Funds are common investment vehicles in the United States and around the world. There are mutual funds, money market funds, exchange-traded funds (ETF), and real estate investment funds, just to name a few.
CNBC reports that in 2020 alone, an estimated 120 million American investors held almost $24 trillion in mutual funds.
Various funds hold a variety of 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 a variety of properties.
These income-producing real estate investments are professionally managed. So the investors get to participate passively without having to become a landlord.
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.
Funds, on the other hand, are illiquid assets with low volatility and low correlation to the stock market. When you add real estate investment funds to a portfolio that is heavily weighted toward stock, you introduce more stability to that portfolio. 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 the red shirt and others would prefer the blue jeans. And still, others would want both the red shirt and the blue jeans. This analogy applies to private real estate funds and REITs.
They are very different investments. REITs are a sector play within the stock market. Funds are an alternative investment of physical real estate.
Both have a history of long-term quality returns. But they differ in their risk profile. REITs have three to four times the volatility of direct ownership of real estate.
This low volatility / high stability nature of private real estate gives 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.
When constructing your portfolio, it’s likely that you’ll include stock or stock-based assets like mutual funds. If you decide to invest in REITs, then you’re adding to the amount of stock you own.
For many reasons, including diversification, most investors want to hold a portion of their portfolio outside of 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. That’s why many people have turned to real estate to add diversification and stability to their portfolios.
Studies show that adding real estate to a portfolio constructed of stocks and bonds does three positive things. First, it increases the portfolio’s returns. It also decreases the volatility (standard deviation) of the portfolio. The combination of higher returns and lower risk improves the portfolio’s risk-adjusted return (Sharpe ratio).
So if you’re a conservative investor that values diversification and wants to maximize returns while decreasing risk then private real estate investment funds might be right for 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.
It’s important for investors to match their goals and risk tolerance with the business plan and experience of the sponsor who is offering the fund investment.
Private Equity Real Estate Funds
As we discussed earlier, private equity funds pool like-minded investors’ capital to buy properties that are professionally managed.
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 over nearly $1 billion in transaction volume.
We know how to make our investors money.
In 2019, we opened Fund I. It was originally designated as a $20 million fund. However, due to overwhelming investor demand, it was raised to $40 million.
Fund I closed to new investment dollars in January of 2022. It is performing well and to date has been a great success.
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 add 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, be sure to sign up on our waitlist to be contacted when it opens. Just click the link below.
Large, 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 together to purchase some of the biggest 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 utilize marketing companies to maximize the number of dollars raised.
Prior to 2012, real estate investors heard little to nothing about crowdfunding. That’s due to the fact that the SEC imposed a ban on advertisement in our industry.
Without the ability to advertise, sponsors had to rely on word of mouth. Those who performed well thrived. Those that didn’t perform well 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 sponsors and new sponsors no longer had to build a database of loyal investors through excellent operations by building 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 a wave of 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. They also need to confirm that the sponsor has a long track record for 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 following of investors because of their consistent performance. As such, they raise capital for themselves and typically don’t utilize crowdfunding.
Real estate investment funds offered by top syndicators can be a very good investment. But not all syndicators offer funds.
Some bring properties to market one at a time. Obviously, there is less diversification in investing in one property instead of multiple properties within a fund.
Nevertheless, single properties in good markets that are purchased correctly and managed optimally can be a great 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 and 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 that is more correlated to the broader stock market than a direct investment in physical real estate. And it doesn’t have the tax benefits that physical real estate has.
Real Estate Exchange-Traded Funds (ETF)
Real estate ETFs are similar to real estate mutual funds in that they pool money to buy REITs. Similarly, they are both regulated by the same securities laws and regulatory bodies as well.
ETFs tend to be more cost-effective and more liquid than mutual funds. There are some other subtle differences that are beyond the scope of this article. For our purposes, real estate exchange-traded funds are quite 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 common.
The sponsor will typically raise investor capital for up to two years at the beginning of the fund’s lifecycle.
As commitments accumulate, the sponsor will start acquiring properties and implementing their business plan. When properties are acquired, the operations team goes to work with the goal of maximizing net operating income (NOI).
As the years go by and the fund seasons, the exit strategy for each property will be executed.
