The Importance of Good Loan Servicing

A significant portion of Redwood’s clients manage mortgage pool funds. When working with these clients, some of whom have large portfolios of loans, we have seen a variety of loan servicing strategies and capabilities. Those managers who have a clear strategy and strong capabilities in loan servicing are able to more effectively manage their loan portfolios, are able to receive and distribute financials and investment returns to their investors, and more tightly control the performance of their loan portfolios.

There are two primary options when considering how your Fund should service its loans: in-house or outsourcing. Whether you are going to service your own loans or outsource that responsibility, there is a significant amount of detail about each loan which must be captured and reported on, including:

  • Interest Charged: At what point will interest be charged? Will the borrower pay any interim interest up front?
  • Payment Frequency: Will the borrower be paying interest monthly or at maturity? Will interest carries be involved?
  • Modifications: Is a forbearance agreement in place or has a full modification occurred? What unpaid interest or fees are being considered, and what additional fees will be charged?
  • Foreclosures and Bankruptcy: Will the asset need to be impaired post-foreclosure? Are there any lien positions that need to be considered?

Experienced private lenders or those with the right internal infrastructure may be able to effectively service their own loans. Some considerations fund managers may have when making a decision about whether to outsource or not: cost of outsourcing and the impact that will have on fund returns; ability to generate an additional source of revenue to managers; internal capabilities and ability to effectively source and retain talent; and whether to focus on core capabilities and allow others to provide loan servicing.

I would offer a word of caution to first-time servicers: you may run a higher risk of not being able to support a rapidly growing portfolio as compared to an outsourced servicer’s established infrastructure and ability to scale, and poor loan servicing can create a great deal of issues down the line for you, your borrowers and your investors.

Through Redwood’s activities as a third-party Fund Administrator, I have a great appreciation for the complexity of loan servicing and I urge all potential and current clients to not underestimate the potential impact of loan servicing on their financial statements.

From Redwood’s perspective as a Fund Administrator, in order to produce those financial statements, we need to determine out how much money will eventually end up in the investors’ pockets. The process is not as simple as the concept; the life of the loan must be translated from a cash basis to an accrual basis, under Generally Accepted Accounting Principles, which requires forecasting and then adjusting accounting journal entries. In our experience in working with a number of both in-house and outsourced loan servicers, we see a wide variance in loan-servicing capabilities. Invariably, those with solid loan servicing allow us to produce investment returns and financial statements in a fraction of the time that those with poor loan servicing.

 

Nate Ashley

Redwood’s Senior Fund Accountant Nate Ashley works with a number of clients who both service their own loans and who outsource their servicing to a third-party. Feel free to reach out to Nate at nate.ashley@redwoodrea.com should you have any questions or are in need of recommendations for a servicer.

 

 

Nothing in this blog is intended to be or should be construed to be legal, accounting, or other professional advice that requires a license to provide. Anyone acting on the information contained in this blog should consulting with independent professional advisors.  

A Trip to NYC thanks to the new Partnership Audit Rules

For the last two years I have attended Financial Research Associates’ Private Investment Funds Accounting and Tax conferences in New York City. These events are a great opportunity to catch up on the latest trends and issues in private equity accounting. A few months ago, one of the conference organizers asked me to present. It took me a few weeks to get over my apprehension of presenting and say yes; after all, discomfort is the pathway to growth.

May’s conference focused on the impact recent changes in tax legislation will have on private equity and hedge funds. For the weeks leading up to the conference, I studied up on the new partnership audit rules for which I was a panelist.

These new partnership audit rules will impact all Redwood clients, so I will first share how these rules came about and then what Fund Managers should know about them.

From 1982 until the end of 2017, the Tax Equity and Fiscal Responsibility Act (TEFRA) served as the IRS audit regime. The IRS would audit the partnership and administer the tax down to the individuals and collect. This was a highly inefficient process and the government often ran into statute of limitations issues when attempting to enforce collections. A new audit regime was enacted as part of the Bipartisan Budget Act of 2015, effective for tax years beginning 2018, which repealed the previous procedures under the TEFRA regime. Highlights include:

  • The Tax Matters Partner (TMP) is replaced by the Partnership Representative (PR)
  • Adjustments to partnership-related items are determined at the partnership level and the corresponding tax is assessed and collected at the partnership level, as opposed to the individual level
  • Adjustments are recognized in the year the audit is concluded, as opposed to year being audited
  • Under TEFRA, partners generally retained notification and participation rights in partnership-level proceedings, but with the new rules, partners have no statutory right to receive notice of or to participate in the partnership-level proceedings.

