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Transcript of The Art Of The Raise Final How Fund Structures
1 TAX LIEN ARBITRAGE UNCOVERED
THE ART OF THE RAISE How Fund Structures Are Used In Real Estate Partnerships
2 THE ART OF THE RAISE
COPYRIGHT © 2016 DANDREW MEDIAALL RIGHTS RESERVED.
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3 THE ART OF THE RAISE
CONTENTS What Does It Mean to Have a Real Estate Fund? ....................................................... 4
Types of Structures Are Out There .............................................................................. 5
Private Capital With A Dedicated Allocation ................................................................ 6
Joint Venture Fund ...................................................................................................... 7
The Classic Limited Partnership Structure ................................................................... 9
Aligned Investment Agreement with Institutional Capital ........................................... 10
Brokerage Structure ................................................................................................... 11
Types of Funds ............................................................................................................ 12
Calling the Capital ....................................................................................................... 13
The Three Sources: ................................................................................................... 14
Due Diligence ............................................................................................................ 15
Why Investors Like Real Estate ................................................................................. 16
Relating to Investors ................................................................................................... 17
Building and Selling Your Business Model ................................................................ 19
Calling the Capital ....................................................................................................... 20
Understanding Discretion .......................................................................................... 20
Risk Sharing .............................................................................................................. 21
Fees and Incentives .................................................................................................... 22
REITs ......................................................................................................................... 23
Clawback ................................................................................................................... 24
Catch Up Fees ........................................................................................................... 24
Crossed Promotes ..................................................................................................... 25
Leverage .................................................................................................................... 25
IRRs Vs Multiples ...................................................................................................... 26
Conclusion ................................................................................................................... 28
About the Author ......................................................................................................... 29
4 THE ART OF THE RAISE
What Does It Mean to Have a Real Estate Fund?
A fund is essentially a pool of money investors put together to make investments.
Some funds are closed, and managers seek funds primarily through their own
connections and networks. Often, these types of funds require large-scale investments,
in terms of millions of dollars.
Other funds can be invested in through traditional investor's markets and may offer
retirees and middle class investors the opportunity to invest.
One of the biggest advantages to investing in a fund is that your money will almost
certainly be managed by a highly knowledgeable and reputable money manager. This
person will likely hold years of experience in the partial investment field, and will know
the ins and outs of the industry. Real estate can allow investors to make huge gains,
and because it involves tangible assets that everyone is familiar with, many investors
consider real estate easier to understand than other types of financial vehicles.
If you are a real estate expert looking to start a fund, you will gain access to more
capital and potentially important connections by bringing investors on board.
Unless you are already very wealthy, you likely will not have the funds necessary to
fund major real estate investments all by yourself.
And even if you have the capital to do it yourself, working with investors will allow
you to spread risk.
Of course, you will have to share part of the rewards, but the trade-offs are well worth it.
Further, through management fees, you can even get paid just for running the
fund.
5 THE ART OF THE RAISE
Types of Structures Are Out There
As we mentioned earlier, there are several types of real estate funds.
Investors and fund managers can choose from a variety of options in order to create a
structure that best serves the needs of both the managers and the investors.
In this section, we will outline four of the most popular types of funds, including:
Private capital with a dedicated allocation
Aligned investment agreement
Joint venture/facility fund
“Classic” LP structure
We will go over each of these types of funds in the following sections and explain some
of the key differences.
We will also highlight some of the strengths and weaknesses of each fund type.
1
2
3
4
6 THE ART OF THE RAISE
Private Capital With A Dedicated Allocation
A private capital fund is pretty straightforward.
Capital simply refers to money, so private capital then is simply private money. This
means that investors are choosing to invest their private money into a certain
undertaking. Often, with this structure it will actually be investors who seek out qualified
managers to handle their investments.
The strengths and weaknesses of this structure largely stem from the fact that it is
usually a small group of investors and a dedicated team of managers running the fund.
Usually, investors and managers will be very familiar with each other, and may even be
friends.
