New Real Estate Fund Manager Conundrum: Joint Venture or Fund Partnership?
December 13, 2019
By Dan Kaplan
The joint venture structure for real estate investments has many positive attributes. It allows you to leverage discreet expertise among a small partnership group, share risks and resources, and accomplish a specific investment goal more quickly and simply than that of a tradition real estate fund. One might ask, however, why utilize a real estate fund structure and what critical issues does a new fund manager need to consider?
Real Estate Fund Structure Benefits
This type of structure gives you immediate access to a larger and a more secure capital base for deal execution. It also gives you the ability to leverage fund structure equity with one credit facility rather than obtain deal-specific financing. Furthermore, it provides you with a longer investment horizon, along with risk and strategy diversification. Finally, you can invest in larger projects of higher complexity and quality.
Fund Manager Considerations
Fundraising and Marketing – Raising fund capital requires a different strategy, because investors who align with the fund’s investment strategy are generally more passive, compared to a joint venture partner who contributes both capital and some form of active investment management. The manager must look at a variety of institutional, high net worth foreign and pension-based funding sources. Representatives of sophisticated funding sources will be highly critical and exhaustive in their diligence of a new manager, especially considering the lack of historical performance metrics. Managers might utilize placement agents to augment their existing network.
Foreign-Sourced Investment Limitations and Issues – Governmental restrictions (e.g., OFAC) help ensure compliance with blocked entities, countries and individuals. There are also a variety of securities laws pertaining to foreign investors. Foreign investors can present tax consequences to both the fund and the investors. The cost of a structure that supports foreign investors needs to be weighed against the benefits derived. Violations of the aforementioned rules and regulations can be substantial, so it is best to consult with qualified legal counsel.
SEC and/or State Registration – Investment managers with greater than $100 million in assets under management (“AUM”) typically must register with the SEC as a Registered Investment Advisor. Investment managers may be required to register if they:
- Have a principal office and place of business in NY and have $25 million or more AUM.
- Are registered under the Investment Company Act of 1940, regardless of AUM.
- Are required to be registered in 15 or more states, regardless of AUM.
- Are internet-only advisors, regardless of AUM.
Deal Pipeline Management – Managing multiple deals with varying criteria requires the manager to have a properly balanced team with expertise across the portfolio.
Cross-Collateralization Risk – The use of a fund-level credit facility normally requires the cross-collateralization of investments.
Cash Management – Investors want capital deployed quickly. Thus, cash management becomes extremely important as the fund manager times cash balances to sources and uses. Poor cash management can have a disastrous effect on fund performance and the promotional returns to the manager who is looking to raise future platforms.
Increasingly Complex Reporting Requirements – Institutional investors have a higher level of detailed reporting requirements, and the timeliness and quality of data are critical to retaining and growing the investor base. Organizations such as the Institutional Limited Partners Association work to increase industry standardization and the ability to meet reporting requirements.
Manager Liability and Risk Management – The manager is exposed to various risks. Therefore, he/she should consult with risk management professionals to ensure the proper insurance coverage such as directors and officers, errors and omissions, and cybersecurity insurance.
Back Office Infrastructure and Scalability – The composition of a fund’s investment portfolio and timing of its implementation pressure the manager to balance infrastructure costs with its fee base and operating agreement expense provisions. Funds are increasingly outsourcing key functions—such as accounting and investor reporting—which provides the manager a greater level of internal control, cost efficiency and flexibility, while allowing him/her to focus on the meeting investors’ goals.
Switching from a joint investment to a fund platform provides tremendous benefits, not to mention challenges. Fund managers should leverage the expertise of their trusted financial advisors, fund administrators and legal counsel to ensure they are best positioned for success.