Joint Venture vs. Fund Partnership: A New Real Estate Fund Manager's Dilemma

The joint venture structure for real estate investments has many positive attributes. It allows you to leverage discreet expertise among a small partnership group, share risks and resources, and accomplish a specific investment goal more quickly and simply than a tradition real estate fund. One might ask, however: why utilize a real estate fund structure, and what critical issues does a new fund manager need to consider? 

Real Estate Fund Structure Benefits 

The real estate fund structure provides immediate access to a larger, more secure capital base for deal execution. It also allows you to leverage fund structure equity with one credit facility rather than obtain deal-specific financing. Furthermore, it provides a longer investment horizon and risk and strategy diversification. Finally, you can invest in larger projects of higher complexity and quality. 

Fund Manager Considerations 

Fundraising and Marketing  

Raising fund capital requires a different strategy because investors who align with the fund’s investment strategy are generally more passive than a joint venture partner who contributes capital and some form of active investment management. The manager must examine various institutional, high-net-worth foreign and pension-based funding sources.  

Representatives of sophisticated funding sources will be highly critical and exhaustive in their diligence of a new manager, especially considering the lack of historical performance metrics. Managers might utilize placement agents to augment their existing network. 

Foreign-Sourced Investment Limitations and Issues  

Governmental restrictions (e.g., OFAC) help maintain compliance with blocked entities, countries, and individuals. There are also a variety of securities laws pertaining to foreign investors. Foreign investors can present tax consequences to both the fund and the investors. The cost of a structure to support foreign investors must be weighed against the benefits derived. Violations of the rules and regulations can be substantial, so it is best to consult with qualified legal counsel. 

SEC and State Registration  

Investment managers with over $100 million in assets under management (AUM) typically must register as a Registered Investment Advisor with the SEC. Investment managers may be required to register if they:

• Have a principal office and place of business in NY and $25 million or more AUM. 
• Are registered under the Investment Company Act of 1940, regardless of AUM.
• Are required to be registered in 15 or more states, regardless of AUM. 
• Are internet-only advisors, regardless of AUM. 

Deal Pipeline Management  

Managing multiple deals with varying criteria requires the manager to have a properly balanced team with expertise across the portfolio. 

Cross-Collateralization Risk 

The use of a fund-level credit facility normally requires the cross-collateralization of investments. 

 Cash Management 

Investors want capital deployed quickly. Thus, cash management becomes extremely important as the fund manager allocates cash balances to sources and uses. Poor cash management can disastrously affect fund performance and the promotional returns to the manager looking to raise future platforms. 

 Increasingly Complex Reporting Requirements 

Institutional investors have more detailed reporting requirements, and the timeliness and quality of data are critical to retaining and growing the investor base. Organizations such as the Institutional Limited Partners Association work to increase industry standardization and the ability to meet reporting requirements. 

Manager Liability and Risk Management 

The manager is exposed to various risks. Therefore, they should consult with risk management professionals to implement the proper insurance coverage, such as directors and officers, errors and omissions, and cybersecurity insurance. 

Back Office Infrastructure and Scalability  

The composition of a fund’s investment portfolio and the timing of its implementation pressure the manager to balance infrastructure costs with its fee base and operating agreement expense provisions. Funds are increasingly outsourcing key functions—such as accounting and investor reporting—giving the manager a greater level of internal control, cost efficiency, and flexibility while allowing them to focus on meeting the investors’ goals. 

Tailoring Your Investment Approach to Your Goals  

Switching from a joint investment to a fund platform provides tremendous benefits, not to mention challenges. Fund managers should leverage the expertise of their trusted financial advisors, fund administrators, and legal counsel to position themselves for success.