The Nuts and Bolts of Rasing Capital

The Nuts and Bolts of Raising Capital: 4

Types of Real Estate Funds

Robb Krautbauer

http://thecommercialinvestor.com/undefined

http://thecommercialinvestor.com/author/sal/

The Nuts and Bolts of Raising Capital:4 Types of Real Estate Funds

If you do not understand the essential principles of what a real estate fund isor why you need to grow into your position as a fund manager, you will needa refresher course.

This is done so that when you are creating and instituting your capital raisingstrategies, you do not misstep and lose out on potential investors because ofyour limited field knowledge.

Today we’ll be talking about the first step in raising capital for a real estatefund. When you are looking to raise capital efficiently, you must first decideon your fund type.

Before we dive in, let’s answer a question I’ve heard more times than I cancount…

What Exactly Is a Real Estate Fund?Your real estate fund is whatever you have structured it to be based on aplanning and creation process that involves a lot of research and time-consuming documentation.

Used with permission from TheCommercialinvestor.com/blog

http://thecommercialinvestor.com/blog/


But simply put, a real estate fund is—quite literally—a supply of capital.

When your investors pool their money together and hand it to you to increaseit, they retain ownership.

You can also reframe it and say that a real estate fund is a financial entity.

Multiple investors get together and pool their money so that thislump sum can be efficiently invested in multiple assets—for the goalof making money from money.

It takes nerves of steel to raise capital from many sources and to beresponsible for an earning fund.

Funds can raise capital from an indefinite number of joint deals as well. Thiswidespread diversification is excellent for your investors.

They will enjoy much greater access to interesting investment opportunitieswhile benefitting from your constant attention, professional expertise, andinvaluable research as a fund manager.

When a fund manager focuses on one specific type of real estate investment,they usually have years of valuable knowledge behind them and can meettheir targets easily.

In return for handing over an investment amount to their chosen fundmanager, an investor will pay the manager fees, often a percentage value ofthe fund.



As a fund manager, it is your job to raise capital, find good deals, executethose deals successfully, and manage the fund—all while making yourinvestors’ money.

Funds invest in real assets like commercial property, residentialproperty, shopping malls, land, small holdings —anything tangible.

A good fund manager will earn their investors stacks of cash from theirexpertly planned investments.

I know of many real estate experts who have started their own funds andearned huge gains for their investors and themselves. With these larger deals,all that remains is for you to consistently learn how to raise capital.

Fund EconomicsIt’s important to realize you can’t just pile fees on top of your fund withoutperforming first; this is something almost all novices do and theyimmediately shoot themselves in the foot.

The Four Main Types of FundsAny good fund manager will tell you that there are four main types of realestate funds.

Get your pen and paper out and prepare to take notes, because we’ll be divinginto each of these types of real estate funds you’ll be choosing from:

Open-Ended FundsThis type of fund is a collective investment that allows for the issuing andredemption of shares at any time during the investment process.


http://thecommercialinvestor.com/4-types-of-real-estate-funds/


Funds are usually bought directly from the fund itself, not from shareholders.

Closed-Ended FundsThis type of fund is a collective investment that has a fixed number of shares.New shares are not created at any stage to meet the investor demand, as theyare in open-ended funds.

The Accessible FundAs a method of identifying the type of fund, accessibility is key.

Sometimes investors will pool in exclusive groups, and sometimes they willraise capital from middle income groups; it depends on the fund.

Fund Capital StructureAs a method of identifying the type of fund, capital structure also leaves someaccurate clues.

Sometimes all of the investors will invest the same amount and, in othercircumstances, different investors will invest different amounts.

Despite the economic downturn, fund managers are cropping up all over theplace.

Targeting the right investment structure is instrumental inattracting the right quality of investor needed to populate yourfund with working capital.

The choice you make here will also have multiple tax consequences.




If a fund, for example, is formed as a limited liability company, it is taxable asa partnership for federal income tax purposes.

The fund itself will not be taxed, however, which means that any income,loss, credits, or deductions will find their way to the investors.

Settling on the correct fund structure will help you piece together yourinvestor pitch, which is crucial in raising capital. Bringing up great tax breaks,for example, could be that little something extra that causes you to landanother excellent investor.

