All Forum Posts by: Lance Pederson

I’ve structured funds with similar strategies and we are administering several funds that have gone the open-end route. The cost and the complexity is very much a concern.

If I were you I’d structure it as a close-end fund with a 2 year fundraise period and a 3 year investment period. You can reinvest proceeds from the flips during the investment period.

You could then start raising for Fund II immediately after the fundraise period expires on Fund I (aka rinse and repeat).

The next move could be to launch an open-end fund that you use as the takeout for the close-end funds. This gives investors the option to stay in or be bought out by new investors coming into the open-end fund.

My personal philosophy is that it’s all about accumulation of assets. By going this route you’re able to take some Promote off the table but retain the performing assets.

Jumping straight to the open-end fund will force you to prematurely have to deal with things like valuation of assets, fluctuating unit prices, redemption rights, etc. Basically you’ll end up spending more time talking to your fund admin and CPA and answering complex questions from investors when you should be focused on acquiring assets and asset management.

Happy to jump on a call to discuss further.

You could do a straight split of profit. Many equity investors prefer to have some type of hurdle in place to protect their downside. 

The setup expenses can definitely be a barrier to entry but the org costs typically end up being a fund expense and something like this typically costs between $10 to $15k. Most guys in your shoes will just handle them deal by deal. The issue is that at some point it ends up effecting your ability to grow and scale. The way I tend to look at it is that it's much like planting a tree. The best time to do it was 30 years ago, the next best time is today. If you need to capitalize your ever growing deal flow on an ongoing basis making the leap to launching a small fund to demonstrate that you can do it isn't a bad move especially when you are executing a strategy with smaller equity check sizes.

There is no right answer on this stuff. You need to have a clear understanding of your long term goals. 

We have a Fund Advisory and Administration practice that I head up and we've helped over 180 real estate sponsors since 2012 architect and setup their funds. We also have a Private Equity Real Estate company that manages four or five funds at any given time. 

For something like this a fund would make some sense. If you are building 10 homes same target, that should be pretty easy for investors to get their minds wrapped around. You would typically determine some type of Preferred Return (e.g., 8%, 10%, etc.) and then a split above that (e.g., 60/40, 70/30, 80/20). You would set the Maximum Offering size of $1M and a Minimum Investment amount (e.g., $25k, $50k, etc.). 

You could set a Minimum Offering amount of $200k and once you received commitments of at least that amount you can call the capital in and start making investments. You give yourself a set window of time (aka Fundraising Period) to get the remaining $800k. For something like this 12 months is probably the appropriate amount of time. 

There are other structures you could explore but this would be one of the more aligned structures. 

Michael,

This is definitely the million dollar question! It's hard enough to build new investor relationships during ordinary times let alone in the middle of a global pandemic. 

There are a handful of books on the market (e.g., Michael Blank, Matt Burk, Hunter Thompson, Adam Gower, etc.) that outline how to build what amount to lead machines online or speak to strategies on raising capital in general. 

Richard Wilson is having an online event tomorrow (December 15, 2020) called the Family Office Super Summit where you may have a chance to mingle with prospective investors. 

There are also investor clubs like For Investor By Investor (FIBI), Keiretsu Forum, The Mile Marker Club, Freedom Founders, etc. that have various programs available that allow you to gain access to their member base either by paying a fee to pitch your deal or becoming an training resource to their members at their various events. 

At a high level though it seems that the strategy that worked best before the pandemic is the one that you must use during the pandemic and that is to build an educational platform to gather people. The podcast seems to be the preferred method of most real estate entrepreneurs these days but others seem to be having success with hosting online meetups as well. Maybe you do both! Most of the books mentioned above will recommend that you have some type of lead magnet/ebook to capture investors contact information followed by some type of auto responder campaign. 

Personally, before the pandemic our firm had great success with live educational events that trained investors how to conduct appropriate due diligence on sponsors and their deals and we've transferred that to a new online platform that is aiming to do ostensibly do the same. 

An alternative path would be to subscribe to databases like Preqin where you can run outbound calling and email campaigns to put these deals in front of the more institutional-type of investors. They will require you to come up with some type of co-investment (e.g., 10%) if they like the deal and the terms won't be as favorable but it can help you get from where you are to where you are going as you build you high net worth investor base. If you go this route you will need to make sure that you make it through their due diligence process. They will expect that you can provide them with detailed information on all of the deals you've done up to this point and that it lives in some type of secure data room (e.g., DocSend, Interlinks, Dropbox) that you can promptly give them access to. 

Hope this helps!

The way that I tend to look at it is that if you are going to be a passive investor you just assume that you’ll be sharing some % of the total profits. It’s typically 25% when all is said and done.

Doing an apples to apples comparison is easier if the deal is a single asset syndication. Funds are much more challenging because they are often blind pools where the assets don’t yet exist.

If you have the pro formas for the individual deals then you'll want to compare the property level cash on cash returns and then the IRR and equity multiple. If cash on cash returns seem low but the IRR is high (e.g., 18%+) then it means they are generating most of the return on the sale which is something you'll need to scrutinize more closely. If it's the other way then they plan on bumping rents aggressively and you'll want to dig in there.

