If you are truly passionate about multifamily real estate investing, you may decide to create a private equity real estate fund. This is a major undertaking but, if you are ambitious and determined, it can be well worth it. Working closely with more established partners, rather than becoming a solo fund manager right away, will help you gain experience and personal financial reserves.
Considerations when Creating a Private Equity Real Estate Fund
A real estate private equity fund is a partnership of investors created to pool capital for real estate investment. The founder and manager of the fund is its general partner (or managing member); the investors are limited partners (or non-managing members). A private equity fund is usually structured as a limited liability company (LLC) or a limited partnership (LP), that is, as a pass-through company. These entities are governed by state laws that can differ widely. Delaware is a popular place to form private equity funds, thanks to its business-friendly legal environment.
Equity funds hold the titles to the properties they develop or acquire and split the profits according to an agreement. The general partner is likely to invest funds along with the limited partners and receive profits on the same basis as the other partners. This practice is known as alignment of interests and is considered a sign of commitment from the general partner. The greatest reward for the general partner most often comes from various fees the limited partners pay and, most especially, from carried interest, which is usually 20-30 percent of the fund’s annual profits, as compensation for managing the fund.
Carried interest is generally not paid until the fund reaches a level of profitability agreed on in advance. Furthermore, there may be clawback provisions allowing the limited partners to seek extra payment at the expense of the general partner’s carried interest if the fund’s performance does not meet certain requirements. Because of these factors, carried interest is treated by the IRS as capital gain rather than income.
A private equity fund provides several advantages compared to investing as an individual. With capital on hand, a fund can invest in projects quickly, without having to negotiate with lenders and wait for their approval. If a fund does approach a lender, it will likely receive better credit terms than an individual investor. Therefore, partners in private equity funds usually participate in larger and higher quality projects than they would as individuals. Investors in private funds generally have to be Qualified Investors and/or Qualified Purchasers and meet certain financial requirements prior to investing.
As a real estate private equity fund manager, it’s important for the general partner to have a very high level of commitment and a clear concept of the fund’s goals. Forming a private equity fund is costly and time-consuming, and the expectations placed on the general partner are high. First, the general partner will have to pay considerable fees to lawyers, accountants, and licensing bodies to organize the fund. That money—possibly several hundred thousand dollars—will be returned once the fund is running, but only after being tied up for months. Among other considerations, a fund manager has to be able to find sufficient investment opportunities to earn a good return on the money at his or her disposal.
Ease into Creating and Managing a Private Equity Real Estate Fund
One of the challenges of running a private equity fund is the high complexity of the accounting involved. The scores of formulae for calculating values and dividing profits also provide a type of flexibility: there is a multitude of ways to come to an agreement. This is one of the many instances where experience is a valuable guide and a good reason to start out slowly. According to recent research, small private equity real estate funds performed significantly better than their giant, multibillion-dollar counterparts between 2005 and 2015 (as measured by fund size and its relative IRR).
At CWS Capital Partners, we are a fully-integrated multifamily real estate investment management firm that offers everything from due diligence and risk management to transaction support and property management. We specialize in assisting our clients with 1031 exchanges, acquisitions, repositioning, and development. We also own and manage luxury multifamily investment communities in major markets around the country, and we employ a team of experts who can help you hone your investment strategy.
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The information provided here is for your general informational purposes only. It should not be considered a recommendation or personalized advisory advice. CWS has made this third party information available from authors it believes are knowledgeable and reliable resources. However, its accuracy or completeness cannot be guaranteed and sentiment may change due to legal or economic conditions.
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