Let’s explore a question that comes up quite a bit: When it comes to commercial real estate, why is the “fund” model a better choice than owning properties directly? We’ll look to a few key differences so we can help clear this up and better define the opportunities that come with the fund model.
First, some definitions. When we refer to “direct property ownership” in this article, we’re referring to properties (typically single family homes) that individuals choose to purchase and rent out as a way to produce cash flow and own real estate that is likely to increase in value over time. When we refer to investing in the “fund” model, we’re referring to what some are now calling “passive investing,” which is when individuals lend on projects and become limited partners with commercial real estate operating companies.
Now that the scene has been painted, let’s look more closely at some of the pros and cons in some key areas of each method of investing in real estate.
Familiarity
Choosing to own real estate property as an investment is likely not new, since most people in a position to do so have already purchased property at least once (their homes). Because of their home-buying experience, they are somewhat familiar with the purchasing process and understand where things can go wrong (and they are comfortable mitigating risks and addressing obstacles themselves). However, when it comes to purchasing a larger-scale commercial property and operating it successfully, most have little to no personal experience. Commercial real estate deals require a level of specialization (and large sums of money). There’s a higher barrier to entry when it comes to commercial real estate deals. While it’s certainly possible to outright own commercial real estate, each deal operates more as a business than an investment. If an individual is not ready to assemble and manage their own team of experts and put at risk a substantial amount of money, they likely are not ready to embark on direct ownership in the commercial market.
Clogged Toilets, Late Rent, Leaky Faucets
When an individual is the direct owner of a property, they’re directly responsible for the tenants’ needs. They can hire help in the form of property managers to handle the day-to-day calls and needs, but they’re still ultimately responsible for their tenants needs. Should anything go wrong, the tenants are calling on them (in extreme cases, maybe calling on them with a lawsuit).
Diversification
If an individual is choosing to directly own property, they’re likely to only have success purchasing (and operating) property-types with which they’re most familiar–in most cases, this means single-family homes. Also, most direct owners prefer to keep close the properties they own and manage, which keeps their options limited to the area in which they personally live. With the fund model, individuals have far more options, increasing their diversification. They’re gaining access to a real estate investment company with expertise in a variety of property-types. Not to mention, they’re more able to access options in diverse locations by using a fund.
Depending on the structure, some funds can offer further diversification by bringing together loans on multiple properties covering multiple property types in multiple locations. In a scenario like this, an individual experiences more diversity and protection not available with direct ownership of a single property.
Lend Like the Pros by Lending with Pros
When lending on a fund with a real estate investing company, individuals are co-lending with the professionals who have proven track records with similar projects. This helps limit a number of risks because they can rely on a group of veterans who have successfully navigated numerous deals and learned from their experiences. If an individual decides to go the direct-ownership route, they’re likely relying on only themselves and whomever else they might have brought in on the deal.
Lend “Passively” or Run a Business?
When an individual directly owns an investment property, the rosy scenario is that they purchase the property, a tenant moves in, pays them monthly and nothing ever goes wrong with the property. However, in reality, there are countless obstacles to funding and closing the deal, gaining access to the grounds, inspections, marketing to tenants, negotiating terms, costly repairs and so on. What was supposed to be a passive source of income quickly becomes their full-time business and they have to manage it. With a fund, on the other hand, they’re able to rely on a team to handle all of the tasks and their time is not wasted in the trenches … their able to lend passively, not get themselves into actively running another business.
While direct ownership certainly has its place (and likely has its place in many portfolios), lending on a fund brings added diversity and can help individuals make better use of their time (and money). Also, an individual’s capacity for direct-ownership is limited (because of their time, resources and locale), while lending as part of a fund does not.
Please note this article is for internal use and not to be shared with non-qualified individuals. Lastly, this article is not an offering or the solicitation of an offer to purchase an interest in any investment vehicle. Any such offer or solicitation will only be made to qualified investors by means of an offering memorandum and only in those jurisdictions where permitted by law. The target returns set forth within all Resolute Capital Partners offerings may not be realized; actual results may differ materially from the stated goals. Prior to investing, investors must receive a prospectus, which contains important information regarding the investment objectives, risks, fees, and expenses of any funds and/or other investment opportunities. Past performance is no guarantee of future results. All investments involve risk, including the loss of principal.