The most critical thing to know when selecting the PR is that you are placing an incredible amount of trust in that person. Any actions they take are binding on the partnership and can be done without partner approval. If there were an IRS audit taking place, the PR would be the only person cognizant of this unless they choose to share the news downstream.

Any partnership formed in 2018 and forward should not have TMP language and should only have partnership language. It is recommended that all Fund Managers carefully review their operating agreements now to prevent future issues with investors such as the agreed upon steps in response to an IRS audit and indemnification provisions for former and future partners. Significant revisions to operating agreements may be necessary to document details including how the PR is chosen, their agreed upon due diligence process and remedies in the event that the PR or other partners fails to operate within the agreed parameters.

Due to the complexity of the PR’s role you may want to consult an attorney for guidance on structuring the key terms the fund’s operating agreement should address.

I hope that all our readers found this helpful (exciting may be a stretch). Stay tuned for my next article on highlights from the conference regarding what’s in store from the SEC and Opportunity Zones.

 

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. 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.

Fund Manager Spotlight – Billy Procida, 100 Mile Fund

I recently had the pleasure of speaking with one of our liveliest clients, Billy Procida, President and CEO of Procida Funding & Advisors, manager of 100 Mile Fund. The morning was well underway for Billy, who is based out of Englewood Cliffs, NJ and just getting started for me here in Portland, OR. We spoke about transitioning to a REIT, the state of the market, and what Billy is investing in now.

Billy has been in real estate since 1980, when he started as a construction worker, followed by a successful career as a real estate developer (he was named “Developer of the Year” by the Associated Builders and Owners of Greater NY, along with a slew of other accolades). He then made another successful move to the investment side.

From 1995-2000, Billy was CEO of William Procida Inc., which financed over $1 billion of developments as an investment banker and correspondent. The firm was also advisor to several financial institutions for due diligence, asset management, sales and marketing.

In 2011, he established 100 Mile Fund, an open-ended vehicle that invests in mortgages and investments in real estate and businesses within 100 miles of the New York City area.

Using the Tax Cuts and Jobs Act (TCJA) to Raise Capital

100 Mile Fund has been operating as an LLC since 2011 and is currently transitioning to a REIT structure to take advantage of one of the provisions in the TCJA which can save their investors’ money and open the door to raise capital from new investors. Within the TCJA, there is a 20% deduction for qualified business income.  Although investment income is excluded from this definition, REIT ordinary dividend income is not. This means that the Fund’s income will continue to be taxed as ordinary income, while investors could potentially go from paying a 37% tax rate to 29.6%.

This represents a savings, for those investors who look at returns on a net (of taxes) basis. According to Billy, this has been an easy transition, as the administrative work in making the change was minimal and the Fund has always operated like a REIT, in that it has over 100 investors and distributes all of the Fund’s income every year.

The party is coming to an end

Billy’s passion and expertise for real estate shone through when we delved into the current state of the market. He believes we are at the end of the longest boom in history and  that all existing and new deals should be carefully re-underwritten as you put your armor on to prepare for a possible pricing correction of 20% to 50%, especially in the high-end residential space of $5M and up.

When I asked Billy how he knows the party is ending, he referred to this as the 1% crash because the assets that may be impacted are high-end projects in major cities where developers have little skin in the game, as that is where he sees the majority of permits and a corresponding oversupply.

Billy published an article last summer, A Time for Pause and Urgency with a map showing housing start cycles and concentrations from the 1970s through to today. “Although the number of housing starts has dropped considerably in recent years, says Billy, 75% of all housing starts today are for high rises in major cities all around the country.” Therefore, he believes we are under-supplied in what Billy refers to as wholesome housing, $250k-$500k homes in urban and suburban markets.

Billy’s simple rule for how to figure out if there is an oversupply: “if you see too many cranes in the sky, beware!” Billy pointed out that this is especially evident in New York City, where condos for which people previously paid $20M+, can’t be sold. Cite the source Billy gave the example of the rapper 50 Cent, who just sold his 52-bedroom house in Connecticut after 12 years on the market for $2.9M, $15.8M less than his original asking price. [1]

Bill believes that those who are not prepared for the impending correction may be wiped out, and the pool of Fund Managers may shrink, as it did during the last recession.

