There has been a large increase in funds over the past 12 months or so, as many professionals in the real estate syndication space transition from co-Manager (aka co-GP) structures to fund structures. There are many (very good) reasons why an investor may choose to make that transition. In prior snippets I also discussed the various funds and fund structures. In today’s quick snippet I’ll offer five key areas you as a passive investor can focus on to perform diligence on funds and fund managers.

1. Understand what specific diligence the fund manager does upfront.

One of the benefits of investing via a fund is that investors may be able to enter into a deal with lower minimums (e.g. $50-100K vs. $100-250K) as well as the benefit of the upfront diligence the fund manager performs on the syndication group they seek to invest in.

  • What type of background checks do they perform (deep background checks or simply a $50 check on Truthfinder)?
  • What type of diligence do they perform on the underlying asset, on the key sponsor’s track record, the financials, and the deal structure & underwrite, etc.

They should be able to share examples of such with you.

2. Understand how the fund manager monitors the investment performance.

Once the deal closes, the real work of executing on the business plan begins. And while the fund manager will not be involved in the day to day operations, it is important to understand what systems and processes they have in place to monitor the investment performance and stay ahead of any potential issues. They should be able to share with you specific reports and examples of such. At the end of the day, the fund manager still has fiduciary responsibility towards its investors.

3. Understand what levers of influence the fund manager has on the syndicator (if any).

While a fund would typically join a syndication as a limited partner, i.e. a passive investor and as such, the fund itself will NOT be involved in the day to day operations, funds typically bring a single but very large seven or eight figure check into a deal. Thus, it is not unreasonable to expect the fund manager to have some influence with/on the syndicators. Depending on the size of their participation into the deal, they may or may not have voting rights but will and should have some level of influence as well as ability to sit in on asset management calls or other meetings open to the managers and general partners. This becomes particularly important during periods of distress when timely communication, visibility, and ability to provide feedback are key.

4. Understand the source of funds of the fund.

Many funds in the traditional multifamily syndication world would be solely funded by the equity (or in other words – private investors’ capital). However, it is not uncommon (especially in the debt fund space) for the fund to take on leverage (aka debt). There are lenders and non-financial institutions who would lend to the fund based on the capital commitments and other factors. As we have learned in prior snippets, leverage tends to enhance returns (as it uses other people’s money). Taking on leverage, however, also increases the level of risk. This is why, when evaluating funds and their proforma returns, it is important to understand their source of funds and then determine if the structure aligns with your risk tolerance.

5. Gain comfort with the fund managers communication and track record.

Similar to a typical syndication structure, communication throughout the tenor of the investment is key for transparency and information purposes. You want to understand how and how frequently the fund manager communicates and what type of reporting they request and receive from the syndicator. They should be able to share examples of both with you, so you can decide if the level of detail and frequency is in line with your expectations. Furthermore, you want to gain comfort with their track record and ability to select well performing investments. While they may not have a 100% batting average, what I would typically look for is consistency and overall performance over a longer period of time.

Bonus Tip:

Not all funds are created equal in terms of the fee structure. Therefore it is important to understand how the manager gets compensated, how such compensation impacts the fund’s and passive investors’ projected returns, and if alignment of interests exists.

There are of course many more questions to as upfront when vetting a fund and a fund manager. I shared some of those in prior snipes and happy to speak with you further, if you’d like to explore the topic in more detail.

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.