The Real Estate Fund Lifecycle Webinar Series | Part 2: Operating Your Real Estate Fund

That's Tami Davidman.

Tami is an audit partner in EisnerAmper's real estate private equity services group. She's based in our New York City office with over 15 years of experience in public accounting. As I mentioned, she specializes in serving alternative investment partnerships, private equity funds, and real estate funds across all asset types, multifamily, industrial, and hospitality. Tami is also a leader in the real estate emerging manager practice, which makes her perspective today especially well suited to our audience. Welcome, Tami. And finally, Dan Kaplan. Dan is a partner at EA RESIG, EisnerAmper's Real Estate Fund Administration Affiliate, the largest real estate fund administration company in the country. And Dan himself brings over 30 years of experience with a concentrated focus on real estate fund advisory services, overseeing both open and closed ended funds, REITs, opportunity zones, and disrupt debt and equity funds. And importantly, Dan has been on both sides of the table.

Before joining EA RESIG, he served as a CFO of a vertically integrated real estate private equity fund, which gives him exceptional insight into what fund managers are actually dealing with us. Dan, great to have you with us today. So now let's jump right into it. We're going to start with the legal and structural foundation. So Yoni, I'm going to start with you. For those first time fund managers, what legal decisions made early tend to have the biggest downstream impact on operations and what do most managers often underestimate?

Yoni Tuchman:
Lisa, first of all, thank you so much. It's exciting to be here with you, Dan and Tami. I have two answers to this first question. This is a very important question you pose. There's the generic answer and then a little bit of a contrarian answer. I'll say the generic answer first and they're both true. Two things can be true at the same time. The first answer is in setting up your fund and if this is your first fund, your firm, and we talked about this on our last conversation, you have to design it appropriately for what you're intending to do. And if you misdesign it and we'll talk about what that means and how you might do that, then operationally things are going to ... Imagine that train in the cartoon going down the tracks and it goes so fast and then the wheels kind of pop off and everything kind of like ... That's what could happen if you get into something without a good design knowing what you're aiming for because the operations of running the fund all stem from how you set it up.

People underestimate that, right? How so? They may not design the structure of the fund right. They may not design the terms of the fund right. They may over engineer for eventualities, conflicts, things that may not be an issue and that could like set you off when you're running your fund and you're looking back at rules of engagement like rules of the road that hamper you unnecessarily, that impose restrictions where they don't need to and therefore require more operational intensiveness, is that a word, than otherwise would need. So that's like one area. Sign it to get at what you need, otherwise the wheels are going to come off because you're going to have rules that don't apply to you potentially. But the other thing that I consider a little contrarian maybe, and you could tell me that it's not, is a lot of times emerging managers who are raising real estate funds, they're more nervous.

They think that there's more that they need to do than they actually need to. And so for example, if you're setting up your firm and I want to talk more about this, we'll get to this probably in other questions, but if you set up your fund as a real estate fund and you're only investing in real estate, primarily in real estate, then a lot of the things that you thought would apply to you as a fund manager won't because a lot of the legal and regulatory stuff that the government imposes on fund managers does not apply to real estate fund managers. So I'll give you just as a quick example, like if you think of yourself as a fund manager like your friends at the country, the proverbial country club are, but they're raising venture capital and private equity, they're going to have all types of compliance that you may very well not have.

In other words, they have needs for compliance overlay and operational complexity that you may not have. So I would say know who you are, know your lane and know who you're not design the firm, both the documents and the structure and understand the regulatory overlay, depending on really what you're doing, that's going to streamline all of your operations down the road because it's going to allow you to omit overarching or overburden some operations that you may not need. I

Tami Davidman:
Think that's actually a really good point. I can actually, I just had an example that happened last week where I was talking to a new fund manager and they're raising on the smaller end of the spectrum and I asked where's the audit requirement coming from because they were interested in audit services and they were like, "Well, don't we need one?" And I was like, "Well- I love that. I actually think that for your perspective, it might be more investor driven as opposed to the need from a regulatory perspective." So it's important to understand, like you were saying, what is the need versus what is the want?

