What’s in a Real Estate Fund Prospectus?
Before an investment offering can be made to the public, a firm must provide information about that investment in a legal disclosure document known as a “prospectus.” A prospectus must be issued for any investment that will be offered to the public, not just real estate fund investments, and contains information about the company/fund, the management of the fund, what securities are being offered, how those proceeds will be used, details of the offering, financial information, and risks that may be associated with this particular investment.
While there are often a substantial number of sections provided in a fund prospectus, we’ll try to distill these into a smaller number of major categories of information. The information is also often not broken cleanly into the categories below and might take some research to make sure you’ve covered all the pertinent pieces of information. In the rest of this article, we’ll dig deeper into each of these major pieces of information offered in the prospectus. Besides being required by the United States Securities and Exchange commission for any public offering, the prospectus provides investors with details they can use to make an informed decision as to whether or not this specific investment is right for their goals and risk tolerance.
Company Overview and History
This section will provide information on the company/fund such as how and when the company was formed, who the founder(s) were, what the company has done in the past, a description of their strategy and approach to investing, and any future plans and/or expectations for growth. Also included may be information on the other funds offered by the firm and the financial performance of each.
The person or people managing the fund can play a large role in determining whether or not a particular fund is right for you and your objectives. The prospectus usually includes information on the entire hierarchy of management, including the board of trustees of the firm. For the people overseeing day-to-day management of the fund, information such as previous experience, previous firms, a detailed description of their roles and responsibilities, and any potential conflicts of interest that may arise between the managers and the operations of the fund.
A real estate fund is likely to use either debt or equity to raise funds. The prospectus should provide a breakdown of the current capital structure of the fund or the proposed capital structure if the fund is new. Understanding what types of securities are issued is an important consideration. If, for example, the fund is issuing debt, an investor will want to determine whether or not they believe the company can service the additional debt. If the issue is equity, investors will want to determine if additional shares will dilute the value of the company’s equity.
Use of Proceeds
How the firm plans to invest the funds raised is obviously a hugely important part of the investment consideration. The “Use of Proceeds” section lays out the firms’ objective and strategy in great detail. Objectives can span a wide range of possibilities, from a focus on current income to a focus on long-term growth.
The investment strategy portion of the prospectus provides much more information on the specific types of securities, locations, and asset allocations that will be used to meet the objectives of the fund. For larger funds, this can include many different types of potential investments and a description of the firms’ thought process surrounding investment in this particular asset type, along with any risk, tax, or legal considerations associated with each investment type.
The prospectus will outline the number of shares being offered or the number of shares outstanding (for existing funds), as well as any fees associated with the offering. Certain issues such as the use of leverage (common in real estate funds), methods of hedging with securities, or other topics related to the issuance of shares could be discussed in this section, as well.
Unless the offering is for a new fund, there will be a history of the financial performance of the fund. This will allow investors to get an idea of how the fund has performed in the past, what assets the fund currently holds, and any liabilities of the fund. With this information, investors can determine the performance of the fund during different phases of the market, the return of the fund compared to various other benchmarks such as the S&P 500, and whether or not the investor believes the strategy of the fund is appropriate for the current market.
Although there are risks involved with any investment, there are a few that are highly relevant when focusing a fund on a specific industry, such as real estate. The concentration of the investments in real estate related assets means the fund’s performance is closely tied to the performance of the real estate industry. Other risks that are common with real estate funds is market risk and property selection risk. Because any fund that invests in physical real estate must choose a market and specific properties, there are risks associated with the management team’s selection of markets and properties. In addition, if the fund obtains debt on properties that they acquire, there is a risk associated with maintaining the loans on property.
For funds that invest in real estate related securities, such as stocks and bonds, there is also the risk associated with the performance of the stock and bond market, apart from the performance of the real estate market.
The prospectus of a real estate fund is meant to provide a large amount of information on every aspect of the fund, the firm, and the structure of the investment offered. Large, established firms with multiple funds will have much more information available about the past performance of their funds and their managers, providing investors a decent history to rely on. One of the attractions of investing in a professionally managed fund is the experience and expertise of the management team, as well as the funds ability to diversify in ways that may be difficult for individual or smaller investors. Newer funds, however, may be much more difficult to vet. In any case, the strategy of the fund should be compared to the investors’ view of the future market and whether the markets, properties, securities, or other investments match that view.
About the Author
Josh Panknin is a Visiting Assistant Professor of Real Estate at New York University’s Schack Institute of Real Estate and an adjunct professor in the school of engineering at Columbia University. Prior to academics, Josh was Head of Credit Modeling and Analytics at Deutsche Bank’s secondary CMBS trading desk where he helped develop and implement automated models for valuing CMBS loans and bonds. He also spent time at the Ackman-Ziff Real Estate Group and in various other roles in research, acquisitions, and redevelopment. Josh has a master’s degree in finance from San Diego State University and a master’s degree in real estate finance from New York University’s Schack Institute of Real Estate.