Funds are standard investment vehicles in the United States and around the world. Mutual funds, money market funds, exchange-traded funds (ETF), and real estate investment funds are just a few.
CNBC reports that in 2020 alone, an estimated 120 million American investors held almost $24 trillion in mutual funds.
Various funds hold various securities, such as stocks, bonds, short-term debt, and real estate.
What are Real Estate Investment Funds?
Private real estate investment funds are a type of investment vehicle that pools capital from multiple investors to buy various properties.
These income-producing real estate investments are professionally managed, so investors can participate passively without becoming landlords.
How do Funds Differ from Real Estate Investment Trusts (REITs)
Private real estate investment funds differ significantly from REITs. With a fund, you have direct fractional ownership in brick-and-mortar real estate.
Public REITs are fractional ownership (stock) of a company that invests in real estate. Public REITs trade on the stock exchange, which makes their stock highly liquid. In addition to being liquid, REITs suffer from high volatility and closer correlation to the broader stock market.
On the other hand, funds are illiquid assets with low volatility and low correlation to the stock market. Adding real estate investment funds to a portfolio heavily weighted toward stock introduces more stability. You also make it more diversified.
In addition to stability and diversification, direct ownership of real property affords investors tax advantages that are unavailable to REIT investors. I’ll discuss those tax advantages a little later in this article.
Are Private Funds or Trusts a Better Investment?
In some ways, asking which investment is better is like asking if a red shirt is better than blue jeans. Both have merit. Some people would prefer red shirts, and others would prefer blue jeans. Still, others want both. This analogy applies to private real estate funds and REITs.
They are very different investments. REITs are a sector play within the stock market, while funds are an alternative investment in physical real estate.
Both have a history of long-term quality returns but differ in their risk profiles. REITs have three to four times the volatility of direct real estate ownership.
Private real estate’s low volatility and high stability give it a much better risk-adjusted return (Sharpe ratio) than REITs.
Which Type of Real Estate Investment is Right for Me
Most investors embrace the tenets of modern portfolio theory. Disciples of this theory know the importance of adding investments that maximize returns without introducing unacceptable levels of risk.
So, diversification is critically important.
You’ll likely include stock or stock-based assets like mutual funds when constructing your portfolio. If you decide to invest in REITs, you’ll add to the stock you own.
For many reasons, including diversification, most investors want to hold a portion of their portfolio outside the stock market. In the past, many looked to bonds to add stability and diversification to their portfolio.
Unfortunately, bonds have had minuscule returns for many years now. Many people have turned to real estate to diversify and stabilize their portfolios.
Studies show that adding real estate to a portfolio of stocks and bonds has three positive effects. First, it increases the portfolio’s returns. Second, it decreases the portfolio’s volatility (standard deviation). The combination of higher returns and lower risk improves the portfolio’s risk-adjusted return (Sharpe ratio).
So, if you’re a conservative investor who values diversification and wants to maximize returns while decreasing risk, private real estate investment funds might suit you.
Different Types of Real Estate Investment Funds
There is a multitude of different types of private real estate investment funds that you can invest in. They vary by property type, geographic region, and investment strategy.
Investors need to match their goals and risk tolerance with the business plan and experience of the sponsor offering the fund investment.
Private Equity Real Estate Funds
As discussed earlier, private equity funds pool like-minded investors’ capital to buy professionally managed properties.
These potential investments are ideal for investors who want real estate in their portfolio but don’t want the headaches of active management.
37th Parallel’s Multifamily Real Estate Funds I & II
37th Parallel Properties is a full-service multifamily acquisition and asset management firm. We’ve been in business since 2008 and have a 100% profitable track record of nearly $1 billion in transaction volume.
We know how to make our investors money.
In 2019, we opened Fund I. It was initially designated as a $20 million fund. However, it was raised to $40 million due to overwhelming investor demand.
Fund I closed to new investment dollars in January 2022. It is performing well and has been a great success to date.
Fund II will open in the summer of 2022. With Fund II, we aim to build on the success of Fund I. We’ll be purchasing A and B-grade properties in select high-growth markets.
Utilizing a core plus and value-added business strategy, we aim to provide investors with compelling, ongoing passive income with equity growth.
If you’d like to learn more about Fund II, you can sign up for our waitlist to be contacted when it opens. Just click the link below.
Fractional Investing
Significant, multimillion-dollar real estate investment funds will purchase multiple properties. These properties would be out of reach for most individual investors. Fortunately, there is fractional investing.
Fractional investing is when like-minded investors pool their funds to purchase some of the most significant properties in the best markets. It allows an investor to participate in the purchase of hundreds of millions of dollars worth of properties with as little as a $100,000 investment.
