How to Start a Real Estate Fund

With the real estate boon of recent years, plenty of investors have wanted in on the action. But real estate is expensive, and coming up with the money to invest in larger projects isn’t realistic for many people. That’s why starting a real estate fund can be a great next step if you already have experience with single-asset deals.

What is a real estate fund?

A real estate fund is an investment vehicle that pools money from multiple investors. The fund buys an asset (or portfolio of assets) that an investor may not be able to purchase by themselves.

Real estate funds can take a variety of forms but are generally LLCs or limited partnerships. The purchases they commonly make include commercial buildings, apartments and shopping centers. The goal of a real estate fund is to generate income through rent and property appreciation, which is then distributed to the investors.

While there are several ways to create or invest in a real estate fund, here is one step-by-step example:

1. You identify real estate you think would be a good investment. However, you don’t have the capital or risk profile to purchase the property on your own.
2. You reach out to other investors to see if anyone else wants in on the deal. It’s helpful to prepare a summary of your relevant historical performance; lack of a documented track record could turn away prospects. More sophisticated investors might also want to see an independent accountant’s report.
3. You find four others willing to invest in the property you identified. Together you establish an LLC or partnership, with each of you providing capital in exchange for ownership in that entity.
4. The entity itself purchases the real estate. The property can be held as a long-term investment, or you can work together to flip it for short-term gain. Your choice depends on your entity’s goals.

As a founder of the fund, you will be a general partner and fund manager responsible for things such as:

• Finding lenders to secure financing
• Managing cash flow and budgeting for expenses and future investments
• Evaluating properties when looking to boost value and returns
• Assisting in buying or selling properties
• Drafting leases and property agreements
• Advertising properties, creating listings or finding a listing agent

Establishing a real estate fund to purchase a specific property is common. However, you can also do this before identifying any properties. Organizing your entity ahead of time allows you to act quickly when you identify investment-worthy real estate.

Open-end, closed-end… what’s the difference?

A real estate fund can be organized as an open-end or closed-end fund.

Open-end funds can issue an unlimited number of ownership shares. The real estate fund can continue to accept new investors all the time; there is no restriction on how many investors can get involved.

Open-end real estate funds aren’t generally traded on the open market. The only way for an investor to divest themselves of those shares is to sell them back to the fund (or in the case of a partnership, get permission from the other investors).

Closed-end funds issue only a predetermined number of shares. Typically, the closed-end fund will announce that its shares are for sale (like in an initial public offering). Once those shares are purchased, no new ones will be issued. Investors can divest themselves of shares by selling them on the open market.

Documents You’ll Need to Start a Real Estate Fund

In its simplest form, most real estate funds are LLCs (limited liability company).  This type of entity exists separately from its owners. It offers liability protection to its members and passes income and losses through to investors.

While the paperwork needed to form an LLC varies by state, here are a few common documents you’ll need.

Articles of Organization

An LLC’s articles of organization are the official charter document you’ll need before you can commence operations. This document should include your entity’s name, address, purpose, registered agent details and member information. You’ll file your articles of organization with your Secretary of State.

Operating Agreement

Your operating agreement is the governing document of your business. Without it, your state may disregard your LLC status, opening you up to unlimited liability. Operating agreements often include:

• Capital investments of each member
• Ownership stakes
• How income, gains, losses and deduction are distributed among the members
• Expectations and responsibilities of members
• Voting rights and responsibilities
• How decisions will be made and disputed
• How to dissolve the business

Funds are subject to varying degrees of regulation based on their structure and nature. These factors would also dictate the nature of the formation documentation. On the less formal end of regulation are funds known commonly as “Friends and Family” Funds. The more formal funds are registered securities with the Securities Exchange Commission (SEC).

Based on the level of regulation required, some additional documents may be required:

• Private Placement Memorandum (PPM) – A plain English explanation of the nature of the investment and associated risk for your fund
• Subscription Agreement – An agreement between the company and a prospective investor to purchase shares in the company
• Accredited Investor Certification – A certification by a potential investor that they meet certain requirements as laid out by the SEC

The list can go on. It is important to fully understand securities laws when setting up a fund, so a qualified attorney should be part of your team. (Documentation for limited partnerships would be similar to that of LLCs but with a few minor differences.)

Other Documents You Might Need

No matter how you choose to form your real estate fund, a few other documents might be necessary.

• Letter of intent
• Purchase and sale agreement
• Development agreement
• Management agreement
• Loan guarantee fee agreement

These document lists are not exhaustive. The paperwork you’ll need to form and operate your personal real estate fund could — and likely will — look different from this list. Your real estate business advisor should be able to point you in the right direction.

So… should you start a real estate fund?

Real estate funds offer several benefits. They’re a source of readily accessible equity, so you can move quickly as new opportunities arise. They provide access to larger projects and allow you to diversify your portfolio and share risks with other partners. Additionally, this group strength means you can negotiate more favorable terms with lenders. And as a fund manager, you can earn fees above and beyond the returns from your entity’s investments.

But starting a real estate fund isn’t something to take lightly. Talk with your lawyer and CPA firm to ensure you understand the financial and tax consequences of this type of strategy. James Moore’s real estate CPAs have years of experience working with real estate funds and their managers and investors. They’ll be more than happy to put their expertise to work and discuss the options with you.

All content provided in this article is for informational purposes only. Matters discussed in this article are subject to change. For up-to-date information on this subject please contact a James Moore professional. James Moore will not be held responsible for any claim, loss, damage or inconvenience caused as a result of any information within these pages or any information accessed through this site.