This “coziness” has many strengths. Funding
will often be private or raised through personal
networks so managers don't have to “hit the
road” and make sales pitches to raise capital.
Often, this tight-knit group will be flexible and
able to quickly adapt to rapidly changing
circumstances. Given how turbulent the
economy can be and how quickly opportunities
and risks can develop, this may prove essential.
Still, there are sometimes conflicts over
discretion, meaning how much control the fund
manager has to make decisions without the
approval of investors.
Funding is private and relies on personal networks and connections
Ability to quickly respond to
changing market conditions
Strengths
Personal relationships can complicate business
Reliant on a small group of people
High levels of risk for investors
Weaknesses
7 THE ART OF THE RAISE
Further, personal relationships may come to interfere with business relationships. Also,
because the group of investors is generally quite small, they will be taking on a
considerable amount of risk. If the fund should fail or lose money, it will fall squarely on
the shoulders of a small number of investors.
Joint Venture Fund
Sometimes fund managers and investors may reach out to people outside of their own
fund or company to come on board and do investments together.
This is referred to as a Joint Venture (JV) In this situation they may opt to do a join
investment with another investor or property group. This helps to spread risks and
leverages the skills and networks of everyone
who joins up with the joint venture.
Let's say you are running a 20 million-dollar real
estate fund and are approached by a local real
estate developer, John. John a smaller player,
managing only 5 million dollars’ worth of capital
and assets, but he has a good reputation, and
his investments are paying off. John specializes
in an area you are familiar with, but don't count
yourself as an expert, say hotels.
John knows of a great investment opportunity for
an older hotel located on a prime beach. It's
selling for 5 million dollars, but he thinks he can
negotiate down to 4.5 million dollars. Not only
Have to manage fund-to-fund relationships
Have to share in profits
Potential for more politics and infighting
Weaknesses
Able to leverage assets and skills of multiple companies/ funds
Spread risk among several companies/funds
Increased networking potential
Strengths
8 THE ART OF THE RAISE
that, but John is confident that with a million dollars’ worth of remodeling and rehabbing,
he will be able to sell the hotel for at least 10 million dollars.
The problem is that John does not have the 5.5 million dollars to buy and remodel the
hotel and has only 2 million dollars to invest. John decides to approach you and your
fund with a deal. He will put in 1.5 million dollars of his money, and your fund will put in
the additional 4 million dollars.
Then, John will help oversee the remodeling of the hotel and within two years sell the
hotel off to the appropriate party. John will then split the profits accordingly.
As we can see, a joint venture can be a great option because it spreads risk and can
also allow you to tap into skills that you yourself do not necessarily have. In this case,
you don't have hotel real estate development skills but John does.
John, on the other hand, doesn't have the capital necessary to complete the deal, but
you do. By teaming up, both parties benefit and if all goes well, both parties will profit.
One of the most difficult things with a joint venture is mediating differences between
investors.
If the deal is 75-25 with your company putting up 75 percent of the investment, most
likely you will have the most say in any investments. If it's 50-50, however, you may
need a unanimous decision between both parties, and that can sometimes be difficult to
arrange. Learning to deal with and mediate differences in investment philosophies and
points of view may be essential for a joint venture, so always keep that in mind.
9 THE ART OF THE RAISE
The Classic Limited Partnership Structure
This structure is perhaps the most common type of structure for a real estate fund.
Usually, this structure works best for smaller funds with a more limited number of
partners. While the actual dollar amount of the fund may grow to become quite large,
often a classic LP will have a limited number of partners.
An LP simply refers to two or more partners who join together to pool money and make
investments. Each partner is liable only for what they have invested. Partners do not
receive funding through dividends, but instead direct cash access.
Generally speaking, one member will take
charge as the lead LP and invest the largest
single portion of the LP. After a person comes
on board as the lead LP, it's quite common to
continue to raise funds through successive
rounds of fund raising.