I believe, Billy is one of those people who has that real estate gene, with immense knowledge that seems innate. In fact, he reported that he was the first person on CNBC to explain to Maria Bartiromo what a subprime loan was and why it was going to ruin America. During that same time, he wrote of the coming crash and literally got hate mail.

Undeterred, he followed it up with another article called Revenge of the Asset Manager where Billy said “that if you are the CEO of a bank, then you should fire your originators and find out who your asset managers are because you probably don’t know.”

Where is the 100 Mile Fund investing in now? 

So, what is 100 Mile Fund investing in now? Old, ugly and tired assets within 100 miles of NYC, but certainly not in NYC. The Fund made a recent loan to a family-owned catering hall that has been around since the 1950s, where Billy went for sports dinners when he was in grade school. For more, check out his article How the Real Estate Industry Can Save America.

Super sharp, knowledgeable, committed clients like Billy and his team are part of what makes the work that we do here at Redwood so rewarding. If you have a chance to see Billy speak (he recently gave the keynote speech at the Northeast Regional Mortgage Bankers conference) I encourage you to do so!

 

Lance Pederson

As the only third-party Fund Administrator specializing exclusively in real estate, Redwood can provide deep industry knowledge and expert insight to its clients. To learn more about the benefits of partnering with Redwood for your administration needs contact Lance at Lance.Pederson@redwoodrea.com.

 

 

As with any private investment, an investment in 100 Mile Fund is speculative and involves substantial risks. Consider the risks outlined in the fund’s formal offering documents before investing.  Risks include, but are not limited to illiquidity, lack of diversification, and complete loss of capital.

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.

[1] https://www.cbsnews.com/news/rapper-50-cent-sells-massive-connecticut-mansion-at-84-percent-loss/

Key Considerations When Choosing a Fund Administrator

When starting a Fund, it is easy to underestimate the complexities of the operation: raising capital, originating deals, managing cash flow, investor relations, regular reporting requirements, tax returns, and so on. There are a lot of moving parts, which is why many Managers choose to outsource their Fund Administration to an independent third-party.

Whether you are starting a Fund, or contemplating a switch from your current Fund Administrator, finding the best fit can be challenging. There are many different Administrators in the market, big and small, and making the right choice can be a critical factor in the success of your Fund. There are several key considerations you should keep in mind when reviewing your options.

Knowledge of your Industry

The number one consideration when choosing a Fund Administrator should be their experience in your industry. You wouldn’t take your car to a mechanic who specializes in boats, so why trust your small balance real estate (SBRE) fund to a firm that specializes in multi-billion dollar Hedge Funds?

Engaging an Administrator with deep knowledge and experience in the real estate industry means working with accountants who are experienced and able to ask the right questions and provide the right guidance throughout your Fund’s lifecycle; from launch to wind down, through the ups and downs of the market. Quality Administrators also have connections to others with direct experience in the SBRE industry, including Loan Servicers, CPAs, attorneys, and other partners, who can help you grow your business.

Strategic Partnership vs. Outsourced Accounting

Some Fund Managers may be concerned about losing the insights and understanding of a Fund’s dynamics if they outsource administration and rely on a third-party firm to maintain financial and reporting requirements. This is where choosing the right Administrator is critical; you don’t need to lose the experience of having an individual who understands your Fund inside and out. This is the difference between engaging a Fund Administrator in a strategic partnership and simply outsourcing your accounting.

Finding a firm with low staff turnover, where you will have a single point of contact, will give you the benefit of the expertise and independence that comes with engaging a third-party, as well as maintaining the personal touch of having a dedicated individual working on your Fund, with whom you have a strong working relationship. Your Fund Administrator should be an extension of your own team; someone you trust and partner with to deliver accurate and timely reporting to you and your investors.

The Investor Experience

High up on the list of the complexities of managing a Fund is investor relations. Finding a Fund Administrator who can deliver a great experience to your investors through an investor portal is a worthwhile investment. This professionalizes the investor experience through the entire process: from onboarding to delivery of statements and ultimately through wind-down or redemption. Finding an Administrator who can provide a seamless, technology-driven investor onboarding process, including taking care of all the accreditation and compliance requirements, including AML, can play a key role in helping you raise capital from new and existing investors.

Technology can also deliver the transparency many investors now require. Investor portals can save you time responding to investor inquiries by enabling investors to make changes to their contact information and distribution preferences, providing up-to-date information on how their investment is performing, and providing access to Fund and tax documents in a secure environment.

