The general idea underlying real estate investment funds is providing access to larger properties while reducing risk for investors. The largest and most technically complex versions of real estate fund structures are REITs (Real Estate Investment Trusts), which are pooled investment vehicles that must meet stringent regulatory requirements.
These requirements include needing a large number of investors, a substantial asset base, marketing restrictions, and often access only being given to certain classes of investors. Conversely, real estate funds may be as simple as a group of local investors putting together their capital to purchase a handful of single-family homes for rental properties. Or as large as deca billion dollar opportunities.
In this article, we will cover the various types of real estate fund structures, the objectives of different types of fund strategies, and some of the benefits and drawbacks of each so you can make informed decisions when analyzing real estate investment funds.
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Real Estate Fund Specializations
As with investment funds in general, real estate funds are trending in the direction of greater strategy specialization. Strategies may vary by asset class, market area, or both. Examples of asset classes of real estate can include multi-family, office, industrial, retail, and special-use properties.
Real estate fund strategies are often categorized into one or a combination of the following types.
Real Estate Development Funds
Funds that focus on acquiring unimproved land or clearing older property lots to re-develop into more modern real estate concepts are called real estate development funds. These types of funds are heavy with documentation, entitlements, and are complex to establish because of the numerous permitting requirements and construction factors involved. Development funds are generally better for expert-level real estate investors who understand the nuances of construction and how to deal with municipality regulations, as well as investors with a VERY high risk tolerance, as Development investments are one of the highest risk categories in all of real estate.
Joint Venture Real Estate Funds
Joint venture real estate funds co-invest with other funds in a syndication. This can sometimes result in the fund being considered a security, which changes how it’s regulated. Typically, joint venture funds are created to raise funding for a specific purpose or property investment, in which each partner fund contributes a certain dollar amount or percentage toward the joint venture fund.
Structured Finance Real Estate Funds
A structured finance fund utilizes debt financing to purchase real estate with substantial leverage. Usually, these properties have stable value projections that support taking on the debt risk levels necessary. That said, structured finance funds are often cyclical in nature, as they require access to affordable debt financing to be profitable.
Opportunistic/ Special Opportunity Funds
Opportunistic or special opportunity funds use a strategy of seeking out properties that are selling at a discount due to extraordinary or uncommon circumstances. Examples of these properties include foreclosures, unfinished commercial construction projects, or real estate that’s been damaged in a significant weather event. The best opportunity funds find real estate in markets that are otherwise desirable, allowing them to deliver strong returns.
Distressed Asset Funds
Distressed asset funds acquire property that is over-leveraged or has cash-flow problems that prevent it from accessing financing. For these real estate investments to work, the property must be undervalued, along with the fund having access to inexpensive capital, which makes these funds generally cyclical in nature.
Perhaps the antithesis of the strategy-specific funds in this list, multi-strategy funds use a combination of different investment strategies with the intention of better mitigating risk and preserving capital for investors. Although multi-strategy real estate funds have the latitude to leverage a variety of strategies, typically, fund sponsors focus on one or two core investment strategies oriented toward security, with a small portion allocated toward more growth-oriented strategies.
Real Estate Fund Structures
The structure of a real estate fund depends on an array of considerations regarding tax, regulatory, and financial factors that can impact fund performance and the complexity of management. One of the primary considerations regarding fund structure is the tax objectives of the investors in the fund.
Most real estate funds are structured as closed-end funds. These funds are structured to last for a fixed term, often ranging from five to ten years. Investors in these types of real estate funds generally aren’t allowed to either withdraw funds or make additional contributions during the life of the fund. Once the fund is fully capitalized, the investor receives their capital back only if the underlying asset is sold, refinanced, or positive cash flows provide dividends.
Many types of funds like private equity funds, venture capital funds, and other illiquid asset funds are structured as closed-end funds.