Like other partnerships, LPs depend on high
degrees of trust. The better the partners are at
working with each other, generally the better the
fund will function. For an LP to work, the group of
friends or partners must have direct access to a
considerable amount of cash. This is especially
true in real estate investing where investments
can be quite costly.
In other words, a few thousand dollars might be
enough to start up a small stock portfolio, but it's
not going to be enough in most cases to facilitate investing in real estate.
Often easier to manage personal relationships
Quick and responsive
Small group of investors means increased rewards of profits
Strengths
Can complicate personal relationships
Need to establish clear authority and decision-making structure
Limited capital
Small group of investors assume all risk
Risks
10 THE ART OF THE RAISE
Aligned Investment Agreement with Institutional Capital
An Aligned Investment Agreement with Institutional Capital is another important fund
type worth considering.
For the sake of space, we will refer to this simply as “aligned investment” from here on
out. With this type of fund, money is generally provided by an institutional investor, such
as a hedge fund.
Institutional investors are in the game to make money, and if it happens that they
believe that investing in you and your real estate investors will result in strong profits,
they may choose to provide you with the capital you need to invest.
With this type of investment, the institutional
investor generally controls the assets and
usually has the final say on any investments
made. In this sense, the fund isn't yours and the
investments are not yours.
As a manager, you will earn your money
through fees and other forms of income. For
many people, this set-up probably doesn't
sound as enticing as other investment set-ups
that let you maintain more discretion and
ownership of the fund.
Of course, on the other hand, there will be less
direct risk to you. If the fund suffers losses,
ultimately the institutional investor will have to suck them up.
Institution firms may have a lot of power and demand a lot of say
Must work to please and reassure investors
May have to defer to larger organization's wishes
Weaknesses
Access to large amounts of capital
Pooled resources of larger organizations
Risk is assumed by large firms that can handle risk
Strengths
11 THE ART OF THE RAISE
Brokerage Structure
For many people who are familiar with the real estate market, but don't have a lot of
experience in running real estate funds, the brokerage structure is a great starting point.
In this situation, you basically act as a broker for deals. Let's say you are a commercial
real estate broker for Sunshine City and through your daily work, you come across an
office building for sale that looks like a really good deal. You know the owner is going
through some financial difficulties and is looking to offload the property quickly, and so
has priced the property to sell.
As soon as you see the property go up for sale you realize that it's a great investment
but don't have the funds to invest yourself. You happen to have a local friend; however,
who is handling an investment fund and would
have the cash to purchase the building. You
could approach your friend and see if he wants
to do the deal and make the necessary
investment. In exchange, you could receive a
set fee or a part of the investment.
This type of arrangement is great for people who
are familiar with a given field, such as real
estate, but don't have the funds yet to invest.
With this structure, you don't need funds to
invest, but simply knowledge to leverage or sell.
Best of all, a brokerage arrangement will allow
you to get a feel for the investing side of real
estate and help you get your foot in the door.
No committed capital
Relies on selling deals
May not have direct control over investments
Weaknesses
Minimal risk for investors
Good for networks
Can leverage a lot of money
Strengths
12 THE ART OF THE RAISE
Fractionalized Trust Deeds or Notes
You go out chasing folks with small money invest in part of a trust deed
Lots of heavy lifting. Very inefficient. Constantly pounding the pavement for Deal Flow and Investor
Reg D Fund “Classic LP” Structure
Capital is already pooled, Ready to pe deployed.
Capture Management Fees, and other performance
incentives (splits”)
Institutional Capital Alignment
“Approval in a box”
Deal by deal approval.
Allows you to build a track record with a larger player’s
balance sheet
Types of Funds
Dis
cre
tio
n
an
d F
ees Not much discretion.
Investors can walk from the deal
Incentives are not great.
Deal-by-deal
Has slightly better discretion and fees but this model allows you to build your brand.
This is the “gateway drug” to a fully funded fund
Most discretion, best economics. Most money made here.
Prestige! The “Promised Land”
Can add leverage to juice your fees.
