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There are many ways to dip your toes into real estate, depending on how involved you would like to be in the process.
For those who love being hands on and be the primary decision maker, investing directly into real estate, most often in the single family home space, would bring the most satisfaction.
I have found out, from my relatively limited experience with direct real estate rentals, that I am not really cut out for it, finally severing ties with my last remaining direct ownership rental property.
But all is not loss for those individuals, like me, who want to take a more hands-off approach but still want to have exposure to real estate.
This is where crowdfunding and real estate syndications come in.
I personally have invested in real estate syndications that have provided partial ownership of a single property as well real estate syndications that allowed partial ownership of a fund consisting of multiple properties.
For those who prefer a basket of properties for an investment, real estate funds offer a great solution.
Within the realm of real estate funds are ones that are open-ended and ones that are close-ended.
There are pros and cons for both types.
The following guest post from Origin Investments, a company I have been invested in since 2019 (Origin Income Plus Fund) and a sponsor of the blog, provides some insights between these two types of funds.
The Origin Income Plus Fund is an open-ended fund that focuses on purchasing multi-family real estate assets with a long-term/forever hold philosophy.
Distributions are made monthly and can be paid out as cash or re-invested similar to a DRIP (dividend reinvestment plan), and are typically in the 5-6% range, addressing the Income component.
The Plus component is the expected growth appreciation of the assets contained, which you have the ability to capitalize on if you want to redeem shares of the fund (share NAV prices are updated monthly).
Stable monthly income cash flow while still capturing upside growth is a win-win situation in my book and it a fund I truly am happy to be invested in.
Individuals evaluating alternative investment opportunities look to private real estate funds due to their low correlation to the stock market, strong risk-adjusted returns, and tax efficiency. These pooled funds receive money from investors and invest the combined capital into properties as one actively managed portfolio. Pooled real estate funds are broken down into two categories: open-end and closed-end funds. Private real estate funds are illiquid, so individuals should understand the unique structure of each category before investing.
Real Estate Fund Structure & Strategy
Closed-end real estate funds have a predetermined life that is set by the manager at the fund’s onset. These funds are typically value-add and capital gains driven where more of the expected return is earned from the asset sales rather than the income stream. Closed-end funds might employ a “buy-fix-sell” strategy which typically includes some level of construction, repositioning, recapitalization of existing debt, and/or property management changes. Implementing these strategies can take time and therefore closed-end funds may deliver negative returns in the initial years.
Assuming the value-add strategies are executed successfully, the results can produce returns in excess of what can be achieved by purchasing a fully stabilized property. Since the fund’s returns are contingent on the execution of an underlying business plan, proper due diligence on the fund manager’s performance track record is critical. Further, the capital gains-driven approach has tax implications that are important to consider when calculating the total return of an investment
Unlike closed-end funds, an open-end fund structure has no termination date. These funds might employ a “buy-fix-hold” strategy where more of the expected return is derived from the property’s income stream. The core advantage of open-end funds is flexibility. Without an end date, managers aren’t forced to liquidate assets and can focus on long term capital appreciation for investors. However, the need to produce strong, recurring cash flow may potentially reduce the aggregate income stream, resulting in a lower total return than what may be achieved by a closed-end fund. But since immediate cash flow is part of the acquisition criteria, open-end funds also typically have a lower risk profile. Additionally, the fund’s income can be offset using depreciation and interest, providing investors with income that is tax efficient.
Real Estate Capital Raising & Liquidity
A closed-end fund raises capital during a commitment period which may only take place for 12 to 18 months. Investment capital is locked up for the term of the fund and individuals are not able to redeem his or her ownership interests at any time. Because of the lock-up, there is no risk of a forced asset sale. However, a drawback to closed-end funds is that sponsors must sell the assets at some point, even if an asset is achieving returns greater than what was originally projected.
Open-end funds allow investors to enter and exit the fund at regular intervals determined by the fund’s manager. Capital can be raised and repaid on an ongoing basis providing investors access to liquidity without needing to sell the underlying real estate. To balance the liquidity needs of investors with the illiquid nature of the underlying real estate, sponsors still include a lock-up period and redemptions may also be subject to a discount to the fund’s net asset value.
Real Estate Acquisition Strategy
Managers of closed-end funds are only allowed to purchase assets during the fund’s predetermined investment timeline. The downside of this time restriction is that it may create pressure to deploy capital, resulting in a less optimal portfolio. For this reason, it is important that investors evaluate and understand how managers build and manage their deal pipeline while sticking to a disciplined investment strategy.
For example, at Origin, we utilize a “boots on the ground” investment approach where our acquisitions officers live and work in our target markets. This allows us to build local relationships and utilize both on and off-market transactions to maintain consistent deal flow, which is especially crucial when we’re offering closed-end funds.
In an open-end fund structure, there is no timetable that acquisitions teams must abide by. The fund’s perpetual nature also allows managers to reevaluate their investment strategy and rebalance the portfolio if necessary. The rebalancing feature can be important when faced with changing market conditions. For example, when launching the Origin IncomePlus Fund, we had a target portfolio allocation of 75% equity and 25% debt. But the impact of the COVID-19 pandemic created an environment in 2020 where we felt the best risk-adjusted returns could be derived from debt and preferred equity investments. In early 2021, we shifted the IncomePlus Fund’s target portfolio to 55% core plus, 25% preferred equity debt investments and 20% build-to-core ground up developments. We can easily make adjustments to our IncomePlus Fund and will continue rebalancing the portfolio as the market changes.
Which Category Is Best?
As you can see, there are pros and cons to both open-end and closed-end private real estate funds. It’s important that you understand your own investment objectives and make an informed choice based off each type of fund’s strategy, liquidity considerations, acquisition strategy and tax implications that may impact an offering’s projected returns.
If you are in search of financial help, please consider enlisting the service of any of the sponsors of this blog who I feel are part of the “good guys and gals of finance.”
Even a steadfast DIY’er can sometimes gain benefit from the occasional professional input.
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