explore potential opportunities and risks prior to investing in any fund or other alternative investment.

Who Qualifies to Invest In A Real Estate Fund?

There are a few qualifications that investors need to be aware of before they decide if this investment choice is right for them.

Investor Qualifications

Depending on the qualifications that fund management outlines, real estate funds may require that you have a net worth of at least $250,000 and that you contribute an initial minimum investment, which can range from $5,000 to hundreds of thousands of dollars, depending on the size and type of fund you're investing in. Many real estate funds will also have a maximum investment amount, and some will be open ended.

Real estate funds typically require a minimum investment period of one year or longer, although there are also "opportunity zone" real estate funds that allow for turnover in under two years. Real estate is typically considered an illiquid investment because it takes time to sell the property and receive your capital back out of the fund so investors will need to be prepared for this type of timeline.

REITs typically have much lower minimums and will allow you to buy in with a much smaller investment. They're more accessible, generally listed on public exchanges, and available for investment inside most standard retirement savings accounts.

Sponsor Qualifications

You gain from the fund sponsor's qualifications, connections, and experience when you invest in real estate funds. The sponsor is often a sector expert or group with extensive expertise in managing real estate investment opportunities. They’ve already performed detailed due diligence on the properties included in the fund, the market, and analyzed the projections extensively.

Sponsors will provide investors with thorough financial information to evaluate and evaluate prior to asking for financial commitment to the fund. They will also be accessible and delighted to answer any questions about the fund's strategy or how it will be a success for investors. Keep your eyes and ears open for any calls, webinars, or presentations in regard to the fund, as this is an excellent opportunity to get to know the team and the strategy on a deeper level.

The fund manager is in charge of all aspects of the fund's day-to-day operations, allowing investors to invest without being concerned with each transaction made through the fund.

Benefits of Investing in Real Estate Funds

Real estate funds often provide higher than average, consistent returns, that are independent from the stock market’s fluctuations, further proving that investing in real estate is a dependable way to generate revenue and profits over time. Real estate investing allows you to diversify your portfolio instead of having all of your eggs in one basket like with buying an investment property or stock market investments alone.

Investing in real estate funds also gives you access to the real estate market without the hassle of being a property owner or manager. You can pick and choose from different types of real estate investments without having to do all the research yourself - the fund's sponsor will have already done that for you.

Diversification

You combine your money with other investors' to buy a set of similarly rated assets in different locations using real estate funds. You may also diversify your holdings by purchasing shares in multiple funds. You can even diversify across asset types, markets, and appreciation profiles by buying shares in different funds. Diversification lowers risk while increasing the potential for greater returns for investors.

Profitability

Most real estate investment funds are designed to pay investors back before the fund's sponsor makes any money. As a result, the sponsor is under great pressure to ensure that the transaction meets its intended profit goal. The structure of investments is designed to maintain the interests of the sponsor and their investors in alignment.

Tax Efficiency

Most funds are structured to last longer than one year, meaning they will be taxed as long-term capital gains instead of short-term. Real estate funds also allow you to invest in real estate without worrying about depreciation.

Investors may benefit from pass-through depreciation, and the tax benefits will rest on the investor’s shoulders and be driven by their circumstances. Real estate funds offer investors a way to defer taxes on their share of income and capital gains until they actually sell their shares in the fund.

Preferred Returns

When it comes to preferred return, the investor is paid first. If it's a cash flow fund, investors will receive their distributions throughout the life of the investment. This sort of return is necessary because you'll be paid before the professional manager, which is crucial when dealing with higher-risk assets.

Will Your Next Real Estate Investment Be In A Fund?

There are many reasons people decide to invest in real estate and an additional list of reasons they might decide to invest in a real estate fund. Real estate investment funds are a great way to diversify your portfolio without having to take on all the hassles of owning property directly.

Not all funds are created equal, and you always want to do your research and due diligence before investing in a particular real estate fund. Be sure to vet the fund’s sponsor, management team, and explore the fund’s track record. Evaluate the fund’s targeted returns, then determine if you believe in or agree with their strategy and how long it will take to hit their target metrics.

