Written By: Paul J. Foley

Wall Esleeck Babcock LLP

Wintston-Salem, NC

     As we are all well aware, real estate is in a slump. With owners fighting off foreclosure, banks in need of liquidity, and loans becoming more difficult to obtain—cash is king in today’s real estate market. Deals that were unheard of just a few years ago are available for those who can bring cash to the closing table. Unfortunately, after taking a severe financial hit from the real estate slump and with the more stringent lending standards, many with the necessary real estate knowledge, expertise, and experience are unable to access the cash necessary to take advantage of the opportunities that they believe are currently available. At the same time, a large number of potential investors are uncertain about the future and sitting on the sidelines waiting for the right investment opportunity. Local real estate funds have become an increasingly popular way for real estate professionals to access needed cash while providing investors with investment opportunities that real estate professionals previously would have saved for themselves.

     For potential investors, local real estate funds can provide a number of advantages. First, real estate funds provide investors with professional management of their investments. Depending on a fund manager’s background, investors may have access to a real estate professional that never would have accepted outside money before. Second, many real estate funds invest in a specific geographic area. Depending a fund’s investment strategy, it may be easier for a potential investor to understand the risks and potential rewards of a real estate fund that invests locally. Third, the pooling of investors’ money allows many real estate funds to diversify their holdings in a way that investors might not be able to do on their own. Many real estate funds invest in multiple properties, allowing investor risk to be spread over multiple projects. Fourth, fund managers’ incentives are aligned with investors because fund managers are typically paid through a performance fee and do not make a significant amount of money unless the fund is profitable for its investors. Performance fees have come under fire in the hedge fund context because some believe they encourage unrestrained and speculative risk taking. Unlike hedge funds, most real estate funds invest in tangible assets, such as buildings and land, the value of which does not typically fluctuate significantly from day to day. Finally, investing in a real estate fund may help increase the efficient allocation of capital in an investor’s community. A situation in which potential investors are hoarding cash, while those with real estate expertise are sitting idle, is not a recipe for economic progress.

     Local real estate funds also have some disadvantages. First, there is always a risk that an investor will lose some or all of their investment. This is true of any investment and potential investors should review the offering materials of a particular fund to better understand the specific risks. Second, because real estate is an illiquid asset class, real estate funds often do not provide investors with a significant amount of liquidity. Potential fund investors should be prepared for their investment in a real estate fund not to be returned for a number of years. Third, investors typically bear the legal and other start-up costs for a fund before any of their money is actually invested. An ownership interest in a local real estate fund is almost always a privately offered security that is subject to federal and state securities laws and it is, therefore, imperative for both the fund manager and fund investors that the fund complies with all applicable laws, which can be a somewhat expensive process. Fourth, as with most privately offered securities, only “accredited investors” who meet certain net worth or income requirements are typically permitted to invest in real estate funds. Real estate funds often have high minimum investment requirements. Further, it probably is not advisable for an individual to invest a large portion of their net worth in a real estate fund or for a fund manager to accept such an investment, so the net worth and income requirements rarely come into play.

     While no one has a crystal ball, it is not difficult to understand why an increasing number of real estate professionals who have the right experience and ideas have been able to successfully establish real estate funds and find eager investors.

Paul J. Foley is an attorney at Wall Esleeck Babcock LLP in Winston-Salem, NC, where his practice includes the representation of real estate funds.

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