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As a passive investor, one of the more important decisions you’ll need to make is whether to invest in private real estate funds or place your money in individual investment opportunities. Each option has its unique advantages and disadvantages but making the right choice that meets your specific needs will help to maximize the return on your investment.
Property-Specific Syndication - Deal-Specific Advantages
Because the syndication is deal-specific, the limited partner has the opportunity to choose which markets and which assets to invest in. Another key advantage is the ability to research the market and the asset in depth prior to making a choice.
Property Specific Syndication - Lack of Diversification Increases Risk
The main disadvantage is that with an individual property syndication there is a lollack of diversification. The money that you invest is committed to only one asset, rather than several, which could increase your risk if the deal doesn’t perform as anticipated. Your money is also committed to only one market, which can be troublesome if there’s a recession. Not all markets are impacted the same way during a recession, and without diversification you’re unable to minimize any risk.
Private Real Estate Funds - An Experienced Sponsor is Your Kery to Success
Private real estate funds are different from individual property syndication, but there are many similarities as well. Funds are run by experienced sponsors who develop the overall investment strategy, manage all aspects of the investors’ capital, and are responsible for the fund’s performance. Unlike an individual property syndication, the funds are not limited to a single asset class or a single market.
Types of Private Real Estate Funds
There are several different types of private real estate funds, each having their own advantages and disadvantages. An evergreen fund is one where investment returns are recycled back into the fund, rather than distributed to investors. They are advantageous for investors who don’t want their capital tied up for long periods of time. Investors don’t receive sale proceeds in an evergreen fund, but they do have liquidity options, called “redemptions, which are usually within of 90 to 120 days of the request to redeem their investment and liquidate.
There are also open-end funds and closed-ended funds. With an open-end fund, investors are able to enter and exit the funds at specific intervals, which are determined by the fund’s sponsor. Open-end funds have no termination date, and most of the expected return will come from the property’s income stream. With open-end funds, sponsors look for long-term capital appreciation.
With closed-end funds, the strategy is different. Sponsors will purchase properties with a “buy, fix, sell” approach. The intent is to do value-add to the property through repurposing, renovation and construction. Most of the expected return on a closed-end fund are anticipated from the sale of the property, rather than the income stream.
Blind or semi-blind are another type of private real estate fund. In this structure, only one or some of the assets have been identified at the time investors commit their capital to a sponsor. The sponsor will then search for additional assets to add to the fund.
Private Real Estate Funds - Diversification Minimizes Risk
The biggest advantage is diversification, which leads to lower risk. Because investors own shares of multiple assets, the risk is spread across different assets, and sometimes even different locations if the fund is investing in more than one markets. By investing $100K in a fund, for example, you’ll get equity in 5-10 different deals, rather than putting your money in one property. Plus, there’s no need to handle up to 10 different syndication registrations. It only takes one investment and you’re done.
By pooling resources in the funds, investors have access to larger investments, along with properties that are professionally managed. Investors will still enjoy the same limited liability as they would with individual property syndication, as well as have the same tax advantages, including depreciation and interest expense deductions.
Private Real Estate Funds -Be Sure to Vet Your Sponsor
As with deal-specific investments, the key disadvantage to investing in private real estate funds is the lack of control over the deals that your money is invested in.The sponsor also determines when to sell the asset, refinance and withhold distributions, among many other decisions. However, if you invest in the private real estate funds with a sponsor, you’re doing so because you have a high level of trust with the sponsor.
Choosing a Sponsor when Investing
Whether you choose to invest in an individual investment opportunity or a private investment fund, choosing the right sponsor is key. It’s even more critical with private funds, because sponsors often feel pressured into purchasing an asset simply because there is money sitting in the fund waiting to be invested. In my operation, we avoid this by paying investors a nominal amount of interest on their money until the first deal is completed
Vetting the sponsor is extremely important. Examine their track record, discuss their investment goals to ensure you’re both on the same page regarding risk tolerance, asset class and other factors so you have a comfort level and a level of trust in how your capital will be invested.
Summary
Passive investors have many options to explore prior to investing their money in real estate. One of the main options to consider is whether to invest in private real estate funds or in an individual investment opportunity through syndication. Each has its own advantages and disadvantages, and your decision should be based on your individual investment goals.
Each option usually involves investing with a sponsor, so you’ll need to vet the sponsor carefully. Paramount to the process of finding a sponsor, one you feel comfortable with, one who has similar investment goals to yours and one you feel a strong level of trust with. Always meet with potential sponsors and ask pointed questions about risk tolerance and investment objectives. Their answers should provide you with the comfort level you’re looking for.
The key advantage to investing in private real estate funds is diversification because by spreading your risk over several different assets in various geographic locations, you
minimize overall risk. The biggest disadvantage is that you don’t have any control over the deals that your money is invested in but investing with a sponsor you trust will eliminate that issue.
Be aware that there are many different types of private real estate funds. They include evergreen funds, open-end and closed-end funds as well as blind and semi-blind funds. Each has different pros and cons, and you should examine each one to determine the one that best meets your investment objectives.
Advantages to investing in individual investment opportunities include protection from credit risk beyond the property and tax advantages, including depreciation and interest expenses which can help reduce overall tax liability. The disadvantages are lack of diversification and lack of liquidity, as your capital will be tied up until the property is sold.
The main point to remember for either option is to vet the sponsor. You want your sponsor to have a successful track record as well as similar investment objectives to your own. That’s what helps to create a level of trust that is needed when investing your money.
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About the Author
Ellie is the founder of Blue Lake Capital, a commercial real estate investment firm specialized in multifamily investing throughout the United States. At Blue Lake Capital, Ellie partners with both institutional and individual investors to grow their wealth by achieving double-digit returns by investing alongside her in exclusive multifamily deals they usually don't have access to.
A defining factor of Blue Lake Capital’s strategy is founded in utilizing machine learning/artificial intelligence throughout the course of all acquisitions and asset management. This advanced technology enables the company to produce accurate and data-driven forecasting for all assets on a market, property, and even tenant basis. In doing so, Blue Lake is able to lead commercial investments with the full capabilities of today’s technology.
Ellie is the host of REady2Scale , a podcast that highlights honest, insightful, and thought-provoking discussions on the multiple approaches for successful real estate investing.
She started her career as a commercial real estate lawyer, leading real estate transactions for one of Israel’s leading development companies. Later, as a property manager for Israel’s largest energy company, she oversaw properties worth over $100MM. Additionally, Ellie is an experienced entrepreneur who helped build and scale companies by improving their business operations.
Ellie holds a Masters in Law from Bar-Ilan University in Israel and an MBA from MIT Sloan School of Management.
You can read more about Blue Lake Capital at www.bluelake-capital.com and learn more about Ellie at www.ellieperlman.com.