Why Outsource your Fund Administration?

The number of Fund Managers choosing to outsource their fund administration continues to grow, with as many as 45% fully or partially outsourcing their administration needs this year (KPMG 2018). Right now, with new Opportunity Zone Funds popular with investors looking to avoid capital gains, those looking to set up new Funds (or even those with existing Funds) should consider the pros and cons of keeping the administration in-house or outsourcing to a fund administrator.

Redwood, working with new Fund Managers and those with many years of experience, has heard a variety of reasons why our clients choose to outsource their fund administration. Here are some of the top reasons to consider outsourcing:

Greater investor confidence through third-party oversight: The impartial oversight provided by a third-party Administrator is invaluable, lowering barriers for new investors into the Fund in a competitive capital raising market. Knowing an independent party is involved in preparing financial statements, fee and waterfall calculations gives existing and potential investors peace of mind.

Access to experienced accounting talent and technology: Outsourcing fund administration provides access to a team with deep expertise and experience, with a proven process extending beyond basic accounting principles. The Fund Administrator acts as an extension of your own team, without adding headcount, with the additional benefit of providing a wealth of knowledge and breadth of experience, having worked with a variety in clients, both in size and asset strategy.

Investors have an ever growing demand for transparency and real-time data (FIS Global 2014). According to BankDirector.com (2016), engaging a Fund Administrator to implement and manage technology (both financial and investor accounting) is often more cost effective for Managers, with Administrators able to spread the cost across their client base. Engaging a Fund Administrator gives you access to technology and expert staff who understand how to extract the most value from the system.

Lower fund operating costs: Many Small Balance Real Estate (SBRE) entrepreneurs find that the cost associated with engaging a third-party Administrator is lower than keeping the work in-house. A variable fee structure based on Assets Under Administration (AUA) can eliminate future commitment to the costs associated with expanding your back-office as your scale your business (J.P Morgan 2013). Most Funds pay the administration fee directly out of the Fund so that it does not increase expenses for their operating entity, unlike hiring additional staff.

Greater focus on core capabilities – real estate: Despite the value in third-party oversight, lower operating costs, and access to expert staff and technology, the primary driver for Managers to outsource administration is the desire to focus on core real estate activities (KPMG 2018). Ultimately, having a third-party firm focus on the accounting and administration aspects of the Fund frees up the Manger’s time to raise more capital and do more deals.

At Redwood, our clients see the value of outsourcing their fund administration to a company specializing exclusively in real estate. If you know a real estate entrepreneur who wants to spend less time doing accounting and more time doing deals, please reach out to us at info@redwoodrea.com or call 971-222-0288.

 

Neither Redwood nor any of its affiliated entities offer or provide any legal, accounting, or other advice that requires a professional license. None of the materials in this post or any related materials are intended to be or should be considered legal, accounting, or similar advice. No one receiving these materials may rely on them as a substitute for appropriate professional advice. Redwood strongly encourages and advises anyone receiving these materials to consult with their own independent attorneys, CPAs, and other professionals in order to ensure that any actions taken in connection with the materials complies fully with all applicable laws, rules, and regulations.

How the Tax Cuts and Jobs Act affects you

As we approach the tax season we are starting to get more clarity on the Tax Cut and Jobs Act (TCJA or sometimes referred to as “The Keep CPA’s and Lawyers well employed Act”).  I recently attended an excellent event specifically focused on Private Investment Fund Accounting and Taxes and wanted to share a few key takeaways from that event that may be relevant to you and your business.  Some of the changes particularly relevant to SBRE entrepreneurs include:

  • Deduction for Qualified Business Income
  • New limitations on Business Interest Expense
  • Best practice for footnotes and disclosures

Deduction for Qualified Business Income: One key provision of the TCJA is the 20% deduction for Qualified Business Income (QBI) in calculating net taxable income for individuals, estates and trust, which takes the federal tax rate from 37% to 29.6% (subject to various factors). This deduction was put in place by Congress to discourage people from switching entity types in response to the drop in the corporate tax rate.  QBI is generally the net income from a qualified trade or business; investment income is excluded, except for REIT ordinary dividend income.

It is important to note that a qualified trade or business may not be a specified service trade or business (SSTB), the definition of which can be found here. There is, however, a de minimus exception for taxpayers with taxable income below certain thresholds who may still claim the 20% deduction even if the income is from a SSTB. Depending on your business model this means that you may only be taxed on 80% of your share of net income!

New Limitations on Business Interest Expenses: Another key provision for businesses is the limitation on business interest expense, which is limited to the sum of the taxpayer’s business interest income, plus 30% of the taxpayer’s adjusted taxable income, which approximates EBITDA (until 2022) and EBIT thereafter.  This limitation does not apply to a “small business,” generally defined as a partnership or corporation with average annual gross business receipts over a rolling three-year period of $25M or less. There is a special provision that allows real estate businesses to opt out of these interest deduction limitation rules if they adopt the “Alternative Depreciation System,” a concept your tax service provider can help you with.  At the State tax level, most states have adopted the Federal standard, although many states have deferred adoption dates. Depending on your entity structure and use of leverage, you may not want to take this exception.

Best practice for footnotes and disclosures: The conference I attended also included audit and investor focused discussions, and discussions around current topics of interest to regulators. Key issues included:

  • Desire for transparency, consistency and clarity from investors when it comes to audited financial statements (make it simple for investors to understand by including charts and graphs in lieu of verbiage)
  • Ensure all footnotes are consistent with the Fund documents
  • Related parties are becoming more of a hot topic – disclose what is happening (loans, guarantees, family ownership, board seats, etc.)
  • Consistency in valuation approach
  • Disclosure of subsequent events such as redemptions (actual and requested), contributions, related party activity, and significant changes in asset performance

As always, you should consult with your duly licensed CPA to ensure that you are applying these rules appropriately for your fund. Although Redwood is not a CPA, we can help you understand how these issues may be treated, as well as ideas about which issues you should raise with your CPA. If you have any questions don’t hesitate to reach out to us if you have any questions.

 

Erica England, C.P.A

Redwood’s Chief Accounting Officer Erica England C.P.A. has 10+ years of experience working in the private equity industry and is always happy to discuss how Redwood could help you with your fund administration needs. Feel free to reach out to Erica at erica.england@redwoodrea.com to learn more.

 

 

Neither Redwood nor any of its affiliated entities offer or provide any legal, accounting, or other advice that requires a professional license. None of the materials in this post or any related materials are intended to be or should be considered legal, accounting, or similar advice. No one receiving these materials may rely on them as a substitute for appropriate professional advice. Redwood strongly encourages and advises anyone receiving these materials to consult with their own independent attorneys, CPAs, and other professionals in order to ensure that any actions taken in connection with the materials complies fully with all applicable laws, rules, and regulations.