Unlocking the Power of Real Estate Funds: Diversify Your Portfolio and Earn Passive Income

by | Feb 28, 2023 | Investing Advice

In recent years, there has been a surge in popularity for private equity real estate funds, but they are not a novel concept. Real estate syndications have been in existence for several decades, with some dating back to 1926. These funds are categorized into two types: REITs, which are publicly traded stocks that represent ownership in a large collection of properties worldwide, and private investments that enable you to invest alongside a small group of investors.

Commercial real estate used to be considered an unconventional investment, but it’s rapidly becoming more mainstream due to soaring housing prices, rising raw material and labor costs, and a shortage of labor. As a result, many people can no longer afford to own income-producing property, causing investors to turn to small multifamily or other passive commercial real estate investments. One affordable option for entering commercial real estate is through real estate investment funds, which attract investors who want to own commercial property but prefer a passive investment approach. Investors pool their funds to purchase assets, and the fund sponsor handles all operations, including property management. Real estate funds are an excellent way to generate passive income for individuals who want to invest in real estate without being directly responsible for property management. In this article, we’ll provide you with all you need to know about real estate investment funds, including their structure, benefits, profits, returns, and more!

 

What Is A Real Estate Fund?

Real estate funds are a type of mutual investment vehicle that enables investors to invest in multiple properties simultaneously, regardless of the property-to-capital ratio, by contributing any amount of money they choose. This allows investors to avoid the need to have the entire capital amount required to invest in whole properties as an individual. Instead, investors can purchase shares in several properties. Real estate investment funds offer the opportunity to invest in real properties with specific rules and regulations unique to each region. There are various types of funds available, such as dividend-paying real estate investment funds that are similar to mutual funds. These funds combine money from investors and provide them with the opportunity to explore a wide range of investment targets. For example, some real estate funds focus on large residential properties, while others may concentrate on commercial properties that can be sold quickly. Each real estate fund has its own set of regulations, but they generally offer investors a chance to invest in real estate at a lower price point, maintain liquidity since shares can be cashed out early, and earn passive income from rent payments and potential real estate appreciation.


Types of Real Estate Funds

When examining real estate funds in detail, you will discover two primary types. The first type is a private equity real estate fund, which is not publicly accessible and has more stringent membership requirements, such as high net worth or institutional affiliations. The second type is a Real Estate Investment Trust (REIT), which is publicly traded. Although there is a cost to the investor, REITs offer liquidity and can diversify your portfolio.

 

Real Estate Funds vs REITs

A real estate fund is comparable to a mutual fund, but instead of investing in a diversified portfolio of stocks, it concentrates on investing in securities offered by public real estate companies. Real estate mutual funds are distinct from real estate investment trusts (REITs). Real estate mutual funds are exempt from registration with the Securities and Exchange Commission (SEC) under Regulation D, Rule 506, whereas REITs are corporations that invest directly in commercial real estate, and investing in a REIT is akin to buying stocks. REITs and other securities must register with the SEC. Although they can seek exemption from the SEC, this is typically not done as it is expensive, complicated, and time-consuming.

 

How To Invest In Private Equity Real Estate Funds

After finding a firm or sponsor offering an investment opportunity, you have a few options for investing your capital. You can choose to invest with savings from a readily accessible account or use your retirement savings for investment purposes.

 

Wire Liquid Funds

If your investment capital is saved in a highly liquid and easily accessible bank account, you can transfer the entire investment amount to the sponsor based on the instructions provided in the investment documents. The sponsor will then purchase shares in the fund on your behalf and register them in an account maintained by the transfer agent.

A popular way to invest in real estate investment funds is through a self-directed IRA. This type of IRA is similar to a Roth IRA, but it allows investors to invest in a broader range of assets, such as real estate investment funds, which is why it is becoming more popular.

Usually, traditional brokerages do not permit investors to invest in non-traditional investment opportunities from a Traditional IRA, Roth IRA, or 401K. Consequently, investors interested in a real estate fund strategy may have to transfer funds from their existing brokerage account to an IRA custodian that offers self-directed investment choices. One of the key advantages of investing in a real estate fund rather than purchasing and managing a property is that it enables investors to diversify their portfolio while remaining hands-off. However, investors should be aware that self-directed IRAs are self-directed, meaning it is entirely up to the individual to conduct thorough research, perform due diligence, locate good sponsors, and investigate potential opportunities and risks before investing in any fund or alternative investment.