During the lifespan of the fund, investors should receive ongoing cash flow from operations of the property. As properties sell, the investors should receive their pro-rata share of the profits from that property.
When the last property sells, the fund will close. The investor should receive their initial capital investment plus the equity growth that built up over time.
The investor’s compensation should come before the compensation of the sponsor. This is known as a preferred return.
When evaluating private real estate investment funds, it’s important 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 in place.
Evaluating Fund Strategy & Goals
When evaluating any investment, it’s important to match your financial goals and risk tolerance with the return model and risk profile of the investment.
Remember that all investments have risk, but they don’t have the same risk. Some investments are riskier than others.
When it comes to commercial real estate investment funds, the overall annual return typically ranges from 10% – 20%. There can be outliers on either side of this range, but that’s the average.
The four main investment strategies in order of least risk to highest risk are:
- Core Plus
- Value Add
Core real estate tends to be the least risky investment property type. These properties are newer, high-quality builds, in strong markets. These properties are in good neighborhoods that enjoy a strong tenant base.
Core plus properties are similar to core properties, but they have one or more challenges that need to be overcome. That challenge could be a decline in desirability of location or the loss of an anchor tenant just to name a couple.
Value-add 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 issues are common in value add properties.
Opportunistic real estate is ground-up development and construction. Opportunistic real estate has the highest return potential for investors, but it’s also the riskiest investment strategy.
Creating a Private Equity Investment Fund
There are private real estate investment funds available to investors that cover each of these four investment strategies. And they can be found in all of the commercial real estate asset classes; retail, industrial, multifamily, office, hospitality, etc.
With that much variety, it’s really important to match your financial goals and risk tolerance with what the fund is offering. Just as important as it is to find the right fund, it’s also very important to find the right syndicator.
Syndicators or sponsors are the professional real estate companies that bring these funds to market. Their track record, integrity, and business model are important factors to consider before investing.
Benefits of Managed Real Estate Investment Funds
The benefits of multifamily real estate are many. 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
- Strong historical performance even in recessions
If you’d like to see the third-party research and data on the historical performance of the multifamily real estate industry, you should check out these two resources:
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 experience and expertise of the operator. I talk to investors all the time 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 a landlord.
Passive investing in real estate investment funds are 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.
Real estate investment funds can be quite compelling. This is especially true for those who hold the bulk of their net worth in stock market-based assets.
Direct ownership of real estate has a very low correlation to the market. That lack of correlation along with solid returns makes it an ideal investment for diversification.
And as we discussed earlier, research has shown that a portfolio made up of 60% stocks / 40% bonds benefits greatly from adding direct ownership of real estate. 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 larger variety of properties with increased flexibility. In fact, there is such a large variety of opportunities available to you to tailor your investments to your individual needs.
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 investment.
1031 exchanges allow them to sell one property and exchange it for another like-kind property while deferring the capital gains tax that would otherwise be due. They can do this multiple times, trading up for bigger and better properties while deferring taxes using a 1031 exchange.
At the end of the investor’s lifetime, the properties they own get reappraised to their current market value and the basis gets 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 very attractive tax advantages.
How to Get Started with Real Estate Investment Funds
The first step to getting started is to figure out your financial goals and your risk tolerance. What is it that you’re trying to achieve and how much risk are you willing to take?
At 37th Parallel Properties, we deal exclusively with multifamily real estate because it’s the most stable real estate asset class. Risk mitigation is a top priority of ours as we hate risk and do everything we can to minimize it.
We stay away from real estate that is sensitive to economic cycles. We don’t want to suffer through downturns as retail and hospitality did during the COVID-19 pandemic. And, we also stay away from retail because of the threat from 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 in bad times people need a roof over their heads. And shelter is a basic need that can never be disrupted.
That is just some of the reasons why we do what we do. Likewise, you need to decide what is right for you. Once you decide, then you need to scrutinize potential fund investments and the sponsor that is bringing those investments.
Choosing the Right Private Real Estate Investment Firm
Due diligence in vetting potential sponsors is very important. 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 of the 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 useful tool at the link below:
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 over almost $1 billion in transaction volume.
We know how to make our investors money.
If you’d like to learn more about the 37th Parallel advantage or how to get started, I’d invite you to connect with us today. Simply click the link above.