As physicians, we’ve studied all sorts of life cycles throughout our education – from plants to animals to the complex life cycle of humans, from embryology through maturation.
Well, many investments that you might be involved in also have life cycles. It’s important to have a good grasp of them in order to really understand your investments.
Real estate funds are one type of investment that can be difficult to understand. I’ve talked about them recently, and, in fact, the most recent large investment I’ve made has been with one.
Honestly, I didn’t know very much about real estate funds the first time I invested in one. Now I feel much more educated and can better follow along with the investment and understand what’s happening with it. I just want to share with you what I've learned.
Open-End or Closed-End Fund
First, it’s important to recognize whether the real estate fund has an open or closed-end structure.
An open-end structure allows investors to enter and exit the funds throughout the life of the fund at regular intervals determined by the sponsors. However, because the assets in the funds (the properties) are relatively illiquid, the logistics of an open-ended fund are quite complicated.
However, closed-end real estate funds require all investors to join within a certain time frame. Then it is closed to any new investment period and, for the most part, any exits until the fund runs its whole cycle. Since this is the most common type of real estate fund that I get asked about, for the rest of the post, I'll be talking about a closed-end fund.
The Life Cycle of a Real Estate Fund
Here are the major periods in the life cycle of a fund:
- Marketing Period
- Investment or Acquisition Period
- Post-Investment or Divestment Period
- End of Fund
Every real estate fund begins with raising money. At this point, there are no assets in the fund, meaning no properties have been purchased. The fund sponsors or operators will raise money from investors based on a track record, an investment philosophy, as well as terms (the length of the investment, types of returns, fees, and rules regulating how the sponsor can act, etc.).
Funds are typically marketed and named as fund numbers or descriptions. For example, MLG Capital (a sponsor of this site) recently began the marketing period for Fund IV, having closed their previous fund (Fund III) last month. [To make sense of it all, I’ll be using MLG Capital as an example in this post quite a bit.]
Fund sponsors will reach out to investors in order to try and meet a target capital raise. A target can be in the low millions to $200-250 million in the case of MLG Fund IV. At times, these funds might be trying to raise billions. When they’re going for billions, they’re often chasing institutional money, not high net-worth individuals. Otherwise, imagine how many investors they’d have to put together at $50k or $100k minimums to reach their target raise.
I've seen this marketing and capital raising period last from 6 months to 3 years, and it can be highly variable depending on the sponsor and the amount of capital they're trying to raise.
Investment or Acquisition Period
During the investment or acquisition period, the fund starts putting capital to use and acquiring properties, meaning they start hunting for properties and buying them. This period of acquisitions is usually for a predetermined amount of time. For example, MLG Fund IV can purchase properties over a six and half year period.
However, acquisitions can be made as early as month two or three, as it looks like will be the case for this particular fund. What's nice about investing in a fund at the beginning of the life cycle is that it's possible to have your capital “working” sooner. Investors who have committed money typically prefer the investment period to begin as soon as possible because it means they’ll start seeing returns sooner.
Raising capital typically goes on for a few years, and so there is usually some overlap between the marketing period and the investment period. During this whole time, the fund managers are actively seeking new deals and investment opportunities for the fund and calling upon capital that has been pledged by investors.
Typically, investors pledge a certain amount and provide an initial deposit (5-10%). The remaining funds are requested when needed to acquire a property. This process is termed a “capital call.”
As an example, I committed to investing $50,000 in MLG’s Fund III on August 15, 2018. My deposit of 10% ($5,000) was wired in by August 17th. This week (a little over 2 months later), I received my capital call, and they asked for the remainder of the funds ($45,000) to be sent within two weeks. Once the funds are sent, I will be considered fully vested in the fund and my preferred returns will start accruing, meaning my money will start to work at the 8% preferred returns according to the terms.
You only receive a return based on the capital you’ve actually invested, so if you've made the commitment to invest, you want your capital working as soon as possible.
Post-Investment or Divestment Period
The post-investment or divestment period is a predetermined time after which the fund can no longer acquire properties and can only think about selling the assets. This is considered the back half of the fund where they're trying to figure out when the best time is to sell the remainder of their properties.
It’s possible that assets may also be sold during the investment period so these periods could overlap.
For example, a typically targeted hold for any properties purchased by the fund is three to seven years. So it’s possible that a fund might buy a property in year one and sell it off in year four. They can continue to purchase through year 6, so there is some overlap.
To recap, no new investments are made during this period. The focus is on the operation and, ultimately, disposal or sale of the property. Their hope is that they’ve purchased these assets, improved them through better operation and management, and will be able to sell them for a considerable profit, which will be split with investors.
Who decides when to sell? Well, the fund does, when it hits certain objectives and goals. And to be clear, when these properties are sold, distributions and profits are returned to you at that time.
End of Fund
The End of Fund marks the time when all properties are sold and all distributions are returned to investors and sponsors. At this point, you’ll be able to ascertain total returns, calculate your IRR and Equity Multiple, and know how well they did according to their projections.
All that’s left now is to decide what to do with your final returns. Throughout the fund’s life cycle, you will have received a good portion of your distributions and will have had to decide whether to reinvest or enjoy the earnings.
Understanding the life cycle of real estate funds is crucial for knowing where you stand as an investor. Sure, investing in a real estate fund is an extremely passive way of investing in real estate. You could just invest and wait for distributions to hit your bank account, but it’s nice to understand a little bit more about what you’re investing in.
The decisions made in each period can make or break a fund, so it’s really important to understand the sponsor or operator as well. This is why I spend so much time vetting sponsors. Considering where we are in the overall real estate market cycle, I plan on investing only with the most experienced of operators – those who have been through multiple up-and-down cycles and know how to play this market.
I don’t know about you, but I’m fascinated by real estate funds. Again, they’re all relatively new to me and the more I read, invest, and ask questions, the more I learn. I know many readers have questions as well, so I’ve set up a webinar to have some of those questions answered by a fund expert and sponsor of this site, MLG Capital. I’ve asked them to talk about the new fund they’ve launched, provide some more information, and, most importantly, give readers the chance to ask questions.
The webinar will be scheduled soon, however, in the meanwhile I'd like for readers to submit questions to ask them. If you have any questions you'd like to ask about a real estate fund, feel free to comment below or email us [email protected] and we'll try to get it answered on the webinar. It will also be recorded so you can watch it on replay anytime you'd like.