 

Who Qualifies to Invest In A Real Estate Fund?

There are a few qualifications that investors need to be aware of before they decide if this investment choice is right for them.


Investor Qualifications

Depending on the qualifications that fund management outlines, real estate funds may require that you have a net worth of at least $250,000 and that you contribute an initial minimum investment, which can range from $5,000 to hundreds of thousands of dollars, depending on the size and type of fund you’re investing in. Many real estate funds will also have a maximum investment amount, and some will be open ended. Real estate funds typically require a minimum investment period of one year or longer, although there are also “opportunity zone” real estate funds that allow for turnover in under two years. Real estate is typically considered an illiquid investment because it takes time to sell the property and receive your capital back out of the fund so investors will need to be prepared for this type of timeline. REITs typically have much lower minimums and will allow you to buy in with a much smaller investment. They’re more accessible, generally listed on public exchanges, and available for investment inside most standard retirement savings accounts.

 

Sponsor Qualifications

You gain from the fund sponsor’s qualifications, connections, and experience when you invest in real estate funds. The sponsor is often a sector expert or group with extensive expertise in managing real estate investment opportunities. They’ve already performed detailed due diligence on the properties included in the fund, the market, and analyzed the projections extensively.

Sponsors will provide investors with thorough financial information to evaluate and evaluate prior to asking for financial commitment to the fund. They will also be accessible and delighted to answer any questions about the fund’s strategy or how it will be a success for investors. Keep your eyes and ears open for any calls, webinars, or presentations in regard to the fund, as this is an excellent opportunity to get to know the team and the strategy on a deeper level. The fund manager is in charge of all aspects of the fund’s day-to-day operations, allowing investors to invest without being concerned with each transaction made through the fund.


Benefits of Investing in Real Estate Funds

Real estate funds typically provide consistent returns that are higher than average and not dependent on stock market fluctuations, reinforcing the notion that investing in real estate is a reliable method of generating revenue and profits over time. Investing in real estate allows you to diversify your portfolio rather than relying solely on buying an investment property or investing in the stock market. Additionally, investing in real estate funds provides access to the real estate market without the responsibilities and challenges of being a property owner or manager. You can choose from various types of real estate investments without having to conduct all the research yourself since the fund’s sponsor will have already done it for you.

 

Diversification

Real estate funds enable you to pool your money with other investors to acquire a collection of assets with similar ratings in various locations. By purchasing shares in multiple funds, you can further diversify your holdings. Additionally, buying shares in different funds allows you to diversify across asset types, markets, and appreciation profiles. Diversification lowers risk while increasing the potential for higher returns for investors.

 

Profitability

The majority of real estate investment funds are structured to reimburse investors before the fund’s sponsor receives any payment. This puts pressure on the sponsor to ensure that the transaction satisfies its intended profit objective. The investment structure is created to keep the sponsor’s and investors’ interests aligned.


Tax Efficiency

Real estate funds typically have a structure that lasts longer than a year, resulting in long-term capital gains taxation rather than short-term. Investing in real estate funds eliminates the need to worry about depreciation. Investors may benefit from pass-through depreciation, and the tax advantages will depend on their individual circumstances. Additionally, real estate funds enable investors to defer taxes on their portion of income and capital gains until they sell their shares in the fund.

 

Preferred Returns

With regards to preferred return, the investor receives payment first. In a cash flow fund, investors receive distributions during the investment’s lifetime. This type of return is critical because investors are paid before the professional manager, which is especially important when dealing with higher-risk assets.

 

Will Your Next Real Estate Investment Be In A Fund?

There are several reasons why individuals may choose to invest in real estate, as well as additional reasons why they may consider investing in a real estate fund. Real estate funds are an excellent way to diversify your portfolio without taking on the responsibilities of owning property directly. However, not all funds are created equal, and it’s essential to conduct research and due diligence before investing in a specific real estate fund. It’s crucial to examine the fund’s sponsor, management team, and track record. You should evaluate the fund’s targeted returns, determine whether you agree with their strategy, and assess how long it will take to achieve their target metrics. As with any investment, it is important to conduct thorough research. No investment is risk-free, and no investment is entirely foolproof. However, the more information you have about the fund’s structure, the team responsible for it, and the assets inside the fund, the more likely you are to invest your hard-earned money in a profitable opportunity.

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