Crowdfunded Investments
Crowdfunded investments utilize marketing companies to maximize the number of dollars raised.
Prior to 2012, real estate investors heard little to nothing about crowdfunding. That’s because the SEC banned advertisements in our industry.
Without the ability to advertise, sponsors had to rely on word of mouth. Those who performed well thrived, while those who didn’t quickly went out of business.
But the Jumpstart Our Business Startups Act (JOBS Act) lifted that ban on advertisement. In essence, the JOBS Act deregulated our industry.
Failed and new sponsors no longer had to build a database of loyal investors through excellent operations by creating a track record of success. Instead, they could hire slick marketing experts to raise capital for them. These marketers are called crowdfunders.
Crowdfunding has exploded since 2012, and new sponsors are syndicating investment opportunities. This has made it harder for investors to find the best sponsors.
Now more than ever, it’s critical that investors do their due diligence before investing. Investors need to know how long the syndicator has been in business and confirm that the sponsor has a long track record of success. It’s also important to ask how they raise capital. Do they raise capital themselves, or do they employ a crowdfunder?
Strong syndicators have built a loyal investor following because of their consistent performance. As such, they raise capital for themselves and typically don’t utilize crowdfunding.
Property Syndication
Real estate investment funds offered by top syndicators can be excellent investments, but not all offer funds.
Some bring properties to market one at a time. Investing in one property is less diversified than multiple properties within a fund.
Nevertheless, properties in good markets purchased correctly and managed optimally can be an excellent investment.
Real Estate Mutual Funds
When you hear real estate mutual funds, think of REITs. The difference is that a real estate mutual fund invests in multiple REITs, not just one. It’s a way to diversify your REIT holdings.
As such, a real estate mutual fund is a stock market investment. It’s a liquid asset class more correlated to the broader stock market than a direct investment in physical real estate. However, it doesn’t have the tax benefits of physical real estate.
Real Estate Exchange-Traded Funds (ETF)
Real estate ETFs are similar to real estate mutual funds in that they pool money to buy REITs. They are also regulated by the same securities laws and regulatory bodies.
ETFs tend to be more cost-effective and more liquid than mutual funds. Some other subtle differences are beyond the scope of this article. For our purposes, real estate exchange-traded funds are pretty similar to real estate mutual funds.
How Do Private Equity Real Estate Funds Work?
With private real estate investment funds, there is a timeframe within which the fund will operate. It could be five years, ten years, or some other number. Ten years is pretty standard.
At the beginning of the fund’s lifecycle, the sponsor typically raises investor capital for up to two years.
As commitments accumulate, the sponsor will acquire properties and implement its business plan. When properties are acquired, the operations team works to maximize net operating income (NOI).
As the years go by and the fund seasons, the exit strategy for each property will be executed.
Investors should receive ongoing cash flow from the property’s operations during the fund’s lifespan. As properties sell, the investors should receive their pro-rata share of the profits.
When the last property sells, the fund will close. The investor should receive their initial capital investment plus the equity growth built over time.
The investor’s compensation should come before the sponsor’s compensation. This is known as a preferred return.
When evaluating private real estate investment funds, it’s essential to understand how profits are split (waterfall) between the investors and the sponsor. The bulk of the profits should go to the investor, and an investor-preferred return should be made.
Evaluating Fund Strategy & Goals
When evaluating any investment, it’s essential to match your financial goals and risk tolerance with the investment’s return model and risk profile.
Remember that all investments have risks, but not all risks are the same. Some assets are riskier than others.
Regarding commercial real estate investment funds, the overall annual return typically ranges from 10% – 20%. Outliers can be on either side of this range, but that’s the average.
The four primary investment strategies in order of least risk to highest risk are:
- Core
- Core Plus
- Value Add
- Opportunistic
Core real estate tends to be the least risky investment property type. These properties are newer, high-quality builds in solid markets and good neighborhoods with a strong tenant base.
Core plus properties are similar to core properties but have one or more challenges that must be overcome. That challenge could be a decline in the desirability of the location or the loss of an anchor tenant, to name a couple.
Value-added properties need a significant injection of capital. These properties tend to have completely outdated finishes and significant deferred maintenance. They commonly have vacancy issues and a less-than-desirable tenant base. Operational and management problems are common in value-added properties.
Opportunistic real estate involves ground-up development and construction. It offers investors the highest return potential, but it’s also the riskiest investment strategy.
Creating a Private Equity Investment Fund
Private real estate investment funds are available to investors that cover each of these four investment strategies. They can be found in all commercial real estate asset classes: retail, industrial, multifamily, office, hospitality, etc.
