Definitive Guide on Real Estate Private Equity Fund Structures and Taxes

Types of Private Equity Real Estate Fund Structures

Factors Impacting Real Estate Private Equity Fund Structure

When forming a private equity real estate fund, several factors influence the type of structure:

• Investment strategy and objectives
• Investor preferences and liquidity needs
• Tax considerations
• Risk tolerance and return expectations
• Market conditions and timing
• Fund size and scalability

Choosing the Right Real Estate Fund Structure

Understanding the nuances between each fund structure can help you make an informed decision. Examples of real estate private equity fund structures include:

• REITs
• Special purpose entities (property LLCs)
• Separate management company/GP
• Management company structure (LP vs. LLC vs. S-Corp)
• Corporate blockers
• Open-ended or closed-ended
• Joint Venture

REITs

Real Estate Investment Trusts (REITs) are a crucial consideration when constructing an equity or fixed-income portfolio. REITs own and manage income-producing commercial real estate, including properties or mortgages. They provide diversification, potential returns, and high-yield dividends.

REITs allow investors to diversify across property types without directly owning individual properties, and investors receive dividends directly and are taxed at their individual rates.

However, real estate cycles impact REIT performance (expansion, recession, recovery), so it’s important to be aware of where we’re at in a cycle when choosing this structure.

Special Purpose Entities (SPEs)

Special Purpose Entities (SPEs), or property LLCs, are separate legal entities created for specific purposes, such as isolating assets or financial activities from a parent company. SPEs are commonly used in finance, real estate, and project development. They mitigate risks and protect the parent company.

SPEs protect other fund assets from risks associated with a single property and clearly defines ownership for investors. Some challenges include managing multiple LLCs additional expenses for each separate entity.

Separate Management Company/General Partner

A management company is an operating entity employing investment professionals responsible for allocating capital and managing investments, including handling day-to-day operations, evaluating opportunities, and managing portfolios across multiple funds. The general partner of the fund (GP) is the legal entity with authority to make fund decisions. It assumes legal liability and enters into a management agreement with the management company.

This separation allows management fees to be structured tax-efficiently.

Management Company Structure

There are three options for management company structures:

• Limited Partnership (LP): Commonly used for management companies. LPs offer tax benefits and are used in joint ventures and investment structures.
• Limited Liability Company (LLC): Similar to an LP but with no liability for a GP
• S-Corp: Less common in real estate but can be used for management companies. Offers pass-through tax benefits but are limited in the number and type of shareholders.

Choosing the right fit will mean looking at the tax implications for each and investor preferences.

Corporate Blockers

Corporate blockers are entities (often C-Corps) that shield investors from certain tax liabilities. They are often used in complex structures and by using them, investors can legally reduce their tax liabilities, which can have a significant impact on overall investment returns. They can also help attract institutional investors, particularly foreign investors. However, managing additional entities can lead to administrative complexities.

Open-Ended or Closed-Ended Funds

Closed-end funds, on the other hand, are more appropriate when investing in assets with long hold periods and interests are not easily transferable. Most real estate funds are closed-end funds. They typically have a specific term with the option to extend under certain circumstances. Investors are typically not allowed to withdraw or contribute additional capital during the life of the fund and receive a redistribution of capital when assets are sold or some other kind of capital event occurs, such as a refinancing.

Joint Venture

This structure unlocks a larger, more reliable pool of capital for deal execution. Leveraging fund equity with a single credit facility eliminates the need for deal-by-deal financing, streamlining the process. It also grants a longer investment horizon and inherent diversification due to the pooled nature of the fund. This translates to the ability to tackle larger, more complex, and higher-quality projects.

Choosing the right real estate fund structure involves balancing legal, tax, and operational considerations; as noted above, each structure has its advantages and trade-offs.