Summary: In this article you’ll get an answer to the question what is a real estate investment fund; you’ll also learn how funds work, how to determine if a fund is the right choice for your financial strategy, and the differences between investing as an individual vs. with a fund. Through these insights, you’ll not only be able to confidently answer, “what is a real estate hedge fund,” but you’ll also gain the knowledge needed to determine the benefits and potential risks of possible funds. Read on to discover all you need to know about real estate funds. This article is based on the RealWealth Webinar, How To Earn Rental Income Without Being a Landlord, hosted by our Co-Founder and Co-CEO, Kathy Fettke.
Did you know that real estate funds offer many advantages? These funds offer real estate investors the opportunity needed to have increased 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 run as an LLC (or other type of entity) and are designed to achieve certain 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 an individual investor. By pooling investor money, real estate funds also give investors the opportunity to explore various types of properties. For examples, some funds might focus on purchasing large residential properties, while others might be focused on buying commercial properties that can be easily sold. While the rules for each real estate fund vary, generally speaking, the funds offer investors the opportunity to more readily liquidate their shares, and thus receive the funds when they need them most.
Benefits of Owning Real Estate Individually vs Investing in a Real Estate Fund
Owning real estate individually offers several advantages; however, participating in a real estate fund also has its own set of benefits. From diversification to tax benefits, there are many reasons that you might choose to invest in a real estate fund.
3 Benefits of Owning Real Estate as an Individual
Did you know that there are several benefits to owning real estate as an individual?
- 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 sell a buy and hold investment property.
- 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.
- 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.
5 Benefits of Investing in a Real Estate Fund
Real estate funds offer several advantages to the savvy investor.
- Diversification. — Real estate funds offer the opportunity for you to pool your money, and thus purchase different types of assets in various markets. By owning shares in a pool of properties, you can also employ different investment strategies to provide real and true diversification. Additionally, with diversification comes reduced risks, as well as the potential for higher returns.
- 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, understands investment strategies, knows how to choose the right markets, and can help you choose properties with the right balance between risks and rewards.
- 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 vein, preferred returns often times reduce the financial risk of each investor.
- 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.
- 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 other opportunities to save additional money.
Steps to Investing in a Single Family Home vs a Fund
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.
5 Steps to Buying Investment Property
The below 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 selected market should have good job growth, high real estate markets, increased population growth, and have the opportunity for high cash flow properties. Within these markets, it is important to identify local individual who will provide the management tactics needed to properly lease out 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, it will be time for you to enter into 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 that you obtain all of the inspections and appraisals that you need 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 potential 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 do everything yourself, or want to leverage the numerous benefits of working with a trusted local property manager, it is important that you keep an eye on the market performance of your investment. 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.
5 Steps to Investing in a Real Estate Investment Fund
The below 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, as well as your 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 as a beginning (when it starts) and an ending (also known as its shelf life). The shelf life of the real estate fund has to meet your financial goals. It is important that you spend the time getting to know the intricate details, as well as how you will be paid, when you will be paid, and understanding the entire 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 risks, while simultaneously enjoying the potential for increased gains. 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 involves paperwork that must be carefully filled out. You will then need to wait for approval. Upon approval, you will be able to wire the required funds into the escrow account or the 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, 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.
How To Qualify for Real Estate Mutual Fund Investments
Qualifying for real estate mutual funds will depend on the type of fund. 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 money together, investors want to mitigate risks, not take on more risks, as such many real estate funds will require accreditation.
Reg. D 506(b)
Reg. D 506(b) typically requires accreditation. To be an accredited investor, you will typically need to have an annual income of $200,000 as a single or $300,000 as a married couple. Alternatively, you will need to 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 that 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 requirement for the RealWealth) or some combination thereof.
Reg. D 506(c)
Reg. D 506(c) allows companies to raise money without a prior 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 will need to have a net worth, excluding then primary residence, of at least $1 million. Keep in mind, that you must be able to prove your financial status.
Which Investment Makes Sense for You
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 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.
Self Directed IRA Funds
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.
Real Estate Fund Q&A
1. Do you have Multifamily Fund programs or just Single Family?
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.
2. If you have invested in a fund can you get out?
It depends on the fund. Some funds allow you to exit early, while others do not. Make sure that you read all documents, including the section on the “exit strategy” before you join a fund.
3. Do funds have SEC oversight like a mutual fund?
There is always SEC oversight.
4. Are any of the conditions or all of the conditions required to be an accredited investor?
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.
5. What is the difference between a real estate hedge fund and a REIT?
The primary difference is that most REITs are public companies on the stock exchange. Alternatively, real estate hedge funds tend to be private entities.
6. How much leverage is in a fund?
It depends on the funds. This will always be disclosed within the fund’s paperwork.
7. Can you invest in a fund with an LLC with multiple owners?
Yes, you can use an LLC to invest. However, there is criteria that the LLC must meet to be accredited investors. With this mind, you can’t “hide” a non-accredited investor within an LLC, and then try to invest in a fund.
8. What kind of form would I use for tax filing purposes?
The tax form will depend on the way that the fund is structured.
9. Should we invest in a fund using an LLC to protect assets?
If you are investing in an LLC, then this means that you are being offered protection via that LLC.
In conclusion, determining if you should invest in a real estate fund will depend 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 Pre-Strategy Session call with our Member Concierge, Kathy McBride.