13 THE ART OF THE RAISE
Calling the Capital
For any fund to run, the fund manager must put together the capital necessary to make
investments.
Or in other situations, investors may actually put money together, and then approach
qualified people who they think will be able to manage their investments and record
strong returns.
A fund may be open, or it may be closed. A closed fund means they are not accepting
funding, and fund managers only work through their close networks in order to raise
capital.
Often, once a certain milestone is reached, say 50 million dollars, the manager stops
accepting funding altogether. This allows him or her to focus on actually putting the
money to work. After all, while raising capital is important, actually making money off of
investments is the real aim of the fund manager.
There are three primary sources for funding. Your personal network, brokers, and
placement agents. Each one of these sources is unique and has its own advantages
and drawbacks. As such, we will go over them separately and in detail in the next
section.
You should consider all of them closely. Often, it is best to use a mix of the three
funding sources. This helps you maximize the amount of money you receive, while also
ensuring that risk is spread around.
14 THE ART OF THE RAISE
The Three Sources:
1. Family, Friends, and Personal Network. Family, friends, and other associates you
find through your personal network can be a great resource for funding. With this
type of funding, you are often granted a high amount of discretion. As you start
pitching your fund, your network may begin to grow. For example, you might pitch
the idea to a friend, who then in turn introduces you to another friend who might be
interested. You should be warned, however, that business relations often stress
personal relationships.
2. Brokers. Do you know someone who is managing over an investment fund? If so,
they might be interested in acting as a broker for your investment ideas. Basically, if
you see a good real estate investment in the market, you could turn to your broker
and pitch the idea to them. If the broker closes on the deal, they can pay you a fee,
give you a piece of the investment, or compensate you in some other mutually
agreeable way. Often, however, the broker prefers to act as a capital broker. In this
case, the broker will help arrange capital for its clients. The reason brokers prefer to
work with this model is because they often lack the skills and knowledge to properly
manage real estate investments. After all, that's actually your area of expertise, so
why not benefit from it?
3. Placement Agents. Placement agents will introduce you to investors and help you
find investment capital. Their services don't come free, of course, and they will likely
charge you a fee. They may also charge the investor a fee. Placement agents are a
great resource because they often have extensive personal networks that can be
leveraged to drum up investments.
15 THE ART OF THE RAISE
Due Diligence
Of course, investors are not going to simply give you money. They are going to perform
due diligence and inspect your personal background and investment vision, among
other things, to make sure that you deserve this funding. If you have an established
track record, they will look at this very closely. If you are new to managing investments,
investors will look at your overall skill sets to try to figure out how good of an investment
manager you will make.
Your investors will also want to know about your team. How many people will be
working with you? Who will handle what? Do you guys have a track record of working
together? All of these questions and more will be asked. Basically, investors will want to
make sure that the appropriate skills are present and that your team will have the
necessary chemistry to work together.
Trust and credibility will also be major issues. Often, emotions can have as big of a role
in investments as logic. Investors want to feel that they can trust you and your team.
Trust is important both for securing an initial investment and also for increasing the
amount of discretion you have as the fund manager. And, if an investor doesn't trust
you, they probably won't make an investment, no matter how good your pitch is.
16 THE ART OF THE RAISE
Why Investors Like Real Estate
While securing investors may require a lot of time and patience, there are some
advantages to real estate investing vs. other assets. For one, just about everyone can
come to understand real estate investing. Real estate isn't some intangible and hard to
explain derivative or other difficult-to-explain asset. Instead, people get to invest in
something they can see and touch.
Not only that, but also just about every adult has experience working with real estate.
For example, the vast majority of us have bought or renting housing. Many people have
also had to rent, lease, purchase, or build office and commercial space. While not
everyone is an expert, just about everyone can understand the value of real estate.
Further, in spite of the 2009 Financial Crisis, real estate has a very strong track record.
