The Capital Stack
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The Capital Stack Letter #78

The Capital Stack Letter #78

Fund Structure vs Syndication Part I 🏠

June 24, 2023

The Capital Stack

Comparing Funds and Syndication

Real estate deals are funded in a multitude of ways. Companies like ours will typically operate with a fund or raise capital on a deal-by-deal basis (syndication). This week’s newsletter will review the pros and cons of the fund model and next week we will dig into the syndication model.The Fund ModelA real estate fund is a pooled investment vehicle that allows multiple investors to contribute capital, which is then managed by a general partner (GP) or fund manager. The GP is responsible for identifying and acquiring multifamily properties on behalf of the fund. In most cases, the properties are not identified at the time of the capital raise. The GP or Fund manager will pitch investors using the fund's defined investment strategy, once the money is pooled together the fund manager will deploy the capital. Each fund will have a unique investment strategy which will include the targeted asset class, location, and returns.

Pros

Diversification among multiple assets
- A fund can buy an unlimited number of properties, each investor has a small interest in each of the properties, rather than just one specific asset. If one deal goes well, it will increase the total portfolio return.
All funds upfront
- The sponsor or GP can show brokers, sellers, and banks proof of funds which adds a significant amount of credibility making it easier to get offers accepted and easier to obtain debt for the property.
Economy of scale
- Legal docs for a simple fund will typically range from $15,000-$25,000. At a partnership level this same set of docs will be all that’s needed to transact on any of the properties the fund purchases. Unlike the syndication model which requires new legal documents when each property is purchased.
Asset Management Fees
- Although subject to variation, typically involves a sponsor charging a yearly fee of 2% on the equity. This fee structure provides the sponsor with a consistent source of income and reduces their reliance on deal specific fee earnings.
Lock up Period
- A fund will typically have a 5-10 year investment period. During this time, all the funds are invested in real estate and are illiquid. This lockup period allows for the LP to allocate money for a longer term and not have to continually seek investment opportunities. Because the capital can’t be fully returned until the fund is completely liquidated, the money earns a return throughout the entire period. On the other hand, with a deal-by-deal scenario, as soon as the deal is sold, the LP needs to seek out another investment to continue compounding the return on their equity.

Cons

Diversification
- If one deal goes badly, it can sour the entire portfolio of investments.
All funds upfront
- With a preferred return structure, the sponsor is under pressure to deploy capital sooner, which can impact their discipline when it comes to selecting investments. Any “dry powder” sitting in an account not earning a return is cutting into the sponsor's promote, which decreases the amount they’ll make on the investments.
Lock up period
- A fund will typically have a 5–10-year investment period. During this time, all of the funds are invested into real estate and illiquid. The fund sponsor earns an asset management fee of typically 2% on invested capital, so they are incentivized NOT to return capital early. Alternatively, In a deal-by-deal scenario, the sponsor typically earns the bulk of their income on the sale so they are incentivized to complete the business plan very quickly and return all original investor capital allowing them to earn the promote. In a fund structure, when one property is sold, it’s not enough to return all the original capital so investors will have to wait for the fund to be fully liquidated before realizing their full gain. *Many investment groups prefer this as they won’t have to be seeking new investments in the shorter term*

Overall, the choice between a real estate fund or syndication depends on individual preferences and investment goals. A fund structure offers diversification, credibility, the economy of scale, and a longer-term investment approach, but it can also pose risks if a deal underperforms or if sponsors face pressure to deploy capital quickly. Conversely, syndications which we will review in detail next week allow for more control and flexibility on a deal-by-deal basis but requires a continuous search for new investments.

Major Market News

Blackstone Real Estate fund

The article from Reuters (April 11, 2023) reports that Blackstone, a renowned global investment firm, has successfully raised $30.4 billion for its latest real estate fund. The fund, known as Blackstone Real Estate Partners X, exceeded its initial target of $25 billion, indicating strong investor interest. Blackstone's Real Estate Partners X fund aims to invest in various real estate sectors, including multifamily properties. The fund is expected to leverage Blackstone's expertise in identifying value-add opportunities and generating attractive returns for its investors. Real estate funds like the one raised by Blackstone offer investors an opportunity to gain exposure to a diversified portfolio of properties, benefiting from economies of scale.Source: Reuters. Blackstone raises $30,4 billion for latest real estate fund. https://www.reuters.com/business/finance/blackstone-raises-304-bln-latest-real-estate-fund-2023-04-11/

Tips and Tricks

Terms-

Syndication (Deal-by-Deal):

Syndication refers to the process of raising capital on a deal-by-deal basis. In this structure, a sponsor (also known as the syndicator or lead investor) identifies a specific multifamily property opportunity and raises funds from individual investors for that particular deal. We will take a closer look at the pros and cons in next week's newsletter.

Promote:

The promote refers to the portion of profits that the general partner (GP) receives from an investment. In a typical structure where there is an 8% preferred return and an 80/20 split thereafter, the 20% represents the promote. This incentivizes GPs to surpass the preferred return because they earn a share of all profits beyond that threshold. The more they exceed the preferred return, the higher their earnings.

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