How to Start a Real Estate Investment Fund: The 5 Questions You Need to Ask

As real estate syndication attorneys, we get asked a lot of questions about getting started in the business. We know there can be a lot of apprehension when it comes to getting started in such a high stakes game, but we want you to know that you can certainly grow your real estate investment into a full scale business.

“Should I buy a house or an investment property?” That’s a question a lot of us receive from some of our younger friends, family members, and colleagues who are working to build their savings foundation. They may have limited cash flow and wonder how they can get started in investing in property despite minimal funds. You can get into real estate investing with less money than you may have thought! We’ve got some answers to some of the typical questions for all those aspiring empire builders who want to scale up their real estate investment business and start a real estate investment company.

Section 3(a)(11) of the Securities Act is generally known as the “intrastate offering exemption.” This exemption seeks to facilitate the financing of local business operations. It’s a great way to  avoid SEC registration if you can qualify for this safe harbor provision, and that’s exactly what a real estate syndication attorney can help you do. Remember, the SEC is your friend. You just need to know how to work with them to protect yourself!

1. What Securities Exemption Should Your Fund Use?

A securities exemption for a fund refers to the exemption granted by a regulatory body that allows a fund to offer and sell securities without having to register with the Securities and Exchange Commission (SEC) under the Securities Act of 1933. The exemption is typically granted to funds that meet certain criteria, such as having a limited number of investors or only offering securities to accredited investors. 

This regulation is intended to provide some flexibility and cost savings for smaller funds that may not have the resources to comply with the SEC registration requirements. However, it is important to note that funds operating under a securities exemption are still subject to certain regulatory requirements, such as providing disclosure documents to investors and complying with anti-fraud provisions.

Typically when working with a real estate syndication deal, we tend to use a 506(b) or 506(c) exemption, but when working within a fund structure, there are a lot more options. On example is Reg A, which operates under two different options: tier 1 and tier 2. Both tiers require the issuer to file an offering statement on Form 1-A with the SEC. 

This statement includes the offering circular, which is a vital document for investors. Investors must be provided with the offering circular or information on how to access it. Now, here's the catch - an issuer can only accept payment for the sale of securities after its offering statement is qualified by the SEC's staff.

If that all sounded a little confusing, you’re not alone! If you’re serious about your real estate investment fund, you should definitely seek some advice and guidance to make sure you take advantage of the exemptions available to you. Open your horizons when it comes to exemptions with a fund as opposed to a project-specific syndication exemption!


2. How Will You Accept Initial Capital Contributions?

Deciding the kind of commitment you’re willing to accept for your fund is critical for how you are going to move forward. Are you going to require full capital contributions up front, require a small deposit with future capital calls, or some other capital commitment structure? We would suggest you look for investors who are asking you the right questions to make serious commitments to your real estate investment. When you’re thinking about how to start a real estate investment fund, you’ll need to get clear on what kind of investors are going to be the best for your business goals.


3.  How Long Will Your Fund Last?

Will it be a five year fund? Seven year fund? Ten year fund? These types of funds are more project based, begin when assets are acquired and end when all the assets are disposed of. These closed-end funds are relatively straightforward to set up and manage. However, evergreen funds allow investors to come and go and they can be a little more complicated to manage.  The Private Placement Memorandum (PPM) and other offering documents must be regularly updated to ensure material changes are communicated to investors so as not to violate the anti-fraud provisions of the Securities Act of 1933 and maintain compliance with applicable securities exemptions. We recommend, at a minimum, an annual update to all documentation. 

One specific challenge of evergreen funds is valuation.How are shares in your fund going to be priced today versus in 1 year from now? How do profits get distributed? Does everyone get a flat rate of return regardless of when they joined the fund? How do investors exit the fund? How are their shares valued when they exit? These are questions you’ll want to think about and be sure you can explain to investors. 

While there are many ways to value shares in a fund, typically share prices change based on net asset values (NAV). As the value goes up, then the price of a share in the fund will go up as well. You’ll have to explain this when discussing pricing with potential new investors who may be aware of potentially lower buy-in rates in years prior. Be sure you understand how to explain why the value and therefore the price rose. Update your financials and be sure you understand them!


4. How Will You Raise the Capital?

Are you going to raise your capital up front, or over time? You may be able to raise enough money to buy your first property and then use that property to fund future asset acquisitions. Of course then you’ll also have to consider what the price is for future investors and may need to provide audited financials if accepting non-accredited investors once the fund has operating history. 

Ideally, you’d raise all your fund money in the first quarter of your deal and have deals lined up to deploy capital into. That keeps things simple. You don’t have to worry about evaluations or audited financial statements. Try to get that money at the beginning! That begs the question,  how will you accept the initial capital contributions? We suggest you take an initial 10% or 20% deposit to ensure your investors’ actual buy-in to your deal. You prepare the paperwork ahead of time, accept the deposit, and then when you require the pledged money via a capital call, the investor must face the possibility of a penalty if they don’t follow through on their initial investment commitment to offset any additional burden on the fund to raise additional capital from new investors to makeup any shortfalls on reneged commitments.


5. What is Your Exit Strategy?

Your exit strategy is how you plan to make a return on your property investment. In other words, it’s the end goal. Establishing your exit strategy from the start can help you plan for your financial future.


First, how will investors exit? If you have a decade-long or evergreen fund, you may want to allow withdrawal windows for investors that want to get out of the deal. This isn’t strictly necessary, but can be a factor that attracts investors. Typically we suggest you have one single window annually that allows investors to get out with notice of withdrawal. 

You’ll also want to cap the amount of withdrawals to a percentage of the funding to ensure you can continue to maintain your assets. We also suggest building some lead time between initial fund operations  and when the redemption option can be exercised to ensure the fund has sufficient time to stabilize and can stay afloat during any redemption windows!


Then, how will you exit the property once your fund comes to an end? There are a few strategies that are common, with some being more popular than others. First is buy & hold, which is when your fixed-term fund lasts for a set period of time and you keep the property for that amount of time then sell when the time is up. This strategy is great because it’s a simple investment life-cycle that is typically easy to explain to investors, but it usually does involve your investors’ capital being tied up in the fund for quite some time.

Another exit strategy is a 1031 exchange. This is a tax-deferred exchange on investment in one property for investment in another. This allows you to avoid paying capital gains taxes on the property sale, but it also means you have to find another property of equal or higher value within a specific time period which can be a challenge at times depending on the market. This also comes with many other limitations and risks which must be clearly communicated to investors. 

You can also choose to refinance your property to refresh the investment. This can help you to pay off any debt and free up cash to improve your property thus increasing its value. You may also be able to get lower interest rates. Other exit options include selling directly to another investor, selling to an owner-occupant, or adding more investors. 

In any case, we always recommend you work with a trusted attorney before you begin your real estate adventure! Setting up a fund can be really exciting and of course profitable, but you want to be sure you know what you’re doing and have the right team to guide you through the process. 


Are you ready to set up your real estate investment fund? Schedule your FREE discovery call now and learn what would be the best way for YOU to start building your real estate empire!


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