As with any investment, research the opportunity thoroughly. No investment comes without risk, and no investment is foolproof. But the more you know about how the fund is structured, the team running it, and the assets that are inside the fund, the more likely you are to invest your hard-earned money in a profit-making machine!

[Chris Seveney]

@Jorge Abreu

Great post. I would like to add since the advent of regulation a+ you are starting to see an increase in alternative investment / real estate funds that allow non accredited investors and minimums as low as $100.

This is a great way to “test” a company by investing with them and seeing how they perform before committing significant dollars. Also they must register with SEC and submit yearly audited financials and semi annual reports.

[Chris Gallagher]

Does anyone here have a list of recommended, well-vetted real estate funds? How can one compare funds, and evaluate risk?

[Chris Seveney]

@Chris Gallagher

My recommendation is to do your own research on funds because I don’t take someone else’s word. Why? Look at FTX. Some simple due diligence on that company would have caused some concern for people investing in the company (people who had money on exchange is a different story).

I also saw yesterday a company who was fined by the state of Massachusetts banned from raising money in the state (for some serious stuff) just received $200M from an institutional investor.

You really want to get to know the sponsors. The other thing i mention is I have seen a lot of referrals be from people who have never invested with the company but had heard of them or “know someone who invested”. I see that a lot with subcontractors as well

Here are the two links and happy to answer more questions privately

https://www.biggerpockets.com/member-blogs/11998/98488-top-5-strategies-to-implement-before-investing-in-a-syndication

https://www.biggerpockets.com/member-blogs/11998/98489-top-20-questions-to-ask-your-syndicator-before-investing

[Badri Malynur]

@Jorge Abreu  Good article, as we move towards a recession I think more investors will migrate towards funds as they are more reluctant to make $50K- $100K investments in single deals and are looking for more diversification. Investors are also looking for advice on building their entire portfolio instead of people pitching one deal at a time. 

Customizable funds like those provided by Avestor combine the best features of traditional blind funds and individual syndications, providing individuals the ability to pick and choose individuals deals and still get the benefits of the fund like a single K-1. We believe customizable funds allow fund mangers to build a more holistic relationship with an individual investor and build custom portfolios within a single fund that can match an individual's cash flow and risk tolerance. Blind funds like the ones you mentioned do not provide that opportunity. 

[J Scott]

Quote from @Chris Gallagher:

Does anyone here have a list of recommended, well-vetted real estate funds? How can one compare funds, and evaluate risk?

Here's a podcast I did for BiggerPockets last year talking all about how to vet and to due diligence before investing in a syndication / fund:

https://www.biggerpockets.com/...

It's a long one, but if you're looking to invest, it's probably worth listening to.

[Khoa Ha]

Anyone here have any experience forming a Real Estate Fund in California? I have a few questions I would like to ask. 

[Jorge Abreu]

Quote from @Khoa Ha:

Anyone here have any experience forming a Real Estate Fund in California? I have a few questions I would like to ask. 

 Not sure it really matters what state the fund is in. Most importantly you want to follow SEC guidelines in the formation of the fund and how you handle raising the equity. Best thing to do would be to speak to an SEC attorney about it. I can send you some referrals if you would like. 

[V.G Jason]

Quote from @Badri Malynur:

@Jorge Abreu  Good article, as we move towards a recession I think more investors will migrate towards funds as they are more reluctant to make $50K- $100K investments in single deals and are looking for more diversification. Investors are also looking for advice on building their entire portfolio instead of people pitching one deal at a time. 

Customizable funds like those provided by Avestor combine the best features of traditional blind funds and individual syndications, providing individuals the ability to pick and choose individuals deals and still get the benefits of the fund like a single K-1. We believe customizable funds allow fund mangers to build a more holistic relationship with an individual investor and build custom portfolios within a single fund that can match an individual's cash flow and risk tolerance. Blind funds like the ones you mentioned do not provide that opportunity. 

 Funds and REITs are the riskiest. You're going to weigh the pro-forma versus buying government debt, private debt or heck a BDC, not necessarily against buying land. Fund managers do not care about individual investors unless they make up more than 5% of it, and if you're an individual investor that is more than 5% in a fund you just put yourself in the aforementioned risk territory.