A Private Equity Fund is an investment vehicle in which investors pool their money into a private fund intended to make investments on behalf of the group. This model is usually operated as a limited liability company or partnership in which a Fund Manager or a management group, simply referred to as the Manager, oversees the operation of the fund. The Manager, a.k.a. General Partner (GP) has the duty of identifying, underwriting, managing, and disposing the investments and running the day-to-day operation of the fund, while Limited Partners (LP) have a passive role: LPs provide the investment capital, and in return have the freedom to continue their primary business or trade / occupation, enjoy the retirement or pursue other endeavors.
As a prospective investor in commercial real estate — particularly in Private Equity Funds, it is a great time for you to go over your options. With these details, you can fully take advantage of the benefits of real estate, including income from rents, appreciation potential, tax advantages, and diversification into an alternative, but thoroughly tested asset class — all without the responsibilities of hands-on obligations of property owners.
Here is some information that can help you weigh the Pros and Cons of investing in a Private Equity Fund.
Pros
- Experience
Highly experienced fund managers can weather the stormy seas as well as steer the ship well through the smooth sailing.
Obviously, fund investors should undertake meticulous research prior to turning over their money to a fund manager. One of the most important research objectives is to vet the fund manager; and optimally to invest with an expert that has years of proven experience and knowhow in profitable fund operation. To accomplish this, for quite some time investors heavily counted on word-of-mouth referrals from their peers for such research. In today’s age of social media, crowdfunding sites, many very experienced marketers (“Promoters”), it is vitally important to rely on high confidence referrals, mastermind groups (with trusted members), verified 3rd party sources rather than look at the “Bright and Shiny objects”, offered by brilliant marketers.
It is still important for fund investors to acquire the real estate foundation knowledge needed to understand the implicit risks and returns of private equity investments. Strong fund managers offer their investors outstanding Risk Adjusted Returns. It is too easy to get into projects with high IRR targets, but it is hard to pick the right ones with the right operators, deal, and investor level economics. Picking the right projects is major differentiator between good marketers and good fund managers.
- Risk and Strategy Diversification
Expand variability in assets and sponsors, while minimizing investments in a single asset.
All markets experience volatility from time-to-time, so having access to funds that offer diversification as a hedge against such volatility is a plus. Therefore, investing in multiple asset classes that span across multiple geographic markets provides a terrific safety net as a bonus.
Return expectations vary among funds, depend on the fund manager’s expertise and the type of strategy they select. Investors can expect a projection of an expected returns range, but it is impossible to forecast exact numbers. While some single asset syndications may outperform funds, the lower return projections of a fund are offset by minimizing risk through various diversification strategies. Such diversification strategies may include investments across multiple asset classes and markets, as well as various investment strategies.
- Best Access Point
Access deals that are not available to the public.
Find a fund manager that has been around the block and has worked with several operators over time. For an expert like this, it is a no brainer to identify the right syndicators to partner with. This approach eliminates the need to continuously look for new operators and having to do a due diligence on each operator repeatedly. Most deal operators prefer to work with a reliable source of capital (Programmatic capital), and often are willing to give much better economics to the same source of reliable capital. Great fund managers maintain strong relationships with the best operators, participating in most (if not all) of their deals, and enabling the operators to focus on what they do best, acquire and operate the best real estate deals.
- Business Philosophy
Our investors come first.
While each firm’s investment philosophy differs, our approach has always been to highly prioritize our investors’ interests. Therefore, we concentrate to bring the projects into our funds whose highest priority is the best Risk Adjusted Return. Our Income focused funds concentrate on capital preservation and reliable income yield, while Growth focused funds are accelerating tax efficient appreciation of capital while managing risk well.
- Transparency
Transparency creates trust and dialog.
When a company is at its early stage of existence, there is a tendency to keep costs low by performing most, if not all the work in-house. However, in-house accounting could create a “Bernie Madoff” risk. Most sophisticated investors would like to see an external fund administration with a reputable 3rd party administrator.
Hence, we chose Verivest LLC, a reputable third-party administration firm and onboarding expertise, which allows us to concentrate on what we do best – build outstanding Growth & Income funds.
- Communication
To operate at the full capacity, a fund management company must utilize as many tools as possible to ensure efficiency and effectiveness. For instance, in our case, we offer our investors time-saving information tools, such as our Online Portal, Quarterly Statements, Investor Update Quarterly Zoom calls, as well as Annual Zoom Meetings.
Cons
- Lack of liquidity
Growth focused Private Real Estate funds are highly illiquid and are therefore only viable for investors who can afford to tie up large amounts of money for extended periods of time. Income focused funds maybe have substantially better liquidity, but it is still something to be very mindful about and speak with the fund manager about redemption options (if any) before making an investment decision.
- Blind pool
You may not know all the assets/projects that will be placed in a fund.
Investors will not know what all the specific projects are to be included in the fund up front, and hence this type of a situation is referred to as a “blind pool”. While this is true, once the fund is fully set up, the fund manager would be able to share all details of the invested projects. Not only that, but the fund manager should also be able to show the results on a per investment basis. This transparency will allow investors to view performance of each individual investment in the fund.
- Limited availability
Access to private equity funds is generally limited to accredited investors and institutions with large amounts of capital. Investment minimums vary but are typically at least $100,000 to $250,000.
- Longer term investment variability
Investment duration is dependent upon the disposition of all the assets in the investment fund. For example, let us say for a simplicity’s sake, a fund invests in ten projects, then each of these ten projects will have its own life cycle. Some of the principal for each project maybe returned during the lifetime of a project. However, all remaining capital along with a gain from a sale of such project, would hypothetically be returned to investors when the asset is disposed of.
- Relying on the expertise of a fund manager to validate all sponsors investing in and all their deals
If you have a tooth ache, you go to a dentist, right? The same approach should apply when it comes to passively investing in real estate. If you are new to the real estate investing, or in general you prefer to rely on experts’ advice, then identifying such an experienced fund manager with a proven track record is essential so that you could rely on the expert to identify the right opportunities for you to invest in.
- Fees
While the fee structure may differ from one investment to another, you should always look at it as the opportunity cost. That means the fee provides you the opportunity to spend time doing something where you produce income, such as running a busy dental practice, or spending time with your loved ones, or you are doing something with your spare time like improving your golf game. Investing with an experienced and trusted fund manager allows you to spend less time reviewing the individual projects and more time concentrating on your priorities.
Most sophisticated investors would like to see substantial alignment of interest between the fund manager and investors. Good fee structures are light on upfront fees (acquisition fees), allow for fees “as you go” with progress of the fund or a project, and significant “performance fees” based on the outcome of the investment results.
In summary, every investment has its own pros and cons. It is up to you as an investor to decide which investments are more impactful and which are lower on your priority scale to help you determine what course of action to take.
Mike Zlotnik / CEO TF Management Group LLC