Keeping these three considerations – industry knowledge, finding a strategic partner and managing the investor experience – in mind when exploring your options for Fund Administrators will help you select the right partner from the beginning.

 

Lance Pederson

As the only third-party Fund Administrator specializing exclusively in real estate, Redwood can provide deep industry knowledge and expert insight to its clients. To learn more about the benefits of partnering with Redwood for your administration needs contact Lance Pederson at Lance.Pederson@redwoodrea.com.

 

 

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.

Making the Transition to a Fund

Transitioning from a single deal structure to a Fund can be an appealing proposition; chasing investors for one-off deals can become incredibly frustrating and inefficient. However, it is common for experienced real estate entrepreneurs to underestimate the challenges of making the transition.

Is now the right time to transition?

Before converting to a Fund structure, first consider the following:

  1. Do you have a consistent monthly deal volume?
  2. Are your deal sizes smaller, with shorter hold times?
  3. Do you have experience and success raising capital?
  4. Do you have clear goals and objectives for your potential Fund?
  5. Are you ready to commit long-term to the industry?

Transitioning to a Fund might not be for you if your entire focus is on a handful of bigger deals with longer hold times, or if you are not ready to be patient and really put the time in – most Funds take at least three to five years to reach maturity. Managing a Fund is its own business above and beyond the real estate business.

Get the right advice – early

It goes without saying, but do your due diligence before making the transition to a Fund. You should do some financial modelling to compare the economics of what you are doing today versus a Fund, to understand what makes sense and what doesn’t. Good financial modelling will give you insight into key variables you’ll need for success, such as how much capital you need to raise, anticipated costs at the Fund level, profit splits and your target returns for investors. Many entrepreneurs don’t know enough about Fund structures to effectively produce a financial model, so engaging outside consulting to assist in both the financial modelling and overall Fund structure is a smart move, ensuring that you are moving in the right direction from the outset.

Fund administration is a function you won’t have in your current operation and it is a key factor I recommend considering before drafting your Offering documents. Understanding how you will administer the Fund and incorporating this into your Operating Agreement and PPM will make it easier to launch. Keeping the admin in-house or outsourcing is another consideration. If you do commit to doing the admin internally, ensure you are strong on systems, processes and details; if these aren’t your core competencies (and this is often the case for entrepreneurs), consider outsourcing to a third-party such as Redwood.

Good administration provides confidence to your investors, with transparent operations and consistent and accurate communication. It sets the tone with investors about how you’re going to operate and can help you raise more capital from new and existing investors.

Capital Raising in a Fund isn’t easy

Before launching your Fund, have a comprehensive written-strategy in place, which you are prepared to evolve over time. Just because you have good access to capital now, does not mean you will in a Fund structure; a good Fund investor is not necessarily the same as a good individual investor.

Working with your existing investors to prepare them for the transition by sharing your plan and your goals is important; change is hard. As a rule of thumb, you can expect 20% to 40% of your single asset investors to come over to the Fund, but generally they won’t invest as much as they had before, and it will take time to convert these investors to the Fund format.

Consider a dual strategy

Making an all-or-nothing transition to a Fund is generally unwise and you can expect to run a dual strategy for some time. You will likely continue to do one-off deals to generate income while the Fund is getting off the ground. By following a dual strategy, you are still able to leverage your existing investors to Fund one-off deals, maintaining your existing relationship.

Making the transition to a Fund is a long process and one where it pays to get the right advice early to make sure your economic model is financially conducive to a Fund. There are layers of complexity to converting to a Fund structure you won’t understand until you are in the middle of it. Remember that success takes a significant amount of time, dedication, and pairing with the right advisory partners.

 

Lance Pederson

If you are considering transitioning to a Fund and have questions on how to get started, contact Redwood’s Manager Partner, Lance at Lance.Pederson@redwoodrea.com. As the only third-party administrator specializing exclusively in real estate, Redwood can provide the right advice as you launch and beyond, to help you succeed.

 

 

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.

Fund Manager Chronicles: Investor Relations

In the previous installments of Fund Manager Chronicles, I explored lessons learned and effective strategies for raising capital in a Fund format based on my interviews with four successful Fund Managers. This week I will focus on what happens after the capital has been raised – investor relations.

The trust factor

As it was for raising capital, trust was the number one factor in investor relations. One of the Fund Managers I spoke with said that in addition to good returns, investors want to know that they are doing business with good people who are in business for the long term.