While prices did develop into a market pre-2009, real estate had grown steadily for
decades beforehand. Many people made huge amounts of money. And, in the future,
many people will again make huge amounts of money off real estate. Yes, real estate
investing has suffered some brand damage in recent years, but many people still
believe in it. And rightly so, real estate markets may have bottomed out and now might
be the perfect time to invest!
17 THE ART OF THE RAISE
Relating to Investors
So there are many reasons that investors prefer real estate to other investments. Now
you have to relate these reasons to investors, and also sell the particular investments
you want to make.
While people often think of the capital raising stage as the primary time to sell
investments, it is often important to sell your investments at later stages. At the very
least, constantly updating investors to the investments you are making, and explaining
why you are doing so, will build trust and credibility. This could come in handy if you
decide to launch another fund later on.
At both the initial capital stage and later on in the investment stage, you will need to
explain to investors why you are investing in particular properties. Explain to investors
what types of properties you look for and why you like them.
What are the particular attributes you look for in a property? Details in the construction,
such as the type of wood used or concrete poured, so long as these details actually add
value, can go a long way in building credibility. For example, let's say you are investing
in an area with known termite problems, but the building you are looking at investing
was actually constructed of termite repellent wood. Small details like this can go a long
way in making you look professional.
There are numerous other ways you can add details to your explanations. Market
conditions, urban development projections, crime rates, and all sorts of other details can
add value to your investment and thus also your pitch.
18 THE ART OF THE RAISE
You should be working constantly to redistribute money to your investors. At first, this
might seem like common sense. Still, if you think about it, redistributing money may
occasionally come at the cost of making great investments. For example, you might turn
down an opportunity to invest in a great long-term deal and instead choose to invest in a
short-term deal, simply so you can quickly return money to your investors.
In fact, securing some short-term deals that you can make some profits off of, and then
distributing money is a great way to build trust among your investors. This little trick is
known among many professional investors. In short, fund managers will look for a few
very short-term deals to invest in, just so they can send checks to investors' mailboxes.
Why? Money talks and in the investing world, checks are probably the greatest form of
communication you can use.
Besides checks, you should also consider regular newsletters and also impromptu
letters to investors to update them on events. Whether to use email or mail will likely
depend on your clients and their preferences, so give them options. With some of your
largest investors, you should also consider holding lunches or dinners, and other social
events. This will keep the atmosphere friendly, but also ensure that everyone stays
updated.
It is especially important to explain yourself to your core group of investors. These are
the people who are providing the most funds and most connections. A solid group of
core investors can be the difference between a successful and unsuccessful fund.
If all of this sounds like a lot of work, take solace in the fact that over time it will become
easier. For one, you will grow better at pitching and relating to investors. Also, if you
perform well, your track record will grow, and investors will come to trust you more. The
more trust you build, the less explaining you will have to do.
19 THE ART OF THE RAISE
Building and Selling Your Business Model
Once you have caught an investor's interest, he or she is going to be very interested in
seeing your business model. Most potential investors will want to know all of the details
behind how you will conduct business and whom you will deal with. This is especially
true for people who are new to the market. If you have a long track record, investors
may be more willing to invest without going over all the details.
Investors are going to want to know about your basic business vision. What are you
investing in and why? What skills related to this field will you bring to the table? For
example, if you spent ten years as a commercial real estate broker and now see a lot of
opportunities in the market, you should explain all of the details to your investors.
Also, investors will want to know how potential investments will come to you. Do you
have a large personal network in the field? Going back to our example, if you are a
former commercial real estate broker, you probably know a large number of property
developers and other parties who are selling real estate. Make sure you sell any
connections you might have. And if you are setting up a brokerage system where
people will come to you with potential leads, let your investors know.
Also, how are you going to source various aspects of your business? For example, if
you specialize in purchasing houses in bankruptcy and then remodeling them before
flipping for a profit, who is going to handle the remodeling? Will it be in-house? If so,
what experience do you have in this area? If you are outsourcing, what is the
arrangement, and why is this arrangement the best possible option?
