If you are looking for a hands-off way to invest in commercial real estate with your Checkbook IRA or Solo 401(k), professionally managed funds may be worth evaluating. Private equity real estate funds are designed to help investors diversify into a stable asset class not correlated to the stock market that can provide solid returns and limited risk.
What Are Private Equity Real Estate Funds?
Real estate funds are investment vehicles created to accumulate capital for a specific type of commercial real estate investment. A private real estate company, often referred to as the sponsor, will establish a fund with a set of goals and parameters guiding how the money will be deployed. They then raise capital from investors to put to work according to that plan. By deploying fund capital into a diversified mix of projects the fund becomes more stable and less risky than an investment into a single project.
Common Fund Strategies
Private real estate funds normally focus on a specific project type or niche. A fund might look to acquire only class A multifamily complexes in high demand metros, focus on distribution warehousing facilities, or target a certain class of property like self-storage or medical offices in a specific city or region.
Capital may be deployed directly as equity in subject properties or in a combination of equity and debt instruments. The offering prospectus and legal agreements will tell you what the fund focus is.
By specializing, fund sponsors aim to leverage their network and expertise to deliver value for their investor clients.
Commercial real estate opportunities are often grouped into the following categories.
|Core||More conservative, stable properties in high-demand markets. The focus is on cash flow over time. Minimal risk also minimizes the rate of return.|
|Core-Plus||By increasing the amount of leverage used or performing a minimal amount of property re-positioning, a core type property may have the potential for higher returns.|
|Value-Add||These types of projects fall in the medium-to-high range on the risk/return scale. Property development, market timing, or significant property upgrades or repositioning are often involved.|
|Opportunistic||At the high end with respect to risk and commensurate returns, opportunistic funds may target new development, changing the property usage type, or distressed properties.|
Fund Structures & Fees
Most real estate funds are established as limited partnerships using a LLC entity structure. As an investor, your IRA or 401(k) will be subscribing to the partnership as a limited partner.
The fund manager is responsible for creating and operating the fund and is compensated for doing so. Limited partners provide capital but have little if any say over fund operations.
Fund managers are typically compensated in two ways.
An asset management fee in the range of 2-3% of invested capital is common. This supports the operation of the fund, salaries for the fund’s management team, and the costs of finding opportunities for fund investments.
A sponsor “carry” or performance fee which is normally in the 20% range is paid to the manager. This represents a percentage of the profits produced by fund investments.
Funding an Investment
Some real estate funds will have a single funding round and collect investor capital once at the time of fund formation. This is rare, however.
More commonly, real estate funds are capitalized on an as-needed basis. As a limited partner investor, your IRA or 401(k) will commit to a certain amount of funding and is legally obligated to meet that commitment. The fund sponsor will then make a capital call once a suitable project has been identified. Such capital calls are usually focused on a set-period of time in the initial year or so of fund operations.
Be sure to read the fund prospectus and understand the funding obligations and timelines. You may want to keep committed but not deployed funds invested in the interim but would want to be sure to have the necessary liquidity to meet the demand of a capital call when presented.
Who Can Invest?
The majority of private real estate funds are limited to accredited investors. If you personally are accredited, your IRA or 401(k) inherits that accreditation status.
Some funds are available on crowdfunding platforms and available to non-accredited investors.
Minimum investment amounts vary and can be as low as $1,000 – $5,000. Minimums of $100K to $250K are more common with well-established fund operators.
Funds vs. Syndications vs. REITs
Private equity real estate funds, commercial real estate syndications, and REITs are all good mechanisms for gaining exposure to commercial real estate as an asset class. There are advantages and disadvantages to each type. It may make sense to hold investments in each of these vehicles within your portfolio.
A real estate fund is going to be more diversified than a syndication. When you place $50K into a syndication, that is going into a single property. If you wanted to deploy $250K into commercial real estate, you would need to do the research to find and perform diligence on 5 suitable projects. You could place the same $250K into one or two funds and have the capital spread across dozens of fund-held properties.
While REITs are real estate-based investments, they are traded on public exchanges and therefore more closely tied to the news cycle and general market volatility than the underlying assets might merit. REITs do have the advantages of lower barriers to entry and greater liquidity, however.
Advantages of Real Estate Funds
Investments into private real estate funds can be a good fixed-income option for self-directed retirement plan holders.
|Low Engagement||Professional fund managers select and execute the investments. Funds are some of the most passive investments you can make.|
|Stable Income||Real estate funds are designed to issue distributions of income to investors on a monthly, quarterly, or semi-annual basis.|
|Low Risk||Because fund capital is in real property assets and diversified the risk profile is relatively low for most core and core plus funds. Risk increases with more aggressive funds but is still low compared to a majority of other asset classes.|
|Diversification||By allocating fund capital into many projects, the impact of any single project underperforming is minimized.|
|Scale||Real estate funds provide access for your IRA or 401(k) to larger opportunities not available to individual investors.|
Disadvantages of Real Estate Funds
|No-Control||While it is a benefit that funds are passive, it also means your role is passive. You have effectively no control over the operation of the fund. Performing due diligence on the fund therefore becomes the most important component of making such investments. Be sure the operation of the fund will align with your goals.|
|Illiquidity||Fund investments are illiquid, so your plan capital may be committed for several years. Be sure you understand in advance what limitations may be in place, and if there are any available exit options prior to fund termination.|
Tax Considerations for IRA & 401(k) Investors
When evaluating a fund investment, you want to be sure to determine whether the nature of the income produced will generate exposure to Unrelated Business Income Tax (UBIT).
If the fund uses leverage in any fashion, then income derived from the borrowed capital will generate Unrelated Debt-Financed Income (UDFI). Depending on the deal structure and available deductions, the impact of this tax may be minimal. A Solo 401(k) is exempted from tax on UDFI when the debt instrument is used to acquire real property. Financing used for other means will generate taxable UDFI for a 401(k) plan investor.
When the income producing activity of a fund is passive in nature, such as rents from real property or interest, it will be tax-sheltered to an IRA or Solo 401(k). If the income is derived from a trade or business, such as new construction for immediate sale, rehabbing and directly reselling properties, or operating a services business such as self-storage, adult care, or hotels, it can generate Unrelated Business Taxable Income. The impact of this tax can be significant since there are not usually substantive deductions available as is the case with debt-financed real estate.
The offering memorandum should have language disclosing whether the fund may produce income subject to UBIT. Be sure to have your qualified tax counsel review any prospectus before you invest.
Private equity real estate funds are worth considering if you want a passive, secure, hand’s off investment with predictable returns.
Commercial real estate is not correlated to public markets and provides diversification to your portfolio as a result.
Real estate funds are a very passive form of investing. Busy investors who may not have the time or network to manage direct investment opportunities often find this very appealing.
Real estate funds will generally outperform other fixed-income investments such as bonds, though there is a greater degree of risk.