Continuing to show audits, profits, and distribution history earns trust with investors. If a Fund Manager can continue to deliver on initial promises, especially if the market cycle experiences detrimental changes, then that further enhances trust, increasing the likelihood of raising additional capital from your existing investor base, earning referrals and providing the type of collateral and track record prospective investors will be looking for.

Setting Expectations

All four Managers stressed the importance of setting expectations with investors from the beginning. No one likes surprises. If surprises or mistakes do occur, investors expect that you learn from, apologize for, and resolve those mistakes. This type of response cultivates the Fund Manager/Investor relationship and encourages transparent feedback that one of the Fund Managers I spoke to said he is always looking for.

In fact, this same Manager credited his investors as a phenomenal resource who have helped his entire team, challenging them to be better and by questioning and testing their strategies. Another Manager credited his investors who were long-time real estate investors and entrepreneurs, with insights into better underwriting, Fund Management principles and investment structuring advice.

Communication is key

Communication is key and should be done as often as possible. Active communication allows investors to stay passive, allowing Fund Managers to spend their time operating the Fund as opposed to answering excessive questions.

Additional opportunities to meet outside of investment-centric transactions can greatly enhance the relationship between investors and Fund Managers. One of the Fund Managers hosted a large dinner for all their active investors which yielded a strong local turnout. This Manager also hosted an investor lunch and property tour, showing before and after property units, which received an excellent response from investors.

Difficult conversations

If you are going to manage a Fund, then you must be prepared for difficult, honest conversations. For example, if your Fund is not going to be able to deliver what an investor is asking for then you must possess the discipline to be honest with them.

Different things appeal to different people and you must listen to what people say, how they talk, and the questions they ask, and focus on what is important to them. It can be frustrating when investors focus on things that aren’t relevant, and don’t appreciate what you believe to be important. In such instances, it helps to remember that this is part of the challenge of dealing with people.

Managing a fund is as much about building and maintaining relationships as it is about completing transactions. It is in the best interest of Managers and Investors to nurture these relationships through appreciation, honesty, respect, and communication.

This installment was again based on my discussions with the following four Fund Managers who have successfully raised capital in the fund format:

Drew Buccino, CMB

Principal and COO

CALCAP

www.calcapadvisors.com

 

Matthew W. Burk

CEO

Fairway America, LLC

www.fairwayamerica.com

 

Blake Hansen

Managing Partner

Alturas Capital

www.alturas.com

 

Max Sharkansky

Managing Partner

Trion Properties

www.trion-properties.com


 

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. 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.

Fund Manager Chronicles: Raising Capital

In the first installment of the Fund Manager Chronicles, I explored the lessons learned by the Fund Managers I spoke with since starting their Funds. This week I will focus on effective strategies for raising capital, one of the biggest challenges in managing a Fund.

Relationships are crucial

In this day and age, with our lives so intertwined with technology, I found it interesting that when asked about the most effective strategies for raising capital no one mentioned technology. Rather, the overwhelming theme was raising capital when there is a relationship based on trust.

Trust is based on more than a marketing deck – it includes knowing the person you are investing with and seeing their performance over time. Fund Managers who don’t sugarcoat or hide information build trust; honesty and transparency are key to building successful relationships with investors.

This trust needs to go both ways; the Fund Managers I spoke with discussed the need to get to know investors before accepting their money and watching out for signs that the relationship could be problematic. Such signs include investors who are argumentative about the terms of the investment but decide to invest anyway, complain about past investment managers, or drain resources with constant questions and complaints.

Grassroots approach

All four Managers started with a grassroots approach that included making their first investments with all or a combination of friends, family, and business acquaintances. The Managers were able to expand their investor base by taking care of their initial investors, who told people in their circle about the experiences they’d had with the Manager. If investors are happy with what you’re doing they will let others know. Conversely if they aren’t happy with their investment they will spread that information as well.

Through existing investor referrals, one Manager is pursuing the Registered Investment Advisor (RIA) channel. As RIA’s are bombarded by investment opportunities, it helps if there is an introduction by a mutual investor and if you have a variety of offerings.

 Conferences

Although conferences were not high on the overall list, one Manager shared how lucky he felt to be part of the Small Balance Real Estate (SBRE) community. The SBRE Summits he presented at enabled him to connect with many investors with whom he established deep relationships that continued long after these events.

Another Manager has had some success raising money from attending conferences, although it required an incredible amount of follow-up in addition to the costs just to attend. Another Manager viewed so called “investor conferences” as a poor use of time and money.

