Question about setting about fund for investors house flips

[Perry Luo]

Hi everyone, I'm new to this forum and new to real estate house flipping. My friends and I (one is an broker, another is an engineer/construction) are starting a real estate investment company. We want to set up a fund for investors to place their investments and we would pull the money out to make purchases of homes and renovations.

My questions are

1. What type of fund should we set up?

2. How do you determine the amount of return each investors get if the numbers of investors have changed since the beginning of a investment transaction?

3. What is best practice on the timing of when investors are allowed to put their investments/return out? To keep investors happy, see a return, and hopefully keep their investment in the fund?

Any input or other information would be great, thanks!

Perry

[Dion DePaoli]

The standard fund structure is 2.0% Management Fee and 20.0% of the Net Profit goes to the General Partner/Managing Member. This means the investor get's 80% of the net profits. In today's climate it is hard to raise capital so recess from that program include lower management fees, back end split and include a preferred return.

A preferred return is NOT a guarantee. So if the investment looses money so does the investor. Usually the management fee is paid regardless of performance and comes out prior to distributions of returns.

All that said, you can certainly play with the structure a bit to attract investors. Perhaps the group you can get to wants a preferred return or perhaps they want a chance at a higher overall return. In other words, does the investor have greater interest in yield or higher overall returns? This really depends on you and the folks you can market the fund to. Usually preferred returns mean less on the back side of the deal for the investor and vice versa. So a 8.0% preferred return is accompanied by 10% of the net profits on the back of the deal. A 0.0% P.R. is accompanied with a 80% net profit. Both structures would be subject to the same manager fee of 2.0% and the balance of the net proceeds would pay to the manager. You could drop your manager fee to 1.5% or less at your own discretion, again it is all about what the investor is willing to sign up for. This would also include designing manager milestones to take your manager fee, etc. This is a function of what you can sell to investors to get them to invest and what you will need to operate to produce them the return. Be careful to not concede to all the desires of the investor base and not be able to keep you lights on and operate.

In regards to redemption periods. This too is up to you and the investor group you can market to. It is also going to be dependent on the type of investments, whether long or shot term, you make with the funds. If you plan to make long term investments, you will need long term money. Some funds have 12, 24, 36 and 60 month periods. Some funds layer over a lockout period on top of that. So if you had a redemption period of 60 months, you might make a 36 month lockout. Not a ton of investors want to be locked up for long terms in today's climate. Typically, in your subscription documents you will have a clause that prevents you from fulfilling the demand for redemption if the money is invested in an asset and the asset is not liquidated.

Depending on how you want to join your investors together also influences other portions of the fund. Your investors can come in on a project by project basis or in a pro-rata basis. On a project by project basis you would likely only be able to redeem upon the liquidation of the investment or if you had the spare cash you could cash them out by buying their interest. The fund would not owe return or considered the funds deployed until you take the investors funds and place it in an investment and you would hold a commitment from them for their funds until said time. On a pro-rata investment, the investor is a percentage of the entire fund and are allocated return based on the time and percent of their investment. Investors can sort of come into the fund a little more freely on this structure opposed to waiting for a particular investment, although when you take the investment you owe return. You will want to think a bit about what your investing model will allow and what best suits what you want to do. For instance if you allow early period redemption's in a pro-rata fund, the liquidation of an investment may have consequences of the return for other investors.

Fund investment structures are typically a Limited Partnership or a Limited Liability Corporation. You could use a C Corp but I would guess that doesn't fit your needs best.

To truly setup and run a fund is detailed and can be expensive task. The fund, depending on the money you intend to raise will likely fall under Regulation D offering. With that you will have to register the fund and comply with laws and regulations including who can be an investor (accredited investors or friends and family) and who can not. You can raise money from unknown persons provided they qualify as an accredited investor and you perform the proper due diligence. If you setup a registered fund, the company as one of the owners of the fund can market the product via you or an employee or you can higher a Broker/Dealer to market the fund which will cost you some money or both.

The fund will need legal, accounting & audit and administrative support, like I said it is a pretty detailed thing. All of that is expensive. The expenses can be paid for by the fund, netted prior to distributions of profits to investors and managers. You don't want to do this by yourself in any manner. As said above get a lawyer and start to talk to them about it all. The costs I would tell you would be on the excess of $50k and could be $175k depending on what you want to get done.

If this is starting to sound more in depth than what you expected. Then you could do a couple of single projects with one or more investors where they join you in the LLC/LP that buys the asset. Might help you work out some kinks and keep it a bit simple for you. In that structure you could take investors on with equity shares in the company or issue notes and treat them like debt.