20 THE ART OF THE RAISE
Calling the Capital
Understanding Discretion
Discretion is an important concept for many fund managers and investors. Basically,
discretion refers to how much control an investor has over making investments. If the
manager has 100 percent discretion, that means s/he can make whatever investment
s/he wants.
Obviously, many fund managers prefer this set up as it gives them the most flexibility
and allows them to act as quickly as possible.
If a manager is running a closed fund with only 5 investors, these investors may ask to
have greater oversight and control over their investments. In a certain sense, the
investors may ask to act of a sort of board of directors and actually require that their
fund manager obtain approval before making a specific investment. In this case, the
fund manager has no discretion.
Investors might also decide to allow discretion for small dealers. This can be thought of
as “stepping up” discretion. For example, let's say a fund manager is managing over 20
million dollars in assets with contributions from 10 investors. These investors may opt to
give the manager 100 percent discretion for all deals under $500,000 dollars.
If you are just starting a fund, you may not be given full discretion. Still, over time, many
managers have found that with repeated strong performances, investors become more
trusting and are often very willing to increase discretion. Trust is very important. And
over time, many fund managers find themselves with 100 percent discretion.
21 THE ART OF THE RAISE
Risk Sharing
While individual circumstances may vary, risk is generally shared in portion to the
amount of money invested. Most fund types, including limited partnerships, try to limit
total risk to the amount of money that is invested. This means that if a fund goes
bankrupt, usually investors will not be asked to pay up more money than they have
already invested. And if this is the case, those who invest the most will lose the most.
Those who invest the least will lose the least.
Risk sharing is one of the most important reasons why people invest in funds. Even a
wealthy person who has enough money to facilitate all of the trading on his or her own
may opt to start or participate in a fund, instead of going it alone. Why? Most of the time
the investor will be looking forward to sharing risk. The simple fact is that no matter how
good an investment looks, it will come with risk. By sharing risk, an investor limits
liabilities and potential losses.
Of course, with shared risk there also come shared profits. After all, people don't want to
share the risks if they also don't get to share the rewards. Generally, people are
rewarded in proportion to how much they invest. Of course, the people who manage the
fund and actually direct trading, will likely stand to earn more through fees and
performance bonuses.
22 THE ART OF THE RAISE
Fees and Incentives
Managers do not manage over investments free. Managers are highly-skilled and
expect to be well compensated. As such, they usually charge a variety of fees. These
fees and incentives add up to the rewards that a manager makes for managing the
fund, and most importantly producing profits. The manager of the fund expects an extra
cut of the profits, extra earnings, or a combination of both for managing over the fund.
Profit splits are probably the most widely known type of the incentive. With a profit split,
the fund manager essentially takes a share of any profits made. So a manager might
have a 20 percent profit split fee. Then if the fund makes 1 million dollars in profit, the
manager will earn 200 thousand dollars.
Fees are generally designed to align the interest of the manager and the investors. In
short, this means that the more profits the manager produces, the more money he or
she is paid. By providing incentives for performance, investors can ensure that they
maximize profits. This way, investors and the fund manager(s) both benefit from each
other’s mutual prosperity.
Managers also charge fees, usually on an annual basis. With a fee, money is awarded
no matter what. Usually, the fee is based on either the amount of money invested in a
fund, or the amount committed to a fund. There are advantages and disadvantages to
both.
If fees are charged on the amount of funding invested, then you encourage the manager
to invest all of your funds, instead of sitting on them. On the other hand, this could
encourage the manager to invest the funds quickly and without as much prudence,
simply in order to collect fees for investing the money. Of course, proponents of the
23 THE ART OF THE RAISE
invested fee argue that otherwise investors will have no incentive; managers could
simply sit on the funds in order to produce profits. This is unlikely; however, as fund
managers are very careful while managing their reputations and collect a large portion
of their income from profit sharing.
REITs
A REIT, or Real Estate Investment Trust, is an investment security. Usually when
people think of investing in real estate, they think of people investing in actual houses or
buildings. A REIT is more similar to a stock investment. Instead of buying a house, you
invest in a REIT. The company or person who manages the REIT then invests the
money.