Pay close attention to the entity types that you select for your fund.Focus on admission and withdrawal of your investors when structuring.Check on your capital contributions and capital calls.Determine the allocation of your profit/losses, clawbacks, and capitalreturns.Work out conflicts of interest, fees, and expenses.

The Open-Ended FundTraditionally, an open-ended fund can be defined as a type of fund that hasno restrictions on the amount of shares that the fund can issue.

If people want to invest in an open-ended fund, they will be able to—regardless of the number of investors that currently invest.

Another way of looking at it is that open-ended funds refer to the method ofcapital raising used. As the fund manager, you will continuously raise capitalin your open-ended fund—and this capital will be deployed throughout allother fund processes.




When you come across a new investor, the fund assets will simply increase.

That means that the capital amount and the share amount will both increaseto make room for the new investor. When an investor decides to call it quitsand cashes out —whether it is all of their money or part of it—the shares willbe sold back to the fund, and they are cancelled.

While this reduces the number of shares and the overall fund assets, it doesnot affect anyone else’s investment. Open-ended funds raise money by sellingshares of the fund to the public.

The fund manager will earn income by collecting fees from the purchase ofshares or as a percentage of the overall lump sum.

You could also collect commission based on your performance with yourinvestments.

Open-ended funds are consistently and continuously managed—which meansthat you source, purchase, and manage the real estate investments and areresponsible for the financial outcome of the fund.

Sometimes when an open-ended fund has grown too large, a fundmanager will decide to close the fund to new investors. On occasion,they may even close new investments to existing investors.

This only happens if the fund performs extremely well and there is a rush forshares and profit.

The type of fund that you choose depends on your eventual purpose. A fix-and-help fund, for example, invests money into single-family homes, fixesthem up, and then sells them again for profit.




These are a great fit for open-ended funds.

If your fund expects to have a large, broad number of investors with manybuying and selling opportunities in short time periods, then it neatly matcheswith this type.

Open-ended funds are the opposite of closed-ended funds, which I willexplore next. In the meantime, here are some key takeaways to help youdecide on your capital raising structure.

Investors can enter and exit as they see fit.Management continues on an ongoing basis for the fund manager.Buying and selling real estate models suit this well.Growing, larger real estate funds do better when they are open-ended.Your investors maintain control of their shares and investments.You have the responsibility to invest widely and make your pool money.

The Close-Ended FundA closed-ended fund is typically an investment vehicle that is public andraises a fixed amount of capital.

The fund is then structured, and shares are sold like stocks on a stockexchange. In your closed-ended fund, the fund manager will raise capitalduring an initial phase of capital raising.

This could take six months or two years depending on the manager. Once thisinitial phase is closed, no more shares will be created.




Only existing investors can buy and sell their existing shares. That alsomeans that share prices will fluctuate and change—because the market valueof invested assets will change over time.

In the wide world of real estate, closed-ended funds are a lot morecommon than other types.

This is particularly true when you plan on buying high-cost property to holdfor extended periods of time. Because of this, you will find the bulk ofinstitutional real estate funds are, in fact, closed-ended funds.

Investors tend to enter the fund during the capital-raising period—before anyinvesting has taken place. Then everyone purchases shares at the same price.

The typical buy-in for these funds can be 5, 10, or even 20 million dollarseach. Immediately after the allotted fund-raising period, the investmentphase kicks in.

During this phase, which is also predetermined for, say, five years or so, thefund will be liquidated. On that day, every investor will get their pro-ratashare of the proceeds. Sometimes fund managers choose to leave theinvestment period open-ended.

In these types of funds, investors may want to liquidate their investment inthe fund, either partially or fully. When this happens, they will need a willingbuyer. You will need to think very carefully about these models beforeselecting one.

A closed-ended fund gets its name because of the different phases ofinvestment.




Once the initial allotted shares are sold, the fund is basically closed to newinvestors. Buying and selling, however, can still take place between individualinvestors of the fund.

Here are some key points about closed-ended funds. Consider them whenselecting your ideal real estate fund structure.

