What is a Real Estate Investment Fund: Benefits & More

Did you know that real estate investment funds offer many advantages? These funds offer real estate investors the opportunity to increase liquidity, diversification, and access to professional management. At its core, a real estate fund pools money from investors to mutually fund a real estate investment. Typically, these funds are structured as an LLC (or another entity) and are designed to achieve specific real estate and financial goals.

What is a Real Estate Investment Fund and How Do Real Estate Funds Work?

As a mutual investment entity, real estate funds open the doors for investors to invest in various types of properties without applying the same amount of capital that they would as individual investors. By pooling capital, real estate funds also give investors the opportunity to explore a range of property types. For example, some funds might focus on purchasing large residential properties, while others might focus on buying commercial properties that can be sold quickly. While rules vary by real estate fund, generally, funds offer investors the ability to liquidate their shares more readily, allowing them to receive the funds when they need them most.

Owning real estate individually offers several advantages; however, participating in a real estate fund also offers distinct benefits. From diversification to tax benefits, there are many reasons that you might choose to invest in a real estate fund.

Did you know that there are several benefits to owning real estate as an individual?

1. Tax Benefits. From writing off expenses associated with your rental properties to leveraging the power of depreciation, there are several tax benefits that can be enjoyed when you own investment properties as an individual. With the new real estate laws, you can also enjoy pass-through deductions, 100 percent bonus depreciation, and use a 1031 Exchange coupled with a Section 121 to potentially avoid all real estate taxes when selling a buy-and-hold investment property.
2. Control and Flexibility. Not only do you get to decide what type of properties you want to purchase, but you also get to determine when, for how much, and where. In short, as an individual real estate investor, you have all of the control and flexibility that you need to create a completely customized portfolio that meets your exact needs, while simultaneously helping you achieve your financial goals.
3. You get all the Profit. The beauty of owning real estate as an individual is that you receive all of the profit. From monthly rent to the eventual sale of the property, you do not have to split your profits with anyone. However, it is important to note that the flip side of this benefit is that you also take on all of the risk.

Real estate funds offer several advantages to the savvy investor.

1. Diversification. Real estate funds allow you to pool your money to purchase a range of assets across various markets. By owning shares in a pool of properties, you can also employ different investment strategies to provide real and true diversification. Additionally, diversification reduces risk and can unlock higher returns.
2. Professional Management. Like a professional money manager in a mutual fund, a real estate mutual fund offers the benefit of professional management. The latter individual will have a strong real estate background, understand investment strategies, know how to choose the right markets, and can help you choose properties with the right balance between risks and rewards.
3. Preferred Return. With a preferred return, you (the investor) will be paid first. If it is a cash flow fund (whereby the investor will get paid throughout the life of the fund). This is incredibly important, especially for higher-risk funds, since it means that you will be paid before the professional manager. In this context, preferred returns often reduce each investor’s financial risk.
4. You Don’t Need to Qualify for Financing Yourself. Real estate funds give you access to better investment opportunities. Pooling the money together creates the opportunity for positive leverage, whereby the interest that you’re paying is less than the internal rate of return that you are investing in. In layman’s terms, this means that you get to make money on the latter spread. Since you don’t need to qualify for financing, you are able to get the very best access to capital so that you can enjoy all of the benefits associated with positive leverage.
5. Tax Benefits. As a passive investor, you will be able to enjoy additional tax benefits when you invest in a real estate fund. These tax benefits also include pass-through depreciation opportunities, up to a 20 percent deduction on your tax return, as well as other opportunities to save additional money.

Investing in the right type of real estate property will require you to do your due diligence. As seen in the below five steps, investing in a single family home requires different steps than participating in a real estate fund.

The following five steps should be followed if you want to purchase an investment property as an individual.

Step #1: Research Different Markets and Property Providers. The best markets to buy rental property should have strong job and population growth, economic diversity, affordability, and opportunities for cash flow and home appreciation. Within these markets, it is important to identify local professionals who can implement the property management tactics needed to lease turnkey rental properties to the right tenants.

Step #2: If Financing, Get Approved With a Lender. Before you can purchase a single family home, you must be approved by a lender (unless you are planning on paying for the entire property with cash as a single payment). The type and amount of financing that you receive will dictate what type of home you can purchase, as well as where and when you can purchase the home.

Step #3: Find a Property & Get Your Offer Approved. Once you have received your pre-approval for financing, you will be able to find the right turnkey property and make an offer. Upon approval of your offer, you will proceed to the next stage of purchasing an investment property.

Step #4: Get Inspections, Appraisals & Homeowners Insurance. During this stage of the buyer’s journey, it is important to obtain all required inspections and appraisals for the investment property. Make sure that you thoroughly investigate any “red flags.” A failure to pay close attention to potential problems can result in hefty expenses and repairs down the road. Once your home has passed all inspections and appraisals, you will want to purchase homeowners’ insurance as a precaution.

Step #5: Manage Property Managers and Keep an Eye on Market Performance. Whether you choose to manage everything yourself or leverage the benefits of working with a trusted local property manager, it is important to monitor your investment’s market performance. Be sure to spend the time needed to review monthly reports, as well as the quarterly reports on the local housing and job market, so that you can know if your rental home is a) priced accordingly, b) generating the positive monthly cash flow that it should be, and c) if market conditions are changing and thus indicating that it is time to sell.

The following five steps should be followed if you want to invest in a real estate fund.

Step #1: Research Real Estate Fund Managers and Investment Strategy. Ultimately, there are several types of funds with a wide variety of strategies. You want to choose a fund that aligns with your core values and financial goals. Additionally, you want your fund manager to have the experience and expertise needed to a) select the right type of real estate assets, b) manage those assets, c) mitigate risks, and d) help you earn the passive income that you desire.