With that much variety, matching your financial goals and risk tolerance with the fund you are offering is essential. As important as finding the right fund is, finding the right syndicator is also necessary.
Syndicators or sponsors are the professional real estate companies that bring these funds to market. Their track record, integrity, and business model are essential to consider before investing.
Benefits of Managed Real Estate Investment Funds
There are many benefits to multifamily real estate. A partial list includes:
- Ongoing passive income
- Opportunity for equity growth
- Tax advantages
- Hedge against inflation
- Low volatility / High stability
- Diversification from the stock market
- Historical solid performance even in recessions
If you’d like to see third-party research and data on the historical performance of the multifamily real estate industry, you should check out these two resources:
9 Reasons to Invest in Multifamily Apartments
I’ll also discuss a few of these benefits below.
Managed Investments with Passive Returns
Just as it takes specialized knowledge and experience to remove an appendix or build a skyscraper, it also takes expertise to successfully purchase, operate, and dispose of real estate. The difference between making money and losing money in our industry often comes down to the operator’s experience and expertise. I always talk to investors who want to invest in apartments but don’t want to get their hands dirty. They don’t have the time, energy, inclination, or expertise to become landlords.
Passive investing in real estate investment funds is often the ideal solution for these people. Investing in a fund allows them to participate in real estate, leveraging the expertise of professionals while maintaining a hands-off approach.
Portfolio Diversification
Real estate investment funds can be pretty compelling. This is especially true for those who hold the bulk of their net worth in stock market-based assets.
Direct real estate ownership has a very low correlation to the market. That lack of correlation, along with solid returns, makes it an ideal investment for diversification.
As we discussed earlier, research has shown that a portfolio comprising 60% stocks / 40% bonds benefits significantly from adding direct real estate ownership. When adding real estate into the mix, that portfolio gained higher returns, lower volatility, and an improved risk-adjusted return (Sharpe ratio).
Variety and Flexibility of Investments
Instead of putting all your eggs in one basket by buying one property, real estate investment funds give you a wider variety of properties with increased flexibility. In fact, there is such a wide variety of opportunities available to tailor your investments to your individual needs.
Tax Advantages
Another benefit of investing in real estate is the tax advantages. The cornerstone of those tax advantages is depreciation. Depreciation, accelerated depreciation, and bonus depreciation can allow investors to defer taxation on the passive income they receive from their investments.
1031 exchanges allow them to sell and exchange one property for another like-kind property while deferring the capital gains tax that would otherwise be due. They can do this multiple times, trading for bigger and better properties while deferring taxes using a 1031 exchange.
At the end of the investor’s lifetime, the properties they own are reappraised to their current market value, and the basis is reset. Their heirs inherit those properties on a stepped-up basis, which eliminates all capital gains tax and depreciation recapture.
Real estate and real estate investment funds have some desirable tax advantages.
How to Get Started with Real Estate Investment Funds
The first step to getting started is figuring out your financial goals and risk tolerance. What are you trying to achieve, and how much risk will you take?
At 37th Parallel Properties, we deal exclusively with multifamily real estate because it’s the most stable asset class. Risk mitigation is our top priority; we hate risk and do everything we can to minimize it.
We avoid real estate that is sensitive to economic cycles. We don’t want to suffer through downturns like retail and hospitality did during the COVID-19 pandemic. We also avoid retail because of the threat of e-commerce. The success of Amazon and others threatens the viability of brick-and-mortar retail.
We stick with apartments because of their track record of stability. In good times and bad times, people need a roof over their heads, and shelter is a basic need that can never be disrupted.
These are just some of the reasons why we do what we do. Likewise, it would be best to decide what suits you. Once you choose, you need to scrutinize potential fund investments and the sponsor bringing those investments.
Choosing the Right Private Real Estate Investment Firm
It is very important to do due diligence in vetting potential sponsors. How long have they been in business? What is their track record? Do they raise capital themselves, or do they have to rely on the services of a crowdfunding marketing middleman?
These are just a few questions you should ask before investing with a syndicator.
We highly suggest that you use a framework for evaluating potential syndicators. We call ours the M.A.C. framework. You can learn more about this valuable tool at the link below:
Private Real Estate Evaluation Framework
37th Parallel Brings Unmatched Experience
37th Parallel Properties is a private real estate acquisition and asset management firm. We began operations in 2008 and have a 100% profitable track record of almost $1 billion in transaction volume.
We know how to make our investors money.
Contact Us Today to Discuss Your Investment Goals
If you’d like to learn more about the 37th Parallel advantage or how to get started, I invite you to contact us today. Click the link above.
