Targeting real estate fund investors

ARTICLE | February 29, 2024

Authored by RSM US LLP

In a fiercely competitive market, fundraising remains challenging across all fund sizes and strategies—from newly formed firms to longer-tenured organizations.

Tighter lending conditions and stress on liquidity resulting from rapid interest rate hikes put the brakes on dealmaking, leading to longer fundraising cycles. In some instances, the capital-raising environment has prompted some managers to close their funds sooner than expected. Although investors are becoming more cautious about allocating their funds, there is still light at the end of the tunnel for new managers.

A win-win situation: Founder investors and liquidity

One of the most common ways emerging fund managers can attract potential investors is by offering favorable economics. Providing attractive terms to investors is an excellent way for fund managers to secure capital in the earlier stages of fundraising. Offering a discount on advisory or management fees to committed investors (i.e., founder investors) can help tip the scales. Another approach gaining traction is to provide liquidity to investors.

While listing the discounts you provide is a clever strategy, it’s worth noting that the Securities and Exchange Commission recently released several?? new regulations surrounding marketing efforts to new investors. Fund managers need a team of legal and accounting experts to advise them on navigating these rules and disclosure policies.

Articulating your fund’s unique selling proposition

Often, emerging real estate fund managers typically focus on their network (family and close friends) to initially raise capital. As managers expand beyond their network and get outside their comfort zone, articulating the firm’s value proposition will become more necessary for marketing your fund. As fund managers look to bring in more sophisticated investors, they should prepare a professional and established pitch deck to advertise the fund and help it stand out.

Focus on your target investors’ preferences and tax structuring

As you begin to market your real estate fund to potential investors, it’s crucial to consider the investors' perspectives, strategies and goals because they will likely have different preferences regarding how your fund is structured.

Scott Helberg, a partner and real estate senior analyst for RSM US LLP, says, “You can have a sophisticated structure that is ultra-flexible and able to accommodate every single type of investor, ??but it requires more complex tax filings.”

Alternatively, you can have a more basic structure that will equal lower compliance costs. Still, it may not be the best selection if you intend on bringing in institutional capital. For example, large, tax-exempt institutional-type pension funds may require a real estate investment trust (REIT) in their structure. REITs come with a fair amount of additional compliance costs (not including the tax return), plus they have their own rules and quarterly compliance items.

Practicing the art of patience in a sluggish fundraising environment

We can all agree that it’s been particularly challenging for emerging managers to raise capital because investors are looking for firms with established track records or managers with whom they have a preexisting relationship. However, the fundraising cycle is taking longer, even for more prominent fund managers. Gerdes says, “In some instances, we’re seeing funds take upward of 18 months to close.” Due to the decrease in volume and activity, it has become competitive to secure capital. Fund managers can differentiate themselves by leveraging technology, focusing on investor transparency and highlighting their track record to show their ability to execute.

Mitigate investor concerns with consistent cash flow

For emerging managers in the second or third round of funding, it is beneficial to demonstrate the ability to produce long-term sustained cash flow. Investors, lenders and managers are focused on investment portfolios with sufficient cash flows to cover higher borrowing costs and operating costs, such as labor and insurance, while the exit market resets itself. As a fund manager, showcasing your long-term operational management of investments is a unique way to demonstrate your capabilities to new potential investors. Offering evergreen funds with no fixed end date, for example, stands out as an excellent avenue to address near-term liquidity constraints and value compression.

The takeaway

Emerging managers navigating an unpredictable financial market must maintain flexibility in their investment strategies. When narrowing down your target audience, take time to reflect on compliance requirements and assess the potential return on investment. If you're contemplating a more intricate tax structure, question whether the potential institutional investor's contribution justifies the additional costs involved. Stay informed about market sentiment and trends, particularly observing the shift from pursuing short-term, quick gains to focusing on long-term cash flow.