Marketing

Only one of the Managers shared that he was able to raise sizable capital from investors with whom he did not have a pre-existing relationship with from crowdfunding platforms. Another Manager raised small amounts from crowdfunding platforms, although he did not think that the amount raised was worth the associated reporting burden.

Success has also been found in internet marketing focused on producing educational material to help investors learn how the alternative investment world works so that they can make better investing decisions. Having a website that people can dig into is valuable because people don’t like to be sold, but like to be able to easily access information and look at it on their own.

Regardless of the strategy, effectively and successfully raising capital changes your life by opening your network in a way you never imagined.  It connects you with successful people who have the ability to invest significant capital with you and, in some cases, also provide valuable business advice.

Stay tuned for the next installment of the Fund Manager Chronicles, focusing on investor relations.

This installment was again based on my discussions with the following four Fund Managers who have successfully raised capital in the fund format:

Drew Buccino, CMB

Principal and COO

CALCAP

www.calcapadvisors.com

 

Matthew W. Burk

CEO

Fairway America, LLC

www.fairwayamerica.com

 

Blake Hansen

Managing Partner

Alturas Capital

www.alturas.com

 

Max Sharkansky

Managing Partner

Trion Properties

www.trion-properties.com


 

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. 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.

Fund Manager Chronicles: Lessons Learned

One of the coolest parts of working at Redwood (yes, I have a cool job that revolves around accounting) is working with clients who possess a variety of interesting backgrounds and success stories. I recently spoke with four successful Fund Managers to get an understanding of what got them to where they are and what has enabled them to continue to be successful. Over the next few weeks I will share what I learned, including insights into raising capital, investor relations and today’s installment: what they wish they knew when they started.

For this series I’d like to thank the following Fund Managers, who generously shared their time and insights with me:

 

Drew Buccino, CMB

Principal and COO

CALCAP

www.calcapadvisors.com

 

Matthew W. Burk

CEO

Fairway America, LLC

www.fairwayamerica.com

 

Blake Hansen

Managing Partner

Alturas Capital

www.alturas.com

 

Max Sharkansky

Managing Partner

Trion Properties

www.trion-properties.com

 

A focus on continuous learning

One common trait shared among the Fund Managers I spoke with is that they are constantly learning, so when I asked what they wished they knew when they started out, they had a lot to offer. The universal answer to this question was that none of them realized how hard it would be, with the sheer breadth and magnitude of so many moving parts and issues, from capital raising to investor relations to accounting/administration to tax questions. One Fund Manager compared it to having kids – no matter what anyone tells you and how many books you read you have no idea what you are in for until you have a child, or in this case, a Fund of your own. Having a continuous learning mindset helped these Fund Managers work through these challenges.

Getting the right advice

Forming a Fund can be an ordeal in and of itself – often you don’t know what you don’t know! One Fund Manager expressed that he was grateful that he had an awareness about what he didn’t know. It prompted him to pay for the right guidance in forming the Fund and have the right advisory partners in place from the beginning. Getting the right guidance in forming your Fund can help avoid costly mistakes down the line.

Raising capital is hard

Raising Capital is the number one struggle for Managers in the early phases of their Funds, especially in a fund format. Prior to the formation of these Funds, many existing investors had grown accustomed to the syndication model that allowed them to review each deal, ask questions, and potentially earn a higher yield than in a Fund (although not nearly as diversified as a Fund).  One Fund Manager forced the issue by putting as many deals as possible into the Fund and not giving investors the option to invest any other way. Investors who moved to this particular Fund ultimately appreciated the diversity that they didn’t get in the lone deal format, albeit a potentially lower yield than in any given syndicated deal.

Running a Fund business

The Managers also commented on the difference between being in the Fund business versus being in the Real Estate business. In some cases, the challenge of managing idle cash which negatively impacted fund-level returns caused Managers to waive all or a portion of their fees to ensure that investors received their target yields. Similarly, the balance of not calling capital too early while still being able to fund fast-moving acquisitions was another learning experience previously not encountered by new Fund Managers.

Although these Fund Managers employ differing business models and live and invest in different parts of the country, they all share a passion for personal and professional growth that has driven them to be successful individuals that I feel personally lucky to know. Working with and for these entrepreneurs to deliver institutional quality financial reporting, it is a treat to step back and learn about the people and strategies that are allow Redwood to provide this service.

Click here for the second installment of Fund Manager Chronicles, focusing on effective strategies for raising capital.

 

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. 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.

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.