REITs can be set up as an equity REIT in which the value of the financial instrument is
based upon the value of the portfolio. Revenues will come from rent or profits made off
of the sale of a real estate venture. REITs can also be set up based on mortgages, in
which the value of the financial instrument is based on mortgages. With this type of
REIT, profits will be made off of interest rates.
Many investors like to invest in REITs because they are highly liquid assets that can be
sold quickly on financial markets. If an individual chooses to invest in actual properties,
they might have to wait months, or even years, before they can sell the property or
produce profits from rent. With a REIT, if a person must liquidate their investment to
raise cash, it can usually be done in a short amount of time.
As an investment manager, you could choose to set up a REIT. While this may be
difficult for smaller investors, if you build up a strong reputation, this could be a great
way to raise money. Some investment managers prefer running REITs because they
are less dependent and beholden to a core group of investors. Instead, the larger
24 THE ART OF THE RAISE
market can be used to raise capital. Of course, actually reaching the stage where your
reputation and performance are so strong that it justifies a REIT can be very difficult.
Running a REIT may also give you access to corporate level debt structures. This
means that you can sell bonds and raise money as a corporation, a benefit denied to
many traditional real estate investors. REITs also feature some tax benefits. For
example, the profits from REITs are taxed as capital gains, which are currently lower
than corporate, and in many cases personal, interest rates.
Clawback
A clawback is a special circumstance when money is distributed and then “clawed back”
for various reasons. Clawbacks are becoming increasingly popular among companies
for various reasons. Most importantly, clawing back money allows companies to
reinvest and potentially produce more profits.
You should be careful if you decide to use a clawback. Make sure you properly convey
your message to investors, as they may get upset. You will need to stress that the
short-term clawback will result in long-term gains for investors. Indeed, a well-conducted
clawback will benefit investors more than anyone else, so make sure you stress this.
Most investors are looking for stable, long-term growth, so they may even appreciate
the clawback, so long as it is properly conducted.
Catch Up Fees
Catch up fees allow fund managers to receive an extra cut of the profits once a certain
profit threshold is reached. In short, this type of provision gives managers extra
incentives for high performance, while also limiting risk for investors to a certain extent.
Risk is limited because investors only pay catch up for performance.
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This type of fee also gives the fund manager a strong incentive to maximize returns.
The better a fund performs, the more money the fund manager will make. Balancing
between the interests of investors and fund managers is always a tricky but essential
balancing act. Catch up fees offer a great way to balance these needs.
Crossed Promotes
Another important term to understand is cross promotes. This basically refers to cross-
promotional deals. In this situation, a manager from Fund X may decide to back the
manager of Fund Y by transferring some capital from Fund X to Fund Y. Money often
changes hands quickly and fluidly as managers look to maximize returns by hopping on
board for the best investments. Cross-promotes allows funds to take on increasingly
large projections and make bigger investments.
You should be careful; however, because the management fees for both funds can
quickly add up. Some investors may even question if being charged fees two or more
times by two separate funds is fair. Make sure you explain clearly to investors how you
will handle fees and also why the cross-promote will benefit them in the long run.
Leverage
Leverage is one of the most simple and at the same time most complex terms you will
ever come across. At its most basic level, it simply means any technique to increase
gains or losses. You might leverage the value of your home to start a business, and
thus produce profit. You could do this by taking out a (second) mortgage on your home
and then investing your money.
A corporation might leverage the value of its stock, profits, or whatever to borrow money
to reinvest and thus increase profits. On and on the list goes. Of course, in the
complicated world of finance, things are much more complicated.
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When approaching real estate, you may ultimately have to choose between leveraging
your resources at the fund or asset levels. Each has its own unique advantages and
disadvantages. In general, asset leveraging is probably most effective when you already
have a lot of assets, such as property, to leverage. Fund level leveraging relies more on
your company's performance and reputation, so if you have good “street cred” you may
be able to leverage that.