Lisa Knee:
I think that's a perfect way to go. I think that's a great example. The next question. So we get this question all the time and Tami and I always go back to the attorneys and Dan is, so what if I want to register? What makes a difference? What do I do to register? Because we'll get it all the time is, do I have to register to have my fund be compliant? And so people try to understand what are the differences that why you'd want to and why you don't and what are the right, what all of a sudden, what is that next regulatory framework that puts me into that level? Because people will come to us all the time, forget from the audit risk when they say, "Do I need the audit or not? " It's, do I need to register? And sometimes we're like, "Who did you talk to about this?

Yoni Tuchman:
Right. I think these are great. I love that audit point because you're totally right. People have all kinds of misconceptions that often are over compensations and not kind of underestimating what they need to do. And audit is probably the best example of that. Registering any entity in my humble opinion as a lawyer is something you don't want to do. I was like, no, law firms love this stuff because they make all this money off of registering and regulatory. That's not our view. Our view is less is more. If you can live with less, that's the better option. So let's talk about the fund itself and this, a lot of people don't, a lot of emerging managers don't understand this. When you're raising a fund, that fund is an investment company, that's an investment company. What sets your fund apart from a mutual fund that's registered as such, right?

It has all this crazy kind of overhead and operational requirement relating to that, stemming from that. The difference is they're investing in securities and you may not be. If your real estate fund is investing in dirt, brick, mortar, right, you're not investing in securities. You are outside of so much of the regulatory headache that your friends in private equity or venture capital have to deal with. So we have real estate fund clients that register, register because they need to. Why would they need to if they're real estate? Because sometimes, and there's a line, and I can't give legal advice on a webinar, but talk to your lawyer. There is a line that you can cross. And I'll tell you at the fund level, at the fund level itself, there's guidance that ... Let me just take a half a step back and I don't want to monopolize the conversation with this boring kind of legal point.

Your friends who are raising private equity funds, they have to fit within an exemption that limits either the number of their investors at a hundred with some look through rules or the nature or the wealth of their investors so that they're all very wealthy. You as a real estate fund manager probably can avoid both of those headaches. You probably don't need to count your investors. How amazing is that? You can have 300 investors and not 100, right? I'm making a number at 30 more than that. Also, you don't have to care how wealthy your investors are with some exceptions. They have to be a minimum floor, but they don't have to be super wealthy. All your friends in other areas raising funds have to live with that stuff. But if you stay within your lane of real estate and you don't invest in real estate, for example, through someone else's JV where you're the passive investor in real estate through someone else's JV, then your real estate, you can avoid a whole host of naughty regulatory problems, but talk to the lawyer that you're working with so that you understand where that line is.

What does it mean to be predominantly invested in real estate? How much passive joint venture investments can you make in your real estate fund and still be considered a real estate fund as opposed to a securities fund? So there's a lot to talk about there, but I talked long enough about this, but that's I think that's how I'd answer this question.

Lisa Knee:
So I think a lot of these are really important decisions that you're making, starting the fund. And then once you get into operations, when people call us to get into it, it's how quickly do you get your fund administrator in there? What can your fund administrator do? And a lot of times we get that phone call of, "Oh, we can handle this ourselves." Or, "Why do I need that third party administrator?" And so Dan, you and I have had so many conversations with people over the years of saying, when does it make sense? So what are those common operational gaps that we see with those first time managers or an existing manager who might be thinking about using that? Which ones really get it right and really what makes sense from a fund administration standpoint in terms of operations, that day-to-day back office?

Daniel Kaplan:
Okay. So thanks for that question. So what I always encourage is that we be involved very, very early. We had a whole webinar, number one, which we were all listening to and there's an enormous amount of work which ultimately results in your successful raising of capital, but then all of a sudden you're like, "Wait a minute, we have to do a capital call. How do we do that? " So the sooner your administrator is involved, the sooner their infrastructure is set up and you're ready to be off to the races. We understand this is an afterthought, but you have to remember that administrators have a tremendous amount of operational knowledge. A lot of our first time managers, by definition, think about what you are. You came out of a big large shop where all of this infrastructure existed. Now you're responsible for it. So you need to partner up very early.

We have a lot of, just like the attorneys, we have tremendous amount of experience with the operating documents and recommendations about best practices. I'll say it again. Sooner, the better.

