If you’ve been interested in real estate investment management, then it’s likely you’ve been wondering how to create a real estate investment fund. Let’s take a closer look at what precisely a real estate investment fund is, how it works, and what the risks and benefits are.
What Is a Real Estate Investment Fund?
A real estate investment fund is when a group of people come together to invest in a development, property, or real estate investment trust. For those who want to invest in real estate, but don’t want the role of landlord or the responsibility of managing a property, a real estate fund is a great option.
Real estate investment funds give investors the ability to invest in real estate without the same liability or risk that comes from sole ownership. Often, the investment is in commercial real estate, but can also include things such as apartment complexes, land developments, and agricultural land. It’s common for real estate investment funds to invest a smaller portion of their funds into more traditional financial structures, including bonds and money market accounts, as well as real estate investment trusts (REITs). In other words, a real estate investment fund is the mutual fund of the real estate world.
The Structure of a Real Estate Investment Fund
A real estate investment fund is always set up as a corporation, to allow a group of people to pool their money together for the investment. Most often it is a limited liability corporation (LLC) or other pass-through entity like a limited partnership. Unlike a REIT, a real estate investment fund lets investors pool capital without having the same security registration process. It’s different than a money market account in several ways, including how it is taxed. In addition, it’s also structured differently from property ownership.
Some of the most important components of a real estate investment fund’s structure have to do with the fact that it’s an investment in illiquid funds. Real estate investment funds can be broken into two types: those with a set end date (closed) and those with an open one. For an investor, one of the most important considerations in choosing the right real estate investment fund is the schedule of payments of profits. Unlike REITs, a real estate investment fund is not set up to distribute profits quickly in the short-term, and is generally structured to favor long-term investment.
Who Runs the Fund?
It’s important to work with a knowledgeable expert who can effectively manage the investments, while also stay up-to-date on the latest real estate market trends, so they can best advise you on where to invest future profits. Some funds are managed by an online brokerage that require a flat-rate fee per year in order to invest. Others have commission-based fees. Just like a mutual fund, a real estate investment fund can have passive or active management. Today, technology is playing a larger role in the management of investment funds and has begun to revolutionize the industry.
How the Fund Makes Money and How It’s Distributed
There are two primary ways in which a real estate investment fund makes money. One is property appreciation, and the other is wise investing within the market. These are related, but not always passive. For instance, appreciation can happen because of changing real estate market conditions, but it can also result from investing in property development.
Real estate funds are much stronger as long-term investments not just because they are so dependent upon appreciation, but because they are generally structured to reinvest profits into real estate based on the market. While some pay dividends, they are much more involved in reinvestment than a REIT, which pays 90% of profits in dividends.
How a fund is structured (such as whether or not it’s close-ended) determines how the profits are then distributed. In general, the investors initial investment is paid first. A preferred return is calculated based on several factors and paid to the investor. The fund’s manager or sponsor is then entitled to a portion based on the preferred return. Finally, remaining profits are split between the investors and the sponsor or manager.
Benefits of a Real Estate Investment Fund
Overall participating in a real estate investment fund has many perks. Here are a few of the benefits for investors:
- Provides diversification, while allowing investors to take full advantage of the real estate market
- Relatively stable and profitable in the long-term
- Gives people an opportunity to invest in real estate without having to qualify for financing
- Preferred return enables the investor to be paid first
- As part of the pass-through corporation it allows for tax benefits
Risks of a Real Estate Investment Fund
While a real estate investment fund has many benefits, it doesn’t come without risks. Here are some of the pitfalls associated with participating in a real estate investment fund:
- Some real estate investment funds are structured to not let investors withdraw capital early, as it’s a necessary part of how they can safely operate. So if you need to be able to keep a major part of your capital liquid, it’s not a great idea.
- Most real estate funds are structured to make money over time, which means some will not pay at all in the short-term.
How Technology Can Help You Get Started With a Real Estate Investment Fund
Starting a real estate investment fund can be easy if you have the right technology in place. Modern solutions, like AppFolio Investment Management can help you organize your fund, manage finances, and communicate with your investors. Here are some ways AppFolio Investment Management can streamline the real estate investment fund process:
- Fundraising: Promotes new opportunities, lets you track interest of prospective investors, and easily collect online signatures.
- Communication: Allows you to answer investment questions quickly and thoroughly, email investors all at once, and reference all communications easily and securely.
- Data: Organizes assets in one central hub with bank-grade security to increase efficiency and mitigate risk.
- Access: Gives you quick, reliable, self-service investment information 24/7, anywhere on any device.
- Statements & Reporting: Innovative software makes it easy to consolidate data and metrics on a syndication into a single, shareable document that you can distribute to your investors digitally.