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.
Posted in Tax

Understanding How to Handle Loan Impairment in a Changing Market

Many Fund Managers spend a significant time evaluating both borrowers and market conditions for loan collectability. Changing economic and market conditions make these evaluations even more difficult and despite the best due diligence, some loan repayments fall short. Fund Managers must consider how these losses will impact the investors coming in and out of their offering. Redwood’s sound knowledge of accounting standards in both theory and application provides expertise and guidance in navigating these conditions.

Some key considerations for Fund Managers include:

  • Loan Loss Allowance or Reserve
  • Foreseeable Loan Losses
  • Impairment Valuation

Loan Loss Allowances/Reserves: Fund Managers should set a provision for loan losses that enables them to build a reserve on their balance sheet, which is similar to write-offs for bad debts or other similar events. Exactly how losses are determined and at what point they should be recognized differs, depending on whether the portfolio is being collectively evaluated or if a single loan has a foreseeable loss.

In the case of pooled mortgage loans with similar underwriting and smaller principal balances, Financial Accounting Standard (FAS) 5 guidance provides for a reserve or allowance to represent a small portion of the overall portfolio. While no one loan may have a foreseeable loss, economic and market conditions justify keeping the small allowance. However, when a loan does have a foreseeable loss a different accounting standard applies.

Foreseeable loan losses: As a result of periodically evaluating your portfolio of active loans, you may determine that one loan has become impaired. In this situation, accounting standard FAS 114 applies. Once a loan is determined to be impaired, a separate loss allowance can be calculated, in line with any loss that can be reasonably estimated.

Impairment Valuation: While accounting standards suggest several measurements of impairment, using the fair value of collateral may be most relevant to the SBRE community. If the fair value of the loan is less than the outstanding receivables to be collected, a separate allowance should be created along with a corresponding current period Expense to loan losses related to the impaired loan.

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 exactly what issues you should raise with your CPA. Don’t hesitate to reach out to us if you have questions.

 

Nate Ashley

Redwood’s Senior Fund Accountant Nate Ashley provides expert guidance to his clients based on the accounting standards to make sound business decisions in the face of varied economic conditions. Feel free to reach out to Nate at nate.ashley@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.