Asset based leveraging means you are using your assets to gain additional funding.
One simple way to think of this is mortgaging your property. In essence, you are putting
up the value of your assets to gain additional funding. Banks and other companies that
may be looking to loan you money or give you access to capital will be reassured by the
knowledge that you are staking your assets.
Of course, if you have not yet bought a lot of property, you may not have any assets to
leverage.
At the fund level, you are leveraging your fund's reputation and performance. This may
be a bit more speculative than asset based leveraging, so there are often higher risks.
IRRs vs. Multiples
There are two primary ways to measure the performance of a fund. The first way is
called the internal rate of return (IRR), while the second is referred to as “multiples.”
Both methods are used to measure performance, and both have their own distinct
advantages and disadvantages.
With an IRR, the present value of an investment is set at zero. Then all income and
earnings are either measured or projected from this starting point of zero. This way, you
can show the internal growth of the project. This allows you to easily show investors
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how much money the investment is earning over a period of time. An IRR can be
difficult to calculate, however, and is often based on projected or assumed numbers.
A multiple actually refers to dividing one performance measure by another. A simple
and well-known multiple is a Price per Earnings Ratio. You could set up a multiple to
help investors understand how you are performing. For example, you could set up a
measure that shows how much profit you produce off of each dollar invested. If you turn
every dollar investment into 1.2 dollars, then you can show a ratio of 1.2/1.
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Conclusion
When a real estate fund is done right, everyone benefits. Investors benefit by seeing
strong returns and maximizing their investments. Fund managers benefit from collecting
fees, sharing profits, and gaining access to the capital they need to purchase properties
and other assets. Even local communities can benefit from an increased inflow of
capital!
Of course, a real estate fund does not come without its risks. Right now, real estate
markets seem to be stuck on a roller coaster. From Shanghai to Boston, property values
are oscillating up and down. This creates a lot of opportunity for money to be made. By
when the properties are cheap, sell when the properties are expensive. Still, such
turbulent conditions require close and professional monitoring.
Either way, remember to always assess risk when investing in real estate. It's rarely a
good idea to put all of your eggs in one basket, so make sure you consider diversifying.
Monitor markets closely, and stay in touch with stakeholders, such as investors and
brokers. Make sure you communicate effectively, and always be straightforward and
honest.
And one final piece of wisdom: do not underestimate the value of personal networks.
Whether it means attracting capital, or finding deals, personal relationships and
networks are essential. As you try to grow your portfolio, you should also try to grow
your network. Make sure you develop strong working relationships with other managers,
investors, property owners, and others. At the end of the day, these personal
relationships can be as valuable as industry insight and financial capital.
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Robb KrautbauerOwner of Mountain View Investors, Inc.Located in Rio Rancho, NM
Robb has owned and operated Mountain View Investors, Inc. on a full time basis since 2011. Robb also owns a Real Estate Brokerage, Mountain View Realty, LLC. He has had his license since 2013. Robb has executed over 60 fix & flip, buy & hold and hard money loans since 2011 and has been involved in more than 100 transactions as a Realtor.
Mountain View Investors, Inc. is dedicated to the development of successful real estate solutions for both families and investors with expertise in all aspects of Real Estate. MVI specializes in purchasing homes at a discounted price and reselling them at below market value to homeowners and investors.
MVI is also a nationwide principal buyer of 1st lien performing and non-performing real estate notes. Purchasing both single and bulk transactions. Robb has assembled a team of professionals whose main focus is to quickly underwrite and close each and every transaction.
For the last three years, Robb has run a Million Dollar Friends and Family private equity fund. The core focus of the fund is purchasing bank and Government foreclosures to rehab and put back on the market. It is a huge success.
Robb has established many referral business relationships with diverse types of real estate investors and capital providers. He attributes his success to his creativity and persistence in problem solving.
Robb is active in both local and national mastermind groups and continues to invest in education in the Real Estate Investing space. Robb supports the St. Jude Children’s Research Hospital.