Real Estate Fund vs. Deal by Deal Capital Raising

Before deciding to launch a full fund, real estate sponsors should consider whether it makes sense to initially raise capital on a deal by deal basis.  From an investor's perspective, a private equity fund involves trusting the fund sponsor to identify and execute on suitable real estate investment projects and call the capital as deals become available.  On the other hand, with a deal by deal approach, investors play an active role in deciding which investments they are interested in.  Investors are generally provided detailed information on individual projects and are given the opportunity to opt in to specific real estate opportunities after evaluating the merits of the underlying process.

The Deal by Deal Capital Raising Approach

The deal by deal capital raising approach involves raising capital for each individual real estate investment project. This structure requires that fund managers secure funding on a project-by-project basis.  One advantage of the deal by deal capital raising approach is that it allows investors to tailor the funding structure to meet the specific needs of each project. This can include negotiating favorable terms and conditions with investors, such as equity stakes or preferred returns.  A deal by deal approach is often especially helpful for sponsors that have close relationships with a relatively small group of investors.

With a deal by deal approach, sponsors must continuously seek out new capital for each project, which can be time consuming and require ongoing investor relations efforts. This is often problematic for projects that need to be moved on quickly.  Generally, deal by deal capital raising tends to limit the scalability of investment activities.

Despite these considerations, the deal by deal capital raising approach can be an effective strategy for investors who prefer a more hands-on and flexible approach to their real estate investments.  We often see the deal by deal approach for real estate sponsor that are in the early stages of developing an investor base and are not yet ready for a full real estate fund.

The Private Equity Real Estate Fund Approach

Private equity real estate funds are investment vehicles that pool capital to fund a portfolio of real estate assets. Rather than presenting investors with successive opportunities to invest in individual real estate opportunities, private equity fund sponsors raise a larger amount of capital (usually in the form of capital commitments) to fund portfolio investments as they become available.  The real estate fund sponsor is expected to use its investment acumen and expertise to execute the fund strategy based on market conditions that present themselves.

Because they have ready access to pre-committed capital, real estate funds are able to move quickly to take advantage of tight windows of opportunity for time sensitive projects.  Additionally, real estate fund sponsors are often able to use the leverage of pooled capital to influence the shape of opportunities, and to aggregate purchases in ways that can generate additional value for investors.

Private equity funds tend to be able to access capital at scale better than most direct real estate offerings raised on a deal by deal basis.  Private equity real estate fund terms have been developed over many decades and markets have reached a degree of consensus in important areas, making real estate funds appropriate for sophisticated capital raising efforts at scale outside of a fund sponsor's immediate network.

One of the drawbacks to the real estate fund approach is the lack of flexibility for individual investors.  The fund approach also means that there will be more properties in the portfolio, which tends to make the investment a longer-term investment than an individual property in most cases.

Raising Capital for an Individual Real Estate Deal

When raising capital for an individual offering (as opposed to a fund) the focus of the offerings are on the pre-identified real estate project.  Pre-identified assets are usually structured as either single asset acquisition vehicles, with a single property, or multi-asset acquisition vehicles, which include more than one property that has been pre-identified and is available for acquisition. 

Separate offering documents are created for each pre-identified real estate project or group of projects. Legal counsel will assist you with the preparation of offering documents, including: a private placement memorandum, the governing documents--either an operating agreement for an LLC offering or a limited partnership agreement for a limited partnership offering, subscription documents, and state and federal Regulation D filings.

When raising capital for a deal by deal raise, sponsors must be able to act quickly, but at the same time, provide an adequate disclosure of the material information relating to the identified real estate investment.

Raising Capital for A Real Estate Fund

In contrast to a deal by deal capital raise, where the focus is on the pre-identified real estate transaction, the focus of a real estate fund capital raise is on the proposed strategy, as well as the background and prior performance of the fund sponsors.  A real estate fund is considered a blind pool, in that sponsors will be making real estate investment decisions without the investors signing off on the investments.  The fund strategy should clearly explain the approach the sponsor will take toward identifying, selecting, managing and exiting real estate investments.

In contrast to deal-by-deal capital raising, where investors will make immediate capital contributions to invest in an immediately available asset, real estate private equity funds typically involve capital commitments for the life of the fund, which are called on an as needed basis as investment opportunities are identified.

Real estate fund offering documents are similar to offering documents for direct investments and include a private placement memorandum, limited partnership agreement and subscription documents.  The investment terms of a real estate fund define the sponsor compensation, including management fees, performance compensation, and often preferred return provisions.  An important aspect of real estate fund terms is preparing the distribution waterfall, which determines the order in which investors and fund sponsors receive distributions when income is generated and as properties are ultimately sold.

Building a Track Record

We often refer to an emerging manager's first fund as a "pilot fund."  The idea is that prospective fund sponsors should usually not be looking to aggressively scale up a fund until it has developed operational expertise.  Often a more modest approach, using a close group of sophisticated investors to build the initial fund is a better approach.

However, raising capital for a private equity fund usually does require a critical mass of assets under management for a real estate fund to make sense.  A first-time fund should have sufficient assets to successfully diversify assets to prove the concept of the first fund.

For managers that are not yet ready to launch a full fund, a common approach is for sponsors to start raising capital on a deal by deal basis to grow their investor base, generate a track record and build out the necessary infrastructure to transition to a full fund.  As a general rule, deal by deal capital raising is easier, as investors are able to evaluate the underlying real estate opportunity, and determine interest on a property by property basis.  Deal by deal capital raising can often develop the needed trust with an investor base sufficient to justify investing into an emerging real estate fund management team.