Lisa Knee:
So when we think about the attorneys and we talked about in our first series, the LPA, the side letters, those policies, there is a lot on there and there's a lot of ongoing compliance in terms of the side letters and maintaining all that. Dan, what do you see on the day-to-day with the strong fund managers and really understanding how that fund is operating and communicating that to that so that there are no surprises. You mentioned capital calls. We know distributions around the clock of when distributions need to be made and communicating with investors, those phone calls that happen more often than not, right?

Daniel Kaplan:
So the thing that we do, our practice is to do a dry run of everything before the fund even launches. So you should not be in year six and all of a sudden going through and reviewing your waterfall methodology. That should all be baked before the fund even launches. You don't want any surprises because that's truly when cash is going out the door to both LPs and GPs. So I said, when I retire, I'm going to come back and set up a joint law firm accounting firm where I put mathematical examples into every LPA to avoid the confusion that always seems to happen whenever anybody reads these. And no offense, Yoni, I just don't understand the ambiguity sometime, but you definitely have to do dry runs of your calls, distributions, understand the waterfall, build your waterfall model, look at your management fees, understand and implement and write the formula for every side letter so that none of this is something that you're doing on the fly, or even worse, restating or fixing once the fund is locked.

Yoni Tuchman:
Can I

Lisa Knee:
Ever- And even that collaborate ... Go ahead.

Yoni Tuchman:
Sorry, Lisa. I get often enough operational questions from clients like, "How do I do this math? Okay. And Dan just nailed it. We draft these documents and by the way, we stand by them. They work. They're great. They're bulletproof, but there's so much between the words on the page that is just operational knowledge. I'll give you one example. You have two closings or very often multiple closings, more than two. And you're rebalancing capital calls, fees, expenses, investment dollars between different cohorts of investors coming into the same fund over time. Our legal documents tell you how to do that. But if you would ask me to actually run the math on a real live scenario, I would literally say, Call Dan, don't call me. But you wrote the documents. I know, but don't call me. There's a lot that goes on beneath the wording that is ... And by the way, a lot of times, just to defend the profession here, a lot of times that's intentional.

A lot of times documents in different ways. For example, in this area, truing up investors, there's discretion that's baked in and dare I say opacity, is that the word? Sometimes we don't want to be too prescriptive with the math formula in the documents because there needs to be flexibility. You need to be able to stretch.

Daniel Kaplan:
Discretion.

Yoni Tuchman:
Yeah. And that's where your fund admin comes and say, look, we've read a thousand LPAs, but we've also operationalized them. We've actually done the math and that's so key.

Lisa Knee:
I'm going to add another layer on there. Wait, Tami, I'm going to throw it to you with that next layer is understanding where the audit perspective comes in. So really bringing in ... So the fund administration come in and we'll talk about tax later and the legal documents, but when we've had these calls and Tami and the audit team come in, there's a whole different other conversations, whether it's, are you reporting under investment company rules or operation? And so Tami's had those things where people ... I'm going to let you jump in and say, have you thought about how you're looking at your assets from a valuation perspective and what do your investors expect from a reporting standpoint? So Tami, go in and jump in on that from an audit perspective, which changes the whole dynamics because fund administration, tax and legal, we're all in a different camp.

Sometimes the audit team is way out there on their own on how it should be interpreted.

Tami Davidman:
Yeah. So I also just want to differentiate, like there's a difference between investment company from a legal standpoint and like the SEC standpoint versus the accounting guidance standpoint. So when Yoni was talking about everybody, all of you guys are investment, you're starting investment companies, that's from a legal SEC standpoint. So what I'm going to be referring to is different. So I just want to differentiate that starting off setting the scene here. So from an accounting perspective, there's specialized guidance, which is ASC 946 or investment company reporting, which is a different reporting than operating real estate would show. So you're not going to have your land buildings equipment on the financial statements. You're not going to have on your P&L rental revenue and depreciation expense. Instead, what you're going to have is fair value of the investment in the real estate. You'll have a schedule of investments, you'll have financial highlights and your P&L is really just going to be pretty simple.