Investors can only enter during the capital raising phase.Management continues until the allotted time or until the fund isliquidated.Long-term buying and selling models suit this common fund type.Closed-ended funds are great for single investors looking for diversity.Investors are able to buy and sell after the capital raising phase.The fund manager still seeks out and manages investments.You have the responsibility to turn your investments into profit for yourshareholders.

The Accessible FundThe third type of fund refers to the method that the investors have foraccessing the fund.

Many funds are closed, in which case the manager will look for capital closeto home via their own network contacts and connections.

These private equity funds often require large-scaleinvestments—reaching millions of dollars.

For other types of funds, you as the fund manager will raise capital throughtraditional markets, which means that you will be attracting middle-classinvestments.




These funds are open, and they can be created as Intrastate Offerings or 506Reg D funds. Speaking of 506 Reg D funds, they may have a complex name,but this is because they are based on a specific rule—(506) of Regulation D.

All of these types of funds were subject to 506 rules, which enforcedlimitations on advertising and sourcing investments.

The fund manager can only approach investors that they have an existingbusiness relationship with when they choose this fund structure.

Investors have to be accredited, and no more than 35 non-accreditedinvestors are allowed per individual fund.

Your accredited investors can self-certify, and the ones that are not certifiedmust, at least, be able to adequately assess the suitability of your fund forinvestment.

In about 8% of cases, Reg D funds benefitted from the non-accreditedinvestor exemption.

I have personally only ever taken on accredited investors, and I would highlyrecommend that you think along the same lines when you have to set up yourreal estate fund.

When you select a 506, you will have to file a form D no later than 15 daysafter the first sale of shares to keep everything in order.

Luckily, these were the rules prior to September 2013, which have nowpassed.




A new provision, Rule 506c, allows you to use general solicitation in yourinvestor strategies—which means that you can now raise capital frominvestors you have no relationship with at all as long as they are accredited.

It is your responsibility to verify that each of your investors isaccredited, and this verification process will most likely increaseyour capital raising costs.

In the new 506c version, you have to file a Form D at least 15 days beforestarting general solicitation, which means that you cannot switch at the lastsecond from B to C.

Your Intrastate Offerings are just securities that are registered in the statethat your fund operates in.

These types of funds have far less restrictions on advertising and sourcinginvestors, and you can accept non-accredited investors as you see fit. It doesallow you to advertise in newspapers and cold call people—as long as they arein the same state as you.

While these funds offer more flexibility in terms of capital raising, they canplace more restrictions on your investment assets. For example, the fundrequires that at least 80% of all capital raised needs to be invested in yourchosen state.




The Capital Structure FundThe final type of fund structure that you need to be concerned with is definedby its capital structure.

All of the funds that I have mentioned until now have been equity funds.

An equity fund is when an investor becomes the owner or memberof an LLC—or another entity—which is the fund itself.

These are considered “Pari Passu,” which means equal footing in Latin.

When all shares have equal seniority and rights of payment, this term is used.But now I am going to talk about another type of structure—a debt fund.




In this instance, instead of selling equity in the fund to your investors, you asthe fund manager will borrow the money from your investors—who thenbecome lenders or note-holders.

Do you see the difference?

Instead of becoming equity partners and shareholders, they become lendersand note-holders. Debt funds are not something you should consider at thebeginning of your adventure with real estate funds, so I will only touch onthis so that you remain informed about it.

If you do choose to walk down the debt fund path, there are manyimplications involved that you need to investigate.

For the purpose of this post, I will be focusing mainly on 506 Reg D funds—which is the safest and best form of equity fund, in my humble opinion. .

In this particular model, your investors own their shares but have no real sayin the way that you manage the fund, and they have no claim on yourmanagement company.

The fund setup works like this: First you set up your entity (LLC), whichbecomes the fund. Then you create a separate management company thatmanages the fund.

Your investors will own the shares in the fund, but they will not own a thingin your management company.




Because of this, how you decide to invest is the best path forward—and noinvestors can interrupt that, which they often try to do. These two separatevehicles work in unison to create a real estate fund that is straightforward tomanage.

The best part is that capital raising still remains open and flexible so you cancarefully screen, select, and “trial and error” your strategies as you gainexperience with your fund.




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The Nuts and Bolts of Rasing Capital

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