This blog is written from the standpoint of investing in private offerings in real estate through a fund and comparing that with investing in individual assets (one at a time). Investing in a fund has its benefits but also has some characteristics to be aware of that make this strategy different than investing in individual assets (one at a time). Below are some comparisons between these two strategies.
- Diversification. A fund typically acquires a handful of assets. This can be helpful because the fund can provide some diversity in location. Your investment would be in multiple baskets rather than a single basket. Diversification can help lower the risk profile of that investment. If the fund is structured where the fund entity owns each individual asset entity, then the returns at the fund level will be an average of the returns of the underlying assets. This means there is less chance of doing very poorly with the fund investment. However, there is also less chance of catching lightning in a bottle with extremely high returns.
- Set it and forget it. The fund model provides more simplicity to an investor because a single investment into the fund can provide the diversification. Depending on the investor, this may be more appealing. They would rather “set it and forget it”. But, some investors may rather sink their teeth into each deal and want to understand and analyze each deal so the fund model may not be appealing to them. They would rather spend the additional time and effort to do their due diligence on each individual asset, investing one deal at a time.
- Less Investment Money Required for Diversification. An investor can achieve similar diversification with less investment money required by using the fund strategy instead of investing in separate asset offerings. A private offering in a real estate fund can be as low as $25,000. If that fund is purchasing five assets, then your $25,000 investment would have some ownership of those five assets. If you wanted that type of diversification by purchasing an interest in five assets through separate investment offerings, this would require $125,000.
- Diversification of Sponsor. A fund provides diversity in that it purchases multiple assets. However, the fund is operated by a single sponsor team so it does not provide diversity in sponsors. On the other hand, investments in separate asset offerings could provide diversity in sponsors if each asset offering is operated by a different sponsor team. This is important to keep in mind.
- Buying power. Sponsors who are getting access to deals with brokers or who are working directly with owners (sellers) can sometimes get preferential treatment. This is because the seller may have more confidence in the buyer’s ability to acquire the property and do so efficiently because they have an active fund. The fund model can show the seller that the sponsor has a strong track record and has good processes in place for due diligence and access to capital (equity and debt financing) which leads to a higher degree of confidence in their ability to close on the acquisition.
- Return of Invested Capital. Investment in a fund will likely have a longer hold period than investing in a single asset. This is because a fund may be acquiring, for example, five assets, increasing their net operating income (NOI) through improvements and then selling them. This involves five different business plans and market forces rather than just one. All else being equal, it is easy to see how a fund would have your invested capital tied up for a longer time period. Keep in mind though that the sponsor of a fund may provide incremental returns of invested capital when assets are refinanced or sold.
- A blind pool. A fund will acquire a group of assets (“a pool”) within some targeted time period in the future. When investing in a fund, you don’t know exactly what will be acquired and when. This is referred to as a “blind pool”. You should absolutely know and understand the investment parameters (e.g., size of the assets being acquired (range in the number of units), class & condition of assets, potential geographic locations of assets, etc.), but not all assets have been sourced and are under contract. Depending on when you enter the fund as an investor, maybe only one asset is included in the investment presentation. Or maybe you are getting in near the end of the fund, and most of the assets have been acquired and are available for review by the investor. It’s really just a timing issue. Regardless though, some element of a “blind pool” will exist which makes this very different than when investing in a single asset. When investing in a single asset, you know exactly what you are investing in…the location of the asset, the business plan, the timeline, and the return profile.
Whether your investment be in a fund or in individual asset offerings, the bottom line is to understand the differences in these two investment vehicles and make sure that your investing is consistent with your investment goals and objectives.