It's a couple of accounts there and your big one is going to be your gains and losses on that investment. So it's really, really important that we get the basis right here because like I said, those are very different financial statements. So when you start to think about, well, am I an investment company or am I an operating company? The important things here to think about is like, what's really the purpose of this vehicle that I'm starting? Am I starting it? Am I managing outside capital and really trying to bring in returns for those investors or am I really just managing the property and operating the property? The one thing I would also caution related to real estate funds specifically, so this is something that we don't really see a lot on the regular PE side or hedge side is there's a lot of fee income, especially when you have like a vertically integrated real estate investment firm that we need to think about, well, could that potentially throw me into this operating category?

So am I getting all of these development fees? Am I getting property management fees, brand management fees, all of these different things that are really outside of like investment income and capital appreciation. So I always say that before we put pen to paper and start getting the fund administrator to start recording transactions, it's really important to have conversation with the auditor just to make sure that you're on the same page with what that reporting is going to be because the last thing you want is to do all your reporting and then for the auditor to say, "Nope, disagree." And then you're starting from scratch.

Daniel Kaplan:
One quick thing about the differentiation here also, most people when they see investment company guide and fair value reporting, oh, it's so easy. It's unrealized gains and losses and some OPEX. But underneath that, you do need to keep track of all of the data regardless of whether you're reporting on an operating basis because all of this data is going to inform your sub-entity tax returns and your operational performance. So you definitely need to have a, call it a two-faceted reporting where all of this data resides as well as obviously the 946 requirement. Yeah,

Tami Davidman:
It's a great point.

Lisa Knee:
I need to jump in there and add in tax. Sorry guys, but when we talk about this, what do people care? They do. They love that financial statement. Dan, they are looking for their distributions and their contributions, but let's not kid ourselves. The K1 really is what people are looking at and understanding what is happening from a tax perspective. When you're talking as a fund manager, if you don't own or operate 100% of that entity where you can control the tax decisions, if you are doing a JV and you're not the GP of that JV, you really need to make sure how those people are making those decisions, what elections are being made, understanding the nature, as we talked on the first call about who your investor is and what they expect. Are they expecting losses? Are they expecting certain types of returns? And so if you're not communicating with your tax team, first of all, they care about the timing of the K1s, but they care about the accuracy as well and what that expectation is.

So the reason why we're all on this together is because we do keep those conversations open and free flowing and communicate to know when are acquisitions being made we know from a fund admin or from an audit perspective when the capital is being called so that they can make those commitments out to their acquisitions. And it's also legally each acquisition that's made, how is that being structured? So the fund itself is really important in the structure, which each acquisition used to deploy that capital is another communication on how we're acquiring it, how we're structuring that vehicle, what the expectations of returns are and quite frankly, how is that information being reported? Do I need an audit at that level or just at the fund level? If I'm not getting an audit at that level, who is reviewing those financials? How are we having the discussion and who's making the decisions at that entity level?

And depending on how your fund is structured, if you are a GP fund or an LP fund or if you're actually making those decisions, getting that whole team in play of communication is really, really important. We've seen it all too well where how many surprises have all of us seen over the years when we're getting financial information being reported to us because it's from another third party. I'm sure we all have stories on those situations. Tami, we've seen it on management fee calculations where we've seen surprises of people, where do the fees, Dan, you've seen them too. Where do the fees get paid? So feel free to jump in on that. I had to add in my tax two cents in here besides the reporting on there, but that framework is really, really important just to make sure that it's really being ... There is a good foundation for that, especially with an emerging manager and some of those examples that we've seen, Tami, you mentioned valuation.

All the assets get valued differently, explain how a stabilized building might have a little bit different conversation versus a development site.

Tami Davidman:
Yeah. So first of all, emphasizing no one size fits all for valuation. I'm going to kind of talk about best practices, what I've seen in practice, but that doesn't mean that that's the only answer. So generally for a stabilized asset, whether it's multifamily, office, industrial, you'll see some kind of income approach. So whether that's a capitalized NOI approach or some kind of discounted cash flow where the tricky part comes in is really for the development assets because a lot of times the fund managers just want to hold it at cost. And although I fully understand and appreciate that, that's not gap. So it has to be at fair value. There are situations where costs can approximate fair value, but an auditor is not just going to take your word for it. You still have to have some kind of model that supports that and that there's verifiable inputs in there that we can look to and we can test.