Successive Fund Structure
In the less-common successive fund structure, the sponsor creates subsequent funds when assets within a current fund are sold, using the investment proceeds for reinvestment in the new fund. Typically, successive fund sponsors establish a portfolio of various funds to continually manage as assets are sold. A benefit to this approach is sponsors enjoy substantial cost savings overall due to less legal structuring is required to establish the subsequent funds.
Domestic Real Estate Funds
Domestic-only investment funds are usually made up of a collection of specific legal entities with the aim of maximizing tax advantages. These entities include:
- A Limited Partnership, sometimes established in the state of Delaware, to be named as the fund entity (LLCs are increasing in popularity for this purpose as well)
- An LLC that acts as the fund investment manager, established in the jurisdiction of the fund sponsor
- A general partner or managing member of the fund entity, also located in the jurisdiction of the fund sponsor.
In the case of real estate funds, the general partner and the investment manager entities are formed separately to allow subsequent funds to keep separate general partners for liability factors. These funds are typically created by groups of highly sophisticated investors rather than individuals or small-scale investors.
Smart Investing In Real Estate Funds
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Frequently Asked Questions:
In a limited partnership (LP), some partners (referred to as General Partners) manage the business and hold the unlimited liability for the partnership’s debts, while others (Limited Partners) provide funding with limited liability for the debts. The Limited Partners are only accountable for their investment and don’t participate in management.
In contrast, a general partnership (GP) is a partnership structure where all partners have equal management power and unlimited liability for the partnership’s debts. In a GP, each partner bears complete responsibility for the full debt, not just their share, through joint and several liabilities.
To sum up, limited partnerships provide protection to investors through limited liability, while general partnerships don’t offer this protection as all partners are liable without limit.
Apartment complexes, hotels, office buildings, and retail malls are all examples of income-generating real estate assets that can be owned by a Real Estate Investment Trust (REIT).
When compared to other forms of real estate funds, REITs stand apart in a number of ways:
-Real estate investment trusts (REITs) are organized as trusts and must pay out at least 90% of their taxable income to shareholders in the form of dividends.
-Limited partnerships, joint ventures, and private equity funds are some other types of real estate funds.
-The Securities and Exchange Commission (SEC) enforces strict rules for real estate investment trusts (REITs), such as required reporting and dividend payouts.
-The same rules do not apply to other types of real estate investment funds.
-Ownership: Real estate investment trusts (REITs) are publicly listed firms since they have many stockholders.
-On the other hand, there might be real estate funds that are privately held and have a limited number of investors.
-While real estate investment trusts (REITs) prioritize capital appreciation and rental income as their primary investment goals, alternative real estate funds may focus on other strategies, such as property development and resale.
To sum up, real estate investment trusts (REITs) are a specialized sort of real estate investment vehicle governed by the SEC, created to generate income, and organized as a trust with publicly traded shares.
Structures, investment strategies, and regulatory burdens of other real estate funds may vary.
Depending on the type of fund and the investor’s country of residency, the tax consequences of participating in a real estate fund will vary.
However, frequent tax consequences include:
-Taxes on income: Any rental income or capital gains generated by the real estate fund may expose investors to income tax.
-The tax rate will vary according to the investor’s country of residence and tax bracket.
If the real estate fund is organized as a REIT, dividends may be liable to dividend tax.
-When an investor sells their investment in a real estate fund, they may be required to pay capital gains tax on any profit they realize.
-The rate of capital gains tax will vary depending on the investor’s nation of residency and tax category If a real estate fund owns properties, it may be required to pay property taxes, which might be passed on to investors through the fund’s expenditures.
Noting that tax rules and regulations are subject to change, investors should consult a tax specialist for guidance on their unique tax position.
Investing in a real estate fund may have income tax, dividend tax, capital gains tax, and property tax repercussions, depending on the investor’s country of residency, the kind of fund, and individual tax bracket.
President of Saint Investment Group
Nic is a two decade seasoned expert in investing and capital raising, specializing in Real Estate and debt markets. With Saint Investment Group, he leads large-scale distressed asset purchases and innovative syndications for investors.