When evaluating financial projections of any kind it’s important to ascertain the assumptions that were made. You then need to ask yourself whether or not you agree with those assumptions given all of the other variables (e.g., market forces).

If you pan all the way out though, the first thing you need to ask yourself is what are your goals (e.g., spend more time traveling, become a full time real estate professional, etc.) and what problems are you trying to solve in your investment portfolio (e.g., overweighted in stocks, not enough income generating investments, etc).

If you decide to go the passive route, my belief is that you need to vet the sponsor running the deal first, then the market the deal is in and then the deal itself. 

Hope this helps!

My business partner, Matt Burk, wrote a whole book about this subject you might want to check out.

Due to securities laws you can only compensate registered professionals on a performance basis (e.g., % of capital raised) whether they are employees, subcontractors, placement agents or otherwise. This is what makes solving the problem so difficult. 

The two models I see most often used are bringing on another partner to handle the capital side of the business. They will usually form a new entity that only receives the asset management fees and the promote earned on the projects where external capital was raised. The development fees would go to another entity that you and your current partner control.

The other way to go is to hire an employee to head up Investor Relations. You could pay them a base salary and structure something where they get a % of the Promote/Profit earned from the projects.

As Matt lays out in his book, some type of pooled vehicle or syndicated entity ends up becoming part of the solution as well. Said another way, having investors borrow money to OpCo doesn’t scale very well. You need to bifurcate the functions of the business. In this case, you will have a development company and a capital management company.

Hope this helps!

@Tom Dittrich

I think what @Spencer Gray was saying was that you could potentially invest your fund's capital into the GP entity on a given deal which in turn would be invested alongside the other LPs in exchange for some % of the Promote off of the other LPs (e.g. 10%). This would juice the return and provide further credence to any Management Fee or Promote you are charging your investors. This solves a potentially problem for the syndicator of having a more meaningful co-investment (e.g. 10% instead of 2%) into the deal making it easier to potentially raise the remaining LP capital. 

The other angle would be that you just ask the Sponsor for some percentage of the Promote for a large direct investment into the deal (e.g. We'll invest $1M in the deal but we'd like 5% of your Promote off the other LPs).

I've been advising many syndicators lately to just set their syndication up to support this by default by having two Classes of Units. Class A Units, for those that invest $500K or more, get an 8% Preferrred Return and an 80/20 split. Class B Units, for those that invest less than $500k, get an 8% Preferred Return and a 60/40 split. 

This leaves the door open for the Professional Investors (aka Allocators) and the Sponsors end up getting what they often want which is fewer larger check writers. 

@Tom Dittrich It's a completely viable strategy. I've been seeing a lot of these types of vehicles being tilted up lately. There are two structures that work really well for this concept. As someone mentioned the securities work to put the PPM, OA, subscription agreement together would be around $15k. I know a few great attorney's that understand this type of structure really well that I could connect you with. 

1) Traditional Close-End Fund. You set the maximum offering target raise amount. Get commitments from your Members and then call the capital in as you do the deals. You can typically negotiate better economics if you are making $500k+ investments into individual syndications which leaves you enough room to charge your Management Fee and Promote. 2% seems a little steep. 1% is probably more appropriate. 10% Promote is probably better than 20%. You could tilt up a new vehicle once every 9 to 12 months. The end user investors would end up with exposure to 4 to 6 deals. 

One issue that you run into when running these fund of funds is that it's often difficult to get 100% of the commitments up front. You don't really want to wait to start making investments until you have the $2M or $3M committed. We've solved this issue by handling allocations and distributions on a weighted average contributed capital (WACC) basis to solve any dilution issues. 

2) Rolling Fund. This structure is becoming more popular as well since it allows you to only have to go through the formation process once but you can continually bring new investor capital into the vehicle as you make new syndication investments but not have to deal with redemptions like you would in a traditional open-end fund. 

Feel free to reach out if you'd like to discuss in more detail. 

@Patrick Hancock As many people have already mentioned liability protection is the typical reason people put each asset into a separate LLC. We're a real estate fund administrator and most of our clients that have many SFR properties will hold them in just a handful of LLCs and the determination or whether a new one is needed is typically based on the lender providing them with a blanket loan/LOC. If they hold them free and clear they will just keep them in the main Fund LLC.

The other thing that some people are doing is forming a Series LLC. The allows you to have a Master LLC and then spin up separate LLCs underneath it without having to pay an additional franchise tax or file a separate tax return but gives you the flexibility to hold certain assets in those entities and even have the ownership structure be independent (e.g. Property #1 through #10 are owned by Investor #1, #2, #12, #18 and Property #11 through #18 are owned by Investor #3, #19 - #28).

You are right though, it is very difficult to be in the real estate game without spawning dozens and dozens of LLCs. 

As Brian said, you have to take the RMD in cash. We provide third party fund administration for many real estate funds and many of the investors in our clients funds will have it set to reinvest for the first X number of months of the year and then switch to distributions for the remainder so they can make the RMD. 

That way you get the benefit of compounding but still meet the regulatory requirement.