What is a Real Estate Investment Fund?
Introduction
Real estate investment funds provide another entry point for those looking to invest in real estate. They are particularly appealing to those who want to own commercial property, but who want to take a hands-off approach to daily management activities. A real estate investment fund pools capital from investors, and then the fund’s manager oversees all of the fund’s activities, including property management in the case of a fund that buys and renovates and/or holds property for some time. Investing in a real estate fund is a great way to generate passive income for those who are interested in owning real estate, but who do not want the responsibilities of direct ownership.
What is a real estate investment fund?
An investment fund is a pool of capital that has been accumulated on behalf of multiple investors. There are many types of investment funds, such as mutual funds, money market funds, and hedge funds. A real estate investment fund is a specific fund that is focused exclusively on investing in property.
Real estate investment funds can be structured in many ways. Some funds are open to everyone, whereas others are only available to accredited and sophisticated investors. Funds can focus on specific geographies, asset classes, asset types and more. Most real estate investment funds are closed-end funds that target risk-adjusted passive returns for their investors.
Benefits of Real Estate Funds
Flexibility
It is a common misconception that investing in a real estate fund requires an investor to sacrifice flexibility. In fact, the opposite is true. If you were to invest in a single asset, for example, you’ve put all your eggs in one basket – you’d better hope that the investment pays off the way you expected it to! However, investing in funds provides more control and flexibility.
For example, an investor who has $1 million to invest can choose to invest into a real estate portfolio fund that owns a multiple of real estate assets all held within the fund. There are many funds focused on different geographies and asset classes, which allows the investor to choose which types of properties they want to purchase and where. This allows investors to truly customise their portfolios without having to buy individual assets directly.
Profitability
Real estate investment funds are generally structured to return profits to investors before any profit is earned by the fund’s managers. As a result, the manager is highly motivated to ensure the deal achieves its intended profit threshold. Funds are structured in this way as a means of keeping interests aligned between the manager and their investors.
Diversification
Funds can set a wide variety of investment parameters, broadening the reach of potential investments. For example, a fund may focus specifically on a single asset type but be open to different geographies (say, multifamily investments in core markets across the Europe,U.S.A., Australia). Alternatively, a fund might invest in a range of product types in a single market (say, central London).
Another fund might only invest in opportunistic real estate investments that need moderate to heavy rehab on a mid- to long-term time horizon. Other funds will have few, if any, investment parameters. By investing in a real estate fund, individuals can diversify their portfolios, thereby mitigating the risk of having “all their eggs in one basket.” This is one-way investors protect themselves in the event of an economic downturn.
Preferred Returns
Most private real estate funds offer investors a preferred return in addition to their pro rata share of the fund’s overall net profits. While no fund can ever guarantee payment of a preferred return, those who invest in a real estate fund are assured that they will receive the initial profits from the fund’s investment activities before the fund’s manager receives its share (known as the “carried interest”). This structure ensures that the fund’s manager is motivated to achieve their targeted returns; otherwise, the fund’s manager will not earn their share of the profits as anticipated.
Absolute Returns
The absolute returns of a fund refer to the amount of profit the fund has earned. The absolute returns include any additional returns above and beyond the preferred return. Funds that perform exceptionally well will provide absolute returns significantly higher than the anticipated preferred return. However, always beware that a fund’s previous performance does not guarantee its future performance. Always evaluate a real estate fund based on its current merits, not only past performance, and on the experience and track record of the people involved.
Correlation to Other Asset Classes
Real estate, in general, has a low correlation to other asset classes such as stocks and bonds. This is because of the highly illiquid nature of real estate, which cannot be purchased and sold over night. Real estate investment funds allow investors to diversify and protect their holdings. Consider, for example, an instance in which the stock market declines heavily overnight.
Unlike the stock market, which would immediately lose large sums of value, real estate portfolios tend to continue marching on. Rents continue to be paid and profits returned to investors. While the real estate portfolio may eventually see a decline, there is not the same correlation to other asset classes which can experience more drastic drops in value.
Qualifications
When investing in real estate funds, individual investors benefit from the experience and qualifications of the fund managers. The managers are typically industry professionals that are highly qualified to oversee a fund that will be deployed in various real estate projects. A quality manager will be able to provide detailed financials for investor’s to review, and will be happy to answer any questions about their strategy, assumptions, and how and why the fund structure they are building will prove to be successful.
Moreover, the fund manager oversees all day-to-day activities associated with the fund. This allows individuals to invest without being distracted by the nuances of each individual transaction carried out through the fund.
Conclusion
There are many reasons to invest in real estate, generally, and other reasons to invest in a real estate fund more specifically. Real estate investment funds are a unique way to diversify your portfolio without having to take on the stresses of direct ownership.
Of course, not all funds are created equally. Any prospective investor is advised to do their homework before investing in a fund. Be sure to complete your due diligence on the fund’s management, product and track record. Look at the types of investments they make, including the geographic location and type. Evaluate the fund’s anticipated returns and question how the fund intends to achieve them, and over what time period. As with any investment, it is critical to research the opportunity thoroughly. No investment is foolproof, but the more you know of how the fund is structured and who’s involved, the more likely you are to safeguard your hard-earned capital.
Happy Investing and thanks for reading!