As a passive investor, one is often faced with many investment choices. A common question we are often asked is whether it is better to invest in individual opportunities or in a fund. As with many things in real estate the answer is it depends on your own investment criteria and risk tolerance.
When investing in an individual asset, you can choose the market and the asset type/class. You will also receive a single K1. You will have one investment to track. All in all, it is simple. The downside of this approach is lack of diversification, which you can mitigate by making multiple investments in different markets or different asset classes or both.
When investing in a fund, you depend on the operator to select the properties in the fund, which diversifies your exposure; however, some of the assets may be across property classes or markets you are not fond of. You will still receive a single K1 form the fund but it may be more complex due to filings requirements in various states.
There is a variety of funds out there. (i) Evergreen funds that reinvest profits back into the fund. As an investor you have ability to redeem shares (usually with a minimum notification period required and after a seasoning period). (ii) Open ended funds whereby returns are generated from the ongoing cash flow and investors can enter into and exit the fund at specific time frames defined by the sponsor. (iii) Closed end funds whereby returns come from appreciation and the sale and no new money flows into the fund once it is closed and. (iv) Blind or semi blind funds whereby you may know only one or two of the assets in the fund or none at all at the time of your initial investment, as those assets are acquired at a later point of time. (v) Customizable funds whereby you can choose the assets you invest in and may be able to contribute a smaller initial investment in each vs. the typical $50-100K minimum initial investment, i.e. you can spread your $50K investment across a couple of assets.
In some cases the fund may invest as an LP and in others as a GP. There are also funds of funds whereby your fund sponsor may choose to participate in a bigger fund by bringing in a material portion of the proceeds via their fund.
As with traditional individual asset investments, vetting the fund manager is key and even more important under the fund structure as you also need to trust their own vetting process of the various sponsors they choose to invest with.
In addition, one way to mitigate the risk of being under pressure to invest in borderline properties simply because you have money sitting in a fund, some sponsors may choose to pay small interest to their investors as a way to compensate them for tying up capital in the short run and introduce a bit more self-discipline while looking for a strong asset to invest in. Another way some funds manage the capital raising process is to only call the committed capital as/when it is needed or in pre-set stages/timelines.
We hope today’s snippet added a bit more clarity to the fund process to empower you with additional knowledge on your passive investing journey.
Should you have any questions or want to learn more about real estate investing or for an overview of our target markets, please reach out to info@dbacapitalgroup.com.
Disclaimer: The information presented does not constitute legal, accounting, tax, or individually tailored investment advice. Past results do not represent or guarantee future performance.