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:
- Do you have a consistent monthly deal volume?
- Are your deal sizes smaller, with shorter hold times?
- Do you have experience and success raising capital?
- Do you have clear goals and objectives for your potential Fund?
- 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.
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.