Raising CRE Equity Through a Fund Structure
When is it more advantageous to raise equity capital through a fund structure as opposed to one transaction at a time?
One of the most crucial pieces of a real estate investment and development firm is raising equity funds. Numerous smaller and mid-sized real estate corporations have a main operating organization and a number of affiliated limited partnerships and limited liability companies that own the real estate assets and contain equity investments from different investor groups. Typically, the general partner or managing member of these investment firms is an affiliate of the operating company.
The operating entity is typically owned by a family or an entrepreneur and serves as the public face of the business. In spite of the abundance of capital in today’s booming real estate market, it can be quite difficult for smaller and midsized businesses to raise equity financing. The associated flow-through organizations that own the individual properties often handle it deal by deal. Take for instance, a well-established medium-sized CRE investment business on the West Coast, may have any number of associated partnerships and limited liability corporations that collectively control $300 million worth of CRE properties, with $200 million in debt and $100 million in equity.
The operational company and the general partner or managing member of these organizations must manage all the different mortgages, equity offers, private placement memorandums, partnership agreements, subscription agreements, etc. throughout time. For example if there are 25 deals and 400 different investors in the twenty-five deals, the typical equity investment is $250,000.
When does it make sense to start raising equity money in a fund structure as opposed to one deal at a time? This is a topic that many of these smaller and mid-sized real estate enterprises need to consider as their business grows. For equity capital, a fund structure is more effective. It’s less expensive in terms of fees, paperwork, and legal costs, and takes less time to complete. Raising equity for 25 different projects one at a time may potentially result in missed investment opportunities if the general partner is unable to swiftly obtain the necessary equity capital to take advantage of good agreements that call for a speedy closing. In contrast to the six to ten years it may take to accumulate twenty-five independent real estate acquisitions, the general partner might have placed all the properties in the fund if the fund had a $100 million equity raise.
As with any investment program, gravitating to a fund structure is not an easy undertaking, and the first one is always the most challenging. However, for any seasoned real estate investment firm, the advantages exceed the disadvantages by a wide margin. Who will sell the fund’s equity is the main issue with a fund structure. Only accredited investors, such as high net worth individuals, pension plans, endowments, registered investment advisors, and wealth managers, are often catered to by CRE private placement funds. A minimum yearly income of $200,000 ($300,000 if a joint investment) or a net worth of at least $1 million, excluding the investor’s primary residence, qualify as accredited investors. To market the fund’s units, the majority of companies will need to work with an experienced securities firm, broker-dealer, or other placement agency; the cost of this service ranges between 5% and 7% of the fund’s equity raised. As placement agents for third-party funds, there are a lot of independent broker-dealers and real estate brokerage companies.
The unit size of the offering is the next crucial factor. Depending on the fund’s investors, unit sizes will vary. If mostly people, then $100,000 per unit is typical. $250,000 per unit or more is typical if the fund targets multiple institutions. What is the fund’s investing strategy, which is the following crucial question? For instance, would the fund diversify throughout the four main CRE sectors of office, retail, flats, and industrial, or will it invest in a single type of property, such as apartments? Will the fund invest in or engage in development in specialized CRE markets like senior living, modular housing, and self-storage? Will the investments in the fund also be diversified by industry and by geography? This is important and a means of lowering portfolio risk. For instance, a fund that buys office buildings in No. California and Silicon Valley lack industry, geographic, and property type diversity. These regions’ economies are driven by the technology sector, therefore any downturn there will be disastrous for the portfolio. Additionally, any fees or payments from the fund, the investor desired return, and ownership interests must be decided by the fund’s sponsor or general partner.
For organizing the private placement, locating the properties to be purchased, and setting up the financing for the properties, the sponsor of many private placements is charged an upfront fee of 1% to 2%. Additionally, there is an annual asset management fee for managing the fund of.5%-1.5% of the equity raised. A quarterly fee for asset management is charged. The preferred yearly return on investment for the investors will normally range from 5% to 10%, and they will own between 70% and 80% of the fund. In addition to receiving a carrying interest of 20% to 30%, the general partner or sponsor will also be expected to contribute.5% to 5% of the stock offering in cash. It is necessary for the sponsor to make an equity investment in order to put some money, even if it is little, at risk and to better align its interests with those of the investors. A crucial step in the development of the rising medium-sized CRE investment firm into a more institutionally focused investor is raising capital in a fund structure.
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