A time-tested maxim of investing is that a smart investor is one who seeks to diversify their portfolio. And while this strategy is often associated with the ongoing selection of stocks and bonds, it is equally relevant to commercial real estate investing. Investors can build a diversified commercial real estate portfolio one deal at a time, investing in a variety of asset classes, geographies, risk profiles, and more.
But there is another way to diversify one’s commercial real estate investments–by investing in a fund.
What are the advantages of investing in a fund?
Instant diversification: First and foremost, funds allow for portfolio diversification, which is an excellent way to mitigate risk. Think of the old adage, “Don’t put all your eggs in one basket.” An investment in an individual asset either performs well or it underperforms–there is a binary outcome. Funds, on the other hand, spread the risk of underperformance across several investments. Even if one project underperforms, it’s likely you’ll have others that are performing well to help offset losses from any underperforming projects..
Diversify with less: Most commercial real estate deals on CrowdStreet’s Marketplace have a $25k investment minimum. If you wanted to diversify your portfolio with ten different individual investments, you’d ultimately invest $250,000. Conversely, a ten-asset fund, meaning you’ll get a piece of ten different deals, still has the same $25k minimum. Funds are a way to do more with less.
Mitigate overexposure: Funds are one way to participate in unique business plans while mitigating your overexposure to individual assets (e.g. mobile home parks, self-storage, etc). It’s important to note that you, as an investor, have no say in which individual assets the fund ultimately invests. This decision is left up to the sponsor.
The sponsor’s buying power: The fund’s structure can enable experienced sponsors to move quickly and acquire assets at great prices when they become available. When selling or purchasing a property, sellers like to take as close to a guarantee as they can get. Backed by the potential promise of a quick close, funds often command greater bargaining power with sellers. A lower purchase price may help increase potential returns.
More time: Funds rarely oversubscribe as they often target very large capital raise amounts. Usually, there’s a better chance of getting into the fund (less risk of oversubscription) and this “slow burn” gives you the luxury of extra time to conduct your own due diligence and determine if that fund is a valuable addition to your portfolio.
With funds, it’s a little bit of “the more the merrier.” The more capital committed the more assets that can be acquired by the fund. Ultimately, the more assets, the greater the diversification, and presumably, the lower the risk to investors.
What do investors need to know about investing in a fund?
Here are a few things you should consider when evaluating a fund and comparing it to other commercial real estate investment opportunities:
- The fund’s investment strategy: How is the sponsor planning to allocate capital across property types and investment profiles? How many properties is the fund targeting? This will help you understand how diversified the fund may end up being.
- What is the fund’s timeline for deploying capital, meaning actually placing investor dollars into the first investment/property? Some funds might hold onto your investment for several weeks, even months, as they look for the right assets to include. Some funds might already own several assets and may allow new investors to participate in returns originating from those properties under certain conditions.
- What will be the average Loan-to-Value across projects within the fund? Loan-to-Value (LTV) is calculated by dividing the project’s loan amount by its appraised or expected market value, that is one indicator of the asset’s risk. The lower the ratio, the lower the risk.
- What are the fees associated with the acquisition of assets, management of the fund, or deployment of capital?
- When and how frequently will the fund issue distributions?
- Does the sponsor have a solid track record?
Sponsorship is arguably the most important criteria in evaluating funds. Fund investors write a check, trusting that the sponsor will make sound investment decisions when choosing projects for the fund, as compared to an individual asset deal where you have the opportunity to review both the sponsor and the deal prior to investing.
Generally, funds are well suited for investors looking for the greatest amount of diversification while committing the least amount of capital. Ultimately, a fund’s performance is largely dependent upon the sponsor’s investment thesis and the ability to execute its business plan.
Interested in investing in a fund? View currently available funds on the CrowdStreet Marketplace here.