Step #2: Understand Real Estate Fund Return Structure and Timelines. Every fund has a beginning (when it starts) and an end (its shelf life). The shelf life of the real estate fund has to meet your financial goals. It is important that you spend time getting to know the intricate details, how you will be paid, when you will be paid, and the overall timeline.

Step #3: Read Offering Documents. Even though you are a passive investor, you still have to spend the time needed to “manage” the fund managers. In other words, you need to take the time needed to thoroughly review all of the offering documents. Ask any questions that you might have and clarify any doubts before you join a real estate fund. Remember, the fund is designed to help you diversify and reduce risk while still offering the potential for higher returns. However, this does not mean that you should have a “hands off approach;” instead, you need to complete your due diligence from day one.

Step #4: Fill out paperwork, wait for approval, and wire funds. Joining a real estate fund requires careful completion of paperwork. You will then need to wait for approval. Upon approval, you will be able to wire the required funds to the escrow or fund account.

Step #5: Review Quarterly Updates and Distribution Statements. As the fund deploys capital and executes strategies, a couple of things will happen. If it is a cash flow fund, then you will receive monthly, quarterly, or yearly cash distributions. If there is a preferred return, then you will get paid first. These distribution statements will look similar to any stocks, mutual funds, or retirement funds that you are invested in. Make sure that you read these statements carefully, so that you can a) know what’s going on and b) make informed investment decisions.

Qualifying for real estate mutual funds depends on the fund type. With this in mind, as you are researching what fund(s) you want to join, you will need to carefully examine the financial requirements. If you do not meet the requirements, then you will not be approved for the fund. Remember that by pooling capital, investors aim to mitigate risk, not take on more; as such, many real estate funds will require accreditation.

Reg. D 506(b) typically requires accreditation. To be an accredited investor, you typically need an annual income of $200,000 as a single investor or $300,000 as a married couple. Alternatively, you must have a net worth, excluding the primary residence, of at least $1 million. Additionally, Reg. D 506(b) requires a prior existing relationship. This type of relationship is typically defined as someone who has “three touches.” For example, you had a phone call, responded to an email, met in person, joined a group, are a member (for example, this is a requirement for the RealWealth), or some combination thereof.

Reg. D 506(c)

Reg. D 506(c) allows companies to raise capital without an existing relationship. Essentially, you could invest in a company or fund without actually knowing the investor or having the “three touches” required for the Reg. D 506(b). With this in mind, you must also be an accredited investor with an annual income of $200,000 as a single or $300,000 as a married couple. Alternatively, you must have a net worth, excluding the primary residence, of at least $1 million. Keep in mind that you must be able to prove your financial status.

It is always important to invest in a fund that properly aligns with your financial goals. With this in mind, you want to ensure that the projected ROI, potential risk, the timeline (i.e., fund shelf life), and the financial manager have the same values and goals that you do. In this vein, you might determine that it is better for you to invest individually, rather than partaking in a fund.

If you have good credit, enough time, and the finances needed, then you might want to invest in a turnkey rental property. Generally speaking, these types of properties are fairly easy to understand and provide the passive monthly income that you need to meet your financial goals. With this in mind, it is important that you take the time needed to learn the basics of real estate investment before you begin your real estate journey. However, if you don’t want to learn, you simply want to invest, then a real estate investment fund can provide you with the passive income that you desire with little to no time commitment.

For the busy professional, a fund is typically the “better” choice than a turnkey rental property. With the real estate fund, the busy professional will have to dedicate little to no time once they have selected the fund that is right for them. With this being said, the busy professional should still take the time needed to review all quarterly reports, so that they can continue to make informed real estate investment decisions.

You need to be aware of what kind of fund you are investing in. If you are investing in a flip fund, then your IRA could be heavily taxed. However, if you are investing in private lending, then this is considered “investment,” and can thus be a great thing for your IRA (i.e., it could provide great rewards without heavy tax fees). You need to understand the tax implications of any funds before you use your self-directed IRA to invest in any fund.

The RealWealth (RealWealth) currently has single family funds. Since multifamily funds are in a bit of a bubble, RealWealth is holding off on multifamily funds.

It depends on the fund. Some funds allow you to exit early, while others do not. Make sure you read all documents, including the section on the “exit strategy,” before joining a fund.

There is always SEC oversight.

For the accredited, it is either/or. In other words, you will need to prove an annual income of $200,000 as a single or $300,000 as a married couple. If you do not prove the latter condition, then you will need to show that you have a net worth, excluding the primary residence, of at least $1 million.

The primary difference is that most REITs are publicly traded on stock exchanges. Alternatively, real estate hedge funds are typically private entities.

It depends on the funds. This will always be disclosed within the fund’s paperwork.

Yes, you can use an LLC to invest. However, there is criteria that the LLC must meet to be accredited investors. With this in mind, you can’t “hide” a non-accredited investor within an LLC and then try to invest in a fund.

The tax form will depend on how the fund is structured.

If you invest in an LLC, you are offered protection through that LLC.

In conclusion, whether to invest in a real estate fund depends on your financial goals and needs. With this in mind, real estate funds do offer several benefits, including tax breaks, diversification, preferred returns, the potential for reduced financial qualifications, and access to professional management. To know if investing in a real estate fund is right for you, you should always conduct research, complete your due diligence, and speak with your investment counselor. If you don’t have an investment counselor yet, you can schedule a complimentary call with RealWealth Developments Director, Paul DiVincezo.