First-Time Real Estate Fundraisers Must Consider Key Factors
By James Yoakum, Associate, Real Estate & Finance Group, Kleinbard LLC
Real estate, as an asset class, encompasses countless different niches and subsectors, each of which can appeal to a broad range of investors.
From an investor’s point of view, the common denominator across the various real estate asset classes — from single-family homes to apartments to trophy office towers — is the ability to leverage investments in a way that simply isn’t available for most other investment options, not just with bank loans or other sources of debt capital, but also with equity from passive investors.
In a nutshell, one reason for real estate’s broad appeal among investors is the ability to control a valuable asset using mostly (or sometimes entirely) other people’s money.
When developers set out to raise funds from other people’s money for the first time, there are a few basic considerations to keep in mind. These five simple questions for first-time real estate fundraisers will make your efforts as effective as possible and provide for a successful ongoing relationship with the investors entrusting you with their money.
What do I bring to the table?
There are more ways than ever for people to invest their money today. In just the last decade, assets such as cryptocurrencies and non-fungible tokens (NFTs) have become widely available investment options in addition to the traditional lineup of stocks, bonds and real estate assets.
Relaxed regulations around crowdfunding rules mean that even real estate has become more democratized with the rise of investing platforms like Fundrise and Yieldstreet that make real estate investing almost as easy as buying a share of stock.
Because of all these options, when developers are considering raising funds for a real estate project, it is vitally important to have a well-defined market position. This enables you to explain to potential investors why they should invest with you, as a developer or operator, as opposed to choosing any of the other options available to them.
So be prepared to remind potential investors that real estate is a great way to add stability and ongoing cash flow to an investment portfolio. Point out that, depending on the specific type of real estate, it may even provide an inflation hedge, something that is top-of-mind for many investors right now.
But you’ll also have to make it personal — any smart investor will want to know why they should trust you to be the real estate developer they invest with and what makes your specific opportunity stand out from the crowd.
Whether it’s a hard-to-replicate location that you have under contract, a well-oiled property management operation or some other competitive advantage, you must be certain you can clearly articulate what you bring to the table that differentiates you from the competition.
How will the investments be leveraged?
As discussed above, the ability to leverage real estate investments with relatively low-interest debt is one of real estate’s key selling points as an investment proposition.
When you, as a developer, are raising funds from multiple investors who will likely want to remain passive, nonrecourse investors, it becomes somewhat trickier to access debt on the best terms. Even if you can find lenders willing to lend on your project, they may require a guaranty from you or from one or more of your investors. They may also elect not to offer the same terms you could get if you were financing the project’s equity out of your own pocket.
It’s highly important to consider how the structure of a real estate deal will affect the ability to leverage investments. For example, if you know you’ll need one of your investors to provide a guaranty, you may want to offer some type of preferred return in exchange for that guaranty. Or perhaps you’ll want to pursue projects that meet criteria for specific types of financing that your investment group is well-qualified for.
In short, the more equity investors you’re bringing into a development project, the earlier in the process you should start lining up your debt capital.
How will the funding structure impact ROI?
As a developer, it is a common practice to pool funds from multiple passive investors, but there are some added costs and frictions relative to simply investing your own funds.
For instance, pooling investment funds can require more complicated legal work, accounting, tax prep and reporting, all of which will add to the expenses of the overall deal, reducing the bottom-line return on investment.
In addition to monetary costs, having multiple shareholders also generates time and energy costs associated with the personal politics of keeping various investors happy and informed, as well as with regard to simple chores such as keeping contact information up-to-date. These factors need to be considered and accounted for in advance.
How will I communicate with investors and deal with unforeseen setbacks?
If expectations are not clearly communicated at the beginning of a deal, a developer will always be at the mercy of investors when it comes to providing information and dealing with the inevitable changes of plans that are part of any real estate project.
Before taking funds from any investor, be sure you’re on the same page in terms of what ongoing information you will provide, how often investors should expect updates, how long the funds will be committed and how the decision-making process will operate once funds are invested. The better you define expectations in these areas, the easier it will be for you to meet and exceed those expectations.
Are there common fundraising pitfalls I should be aware of?
All too often, a great real estate development opportunity fails to achieve its potential because of poor planning around something entirely unrelated to the real estate deal itself.
One such common trap for first-time fundraisers involves running afoul of securities laws by “accidentally” pitching real estate investments that look like securities. Another common tripwire involves inadvertently structuring real estate ownership entities that fail to meet the typical “single-purpose entity” requirements imposed by lenders.
These and many other honest-but-costly mistakes can be avoided by speaking to experienced attorneys and accountants early in the process when such errors are most easily corrected or avoided altogether.
If there’s a time-worn idiom that succinctly summarizes the five points above, it would have to be “a stitch in time saves nine.” Early planning, preparation and communication are the most important ingredients in successfully raising funds for a real estate deal, and just as importantly, will help ensure that you maximize the returns to your investors. After all, no one gives much advice to second-time fundraisers, because if you do a good job on the first go-round, it becomes much, much easier.
— James Yoakum is an associate in the Real Estate & Finance group at Kleinbard LLC. He has experience in commercial real estate law and real estate finance and has represented clients in executing billions of dollars’ worth of complex commercial mortgage financings, mortgaged-backed securitizations and real estate-backed financing and repurchase facilities.