The other thing that you want to think about from a development standpoint is the de- risking process. So as you de- risk a project, value is unlocked and should be recorded at that point. So just as an example, let's say I am doing a ground-up development and there needs to be new zoning on that development. Well, if I go to the county and I'm able to get the right entitlements, I've now unlocked value, right? Because if somebody else were to come in and even take over from that point forward, that means that they no longer have to go through that process and there's less risk involved in order to get construction started. So those are just things to think about even when you have a development project. It doesn't necessarily mean that it's always going to be at cost.

Lisa Knee:
And that might not always be the same answer for tax. So let's be careful when we're talking

Tami Davidman:
About- 100%. Only talking audit. Only talking about financial statements.

Daniel Kaplan:
One quick point from the administration just to, from a disclosure point of view, there's a very detailed amount of disclosure around your assets, what category they are. Your administrator should be guiding you through all of that level one, level two, level three, as well as the required inputs and the disclosure that needs to be put in the financials in order to pass your

Lisa Knee:
Audit. By the way, what a great tee up for administrators giving the advice and value. We've been seeing a lot and talking a lot, at least all over about AI and that guidance that you just said, your administrator should be guiding you in that. Dan, I'm going to throw it to you a little bit about AI and how you guys are using it for fund management today, but what the most important thing that you guys are still doing with AI is on that personal side. So where are you seeing AI add real value and how are you making those decisions in terms of running the operations?

Daniel Kaplan:
So AI is a buzzword. I live through the 2000 internet generation where the internet was the end all deal and everybody just thought they were magically going to be productive as a result and there was a lot of failures, but from an AI point of view, we are using it and seeing immediate leverage. So by us being levered, by us taking 15 LPAs, if you're not an emerging manager, but you're more established using Claude, I've literally taken 15 LPAs, dropped them into a template and had them abstracted all key provisions and summarized for us and it took us an hour instead of 12. In those other 11 hours, I'm now doing more important beneficial things to help you guys look forward rather than historical reporting. So tremendous amount of efficiency and value add right there, but AI is a great digester and analyzer of information.

It is not God. So at the end of the day, you need a human to look at it and make sure that it's reasonable and so that's part of our process right there. But again, it is a game changer in allowing us to exponentially be there and available for you our clients.

Tami Davidman:
I think that's honestly the best point though, because even from a valuation perspective, you can have AI assist you with coming up with your models, but it doesn't replace the fund manager's experience, judgment and putting together the inputs that are going into that model. So I think that's a really great point.

Lisa Knee:
These 30 minutes go really way too quickly with all this great information. I can't believe where we are. I want to do a closing question to all the panelists. We didn't get to the other question Questions, and I think I didnt even go through half my list of questions, but let me give you guys each a closing question for one sentence. Each, for an emerging manager that's building their fund operations from scratch, what is the single most important thing to get right in year one? And Tami, we're going to start with you.

Tami Davidman:
I think it's the infrastructure. And when I say infrastructure, I mean both from a financial and an operational perspective. So getting all of the right players in place so that you can then build on that and be successful going forward.

Lisa Knee:
Yoni, thank you, Tami.

Yoni Tuchman:
I have to just echo what Tami said. I would say in two words, know thyself, know who you are and that's going to determine what you need to do operationally. Don't over engineer for someone else. This is engineered for you.

Lisa Knee:
Dan?

Daniel Kaplan:
I would echo, I mean, both of those things are very important and getting everything right, you're not going to get a chance at fund two if you don't nail all the deliverables that are required from an investor communication point of view in fund one.

Lisa Knee:
And I would add make sure you invest in the right people and in the right partners. Don't look as a cost saving opportunity. If you're going to build, build for the future too. And so make sure that you spend those dollars wisely with the team that you know that you can grow with. So that would be my add-on. I can't thank the three of you enough. This went really, really fast and it was a lot of fun. I'm sure we could do a part two, three, four, five, six, all the way to 10, a follow-up, but thank you everyone for joining us today. Astrid, I'm going to hand it over to you.

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