Common Terms to Know in Real Estate Fund Investing
Real estate funds can be a great way to diversify a portfolio or to provide access to real estate related investments that smaller investors may not otherwise have access to. In addition, most funds are run by professional fund managers with a great deal of experience and expertise in real estate fund investment. In a previous article, we discussed several different types of real estate funds that investors can consider for their portfolio. All of these funds run on the same basic premise – pooling funds from multiple investors and investing those funds in a variety of real estate assets (there are some single-asset REITs and funds, but these are not the norm, so we’ll focus on the more common role of funds in this article).
However, funds such as mutual funds and private equity real estate funds often pursue different strategies and even different types of real estate related investments. While mutual funds traditionally place funds in a diverse set of real estate securities, private equity funds often choose direct investment in property. But even with these differences, there are some underlying commonalities in the structure and operation of funds that you should be aware of. The remainder of this article will discuss a few of those terms often found in the prospectus for a real estate fund offering and what you need to know about them.
Depending on the size of the company offering the fund, there could be several layers of managers. Companies with multiple funds often have a Board of Trustees or advisors that oversee the management of all funds, while the specific fund being considered will have investment managers with experience and expertise in the strategies the fund is pursuing. Information will be provided on the background and experience of the fund managers.
Fees and Expenses of the Fund
Most funds are professionally managed and charge fees for their services. These vary by type of fund and an investor should consult the prospectus to determine the fees associated with each fund. There are also often performance-based fees that are provided to the firm/managers of the fund that will be described in the fund prospectus.
The investment objective of a fund lays out the type of return the investor can expect. While some funds focus on providing consistent dividend payments to investors, others might be focused more on longer-term capital growth. Many funds offer a mix of dividend income and capital growth, although sometimes a fund will be more heavily weighted towards one than the other.
The investment strategy of a fund is how it intends to achieve returns in order to meet the investment objectives. Strategies could include the direct investment in stabilized properties, the development of properties, or the investment in a diverse set of real estate related securities (equity, debt, derivatives, etc.). Some funds can invest in a wide variety of assets and derivatives while others are more focused on a specific property type or geography.
Financial Information/Performance Information
If the fund has been in operation for a while, there will be a section that provides past financial and performance information. This will include information on how the fund has performed in the past, the return provided to investors, the current financial state of the fund, and what assets the fund currently holds. This section can be very useful in determining when the funds’ strategy and management perform well and when they may underperform. This information, combined with the investors personal view on how the real estate industry will perform in the future, can help the investor determine whether this fund is the right place for their money.
A real estate fund prospectus will include several sections on risk. Generally, there is a discussion of risks inherent in any investment, such as market risk, but there is also a discussion that centers around risks unique to real estate investments. For example, because real estate is a physical asset, any fund that invests directly in the equity or debt of a property is incurring market and specific property risks. Some funds also invest only in one country, meaning that the fund is exposed to any changes in the performance of the market in that one country.
Use of Proceeds
This section of a fund prospectus is pretty straight-forward, though it does contain information about what other activities the fund may use proceeds for, along with the time frame in which the fund expects to have all of the proceeds invested. Sometimes proceeds from the fund can be used to meet operational needs or for hedging purposes.
Investors obviously expect to receive a return on their investment. The fund prospectus will spell out when and how distributions to investors will be made. This section will also often contain information relevant to the taxation of distributions.
Often investors are interested in selling or otherwise transferring their shares in order to realize a profit. The ability to buy, sell, exchange, or transfer funds is dependent on a number of factors (i.e., an open-ended fund vs. a closed-end fund) and will be spelled out in the fund prospectus.
The list of terms above is certainly not exhaustive, but does cover some of the major factors you’ll need to consider when researching potential real estate fund investments. It should also be noted that the exact terminology often differs from fund to fund and the categories above should serve as a guide to understanding the various aspects of a real estate fund prospectus. There can also be vastly different types of information in a prospectus depending on the type of fund being reviewed (mutual fund vs. private equity fund).
Most investors will have an idea of which type of fund best suits their objectives, but the details of how the fund handles various aspects of its operation, distribution, and liquidity of shares can be a big determinant in the decision-making process. It can also be an extremely complicated process full of legal language. Thus, any part of a prospectus that is not well-understood should be reviewed further or the investor should consult with an expert for clarification.