Moses Kagan on Real Estate

Passive real estate investing part 3: Funds

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We’ve previously discussed why active real estate investing can be challenging for individual investors here. And then we talked about investing in syndicated deals. This post is about investing in real estate funds, also called “blind pools”.

The kind of funds we’re interested in today don’t start out owning any properties (the ones that do look more like syndications, because the assets are already in place). Instead, they raise money based on business plans and then, once the money is raised, go out and buy (and, hopefully, improve) the assets that fit their plans.

For example: One fund might raise money in order to go out and buy and flip a portfolio of single family homes in South LA. A different fund might target mid-size office buildings in Des Moines.

The sponsor of a given fund (the person or entity that raises the money) gets paid much like a syndicator does: by charging the fund a variety of fees, (sometimes) by acting as a broker on the deals the fund does, (sometimes) by acting as general contractor on deals the fund does, and by taking a piece of the profits after the investors get their share.

Investors in funds typically expect a preferred return (typically 6-8% per year on capital deployed) plus a share of the profits (somewhere between 50-70%).

Many investors shy away from investing in funds. This is mostly because they don’t get to see real numbers on the asset or assets the fund is going to buy (hence, the name “blind pools”). Instead, they are asked to invest based on trust in the sponsor’s ability to find, acquire, manage, and exit suitable assets.

I believe this bias in favor of syndications is a mistake, because funds have major advantages over syndicators:

  1. Funds can move very quickly. Once a sponsor with capital committed to his fund (often called “dry powder”) decides to do a deal, he can buy a property in days, because he doesn’t have to go around raising capital first.
  2. Sellers perceive offers from funds as more likely to close than offers from syndicators. Because the seller knows the sponsor doesn’t require permission from anyone else in order to close (as long as the deal fits within the parameters of the fund as set out in the operating agreement signed by the investors), the seller can commit to doing a deal with the fund knowing that there is a high likelihood that it will actually go through.

Because of these advantages, I would expect that, on average, funds are able to generate better returns on a deal-by-deal basis than syndicators. Therefore, fee structure, execution ability, etc., all being equal (which they never are), a given fund ought to provide better returns than a given syndicator.

A final point: Investing in any real estate deal, whether passively (through a fund or syndicator) or actively (by buying on your own), entails taking on risk. I can’t emphasize enough how important it is to do your homework before committing your precious capital.

N.B.: The above is not, and should not be construed as, a solicitation of investment in any fund or syndication.


Written by mjkagan

06/07/2012 at 4:40 am

Posted in Buying, How to

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