In February 2021 I appeared on Whitney Sewell’s Real Estate Syndication Show to discuss the lessons I’ve learned on structuring a fund. Below is an outline of topics we discussed, as well as an edited transcription of our conversation. The investor distribution excel template referenced is available at the end of this post as a separate attachment or you can email me directly at firstname.lastname@example.org
DISCLAIMER: I am not an attorney or CPA and am only sharing my experiences in creating a fund and speaking with others who have done the same. In order to create your own fund you must seek professional input from your team, which should consist, at the very least, of an SEC attorney and CPA. The information contained in this white paper and podcast conversation has not been verified for accuracy and is not a comprehensive deep-dive into the topic. It’s intent is to share some common questions and thoughts for those interested in structuring their own fund.
OUTLINE ON FUND FORMATION
Why create a fund? – You want to acquire multiple assets over a period of time. Typically, you’re raising investor equity or soft commitments in order to move quickly when multiple opportunities become available.
Questions to ask when starting a fund:
1. What are the asset types you’ll be acquiring?
2. What is the time period/duration of the fund?
3. Who are your investors and what returns will you be offering?
4. How will you be providing returns to investors?
- Fixed return with no additional equity payout
- Preferred return and equity participation
- Stairstep returns based on success and profitability of fund
5. How do you balance investors who get in first with later investors so that their
returns are proportionate?
- Revalue the investor shares each time you raise additional capital
- Employ a weighted ownership percentage that takes into account the number
of days invested with the number of units purchased.
6. How will you keep track of Investor waiting list and soft commitments?
7. What is the purpose of the fund and ultimate end goal?
- Do you plan to profit from managing the fund / equity share / profit
- Do you intend to buy out your investors and control the assets yourself? If so,
make sure you make that clear in your legal documents and prospectus.
WHITNEY SEWELL: This is your daily real estate syndication show. I'm your host, Whitney Sewell. Today our guest is Brian Hamrick. Thanks for being on the show, Brian.
BRIAN HAMRICK: Hey, Whitney. It's great to be here. Thank you.
WHITNEY SEWELL: Yeah, honored to have you on the show. Brian controls over $32 million in apartment, self-storage and office commercial real estate, as well as performing and non performing notes. He's raised over $9 million from investors through syndications and funds, and he also hosts the Rental Property Owner and Real Estate Investor podcast. Brian, welcome to the show. Give us a little more about your focus in real estate and let's jump into your superpower, the thing we're going to just dive into today to help the listener.
BRIAN HAMRICK: Yeah, absolutely. Whitney, thanks for having me on your show. You know, I'm an opportunistic investor, I invest in apartments, I invest in office, a little bit of retail, self-storage is one of my favorites, and performing and non performing notes, and I've also dabbled in some ground up apartment development, too. So I've done a lot, I've worked with a lot of great partners and I always like to come prepared to shows like yours, and bring my A game. I've had a lot of conversations in the past couple months about fund structure, because I've started a fund, I spent about a year trying to figure out how to do a fund. And if it's okay with you, I'd love to talk about fund structure today. It's not necessarily my superpower, I'm not an attorney, but I've certainly gone down that road and would love to talk about it.
WHITNEY SEWELL: No doubt about it, I would love to talk about that. And I appreciate you just bringing it up and that you, I mean spending a year of research learning this, you're going to be so much more knowledgeable about this than I am for sure. You've done it too. Where did you go to find research? What were the main things that helped you Brian, to learn.
BRIAN HAMRICK: Well, I looked for books on the topic, could not really find many books. I went to networking events, national networking events, and probably that's the best source to find people who've actually put their own funds together, and talk to them and say, why did you structure it this way? How did you structure it? What were some of the considerations? And really, when you talk to 10 different people who have started 10 different funds, you get 10 entirely different answers as to how they went about it and what kind of structure they had. It can be confusing and daunting, but before I get into that, let's make sure people understand what a fund is and how it's different from a syndication.
WHITNEY SEWELL: Please.
BRIAN HAMRICK: I've certainly syndicated apartment buildings, self-storage, these are single asset syndications where you identify the property, you identify the closing date, you go out, you raise your money and once you close, you've got your investors, they're locked in and maybe you hold it five years, 10 years, whatever, but that's a single asset syndication. And I know you've done 100 million in syndication Whitney, so you're very familiar with that process now. But let's say you want to go out and you're not sure what you're going to buy, but you know, for example, there's a lot of distressed retail right now, because of the coronavirus pandemic. And let's say you want to go out and just pick up distressed retail centers, shopping malls, strip centers, things like that, but you're not sure exactly what the exact asset is going to be. So you might start a fund that is meant to raise the money before you identify the asset, and it could be multiple assets that you would pick up in this fund, and that's why you would do a fund structure as opposed to just a single asset syndication.
WHITNEY SEWELL: There's a lot to think through there. Right? Why we would do this and when and who should do this? Maybe even some of the timeline, when am I going to be raising the money or when's it going to be deployed? Maybe we can start with even the types of properties we should be thinking about acquiring or do they have to be the same or can we purchase different types in that fund? Just elaborate on that for me.
BRIAN HAMRICK: From a general perspective, because I'm not an attorney or a CPA, so you should always, of course, talk to your experts on your team about these things. But as far as identifying the asset, if you're an apartment investor, you might say the assets that we're going to go after are distressed assets that are in the 20 to 40 unit range and we're going to pick these up for a million to a million and a half each. We don't know what they are yet, but we're going to raise enough money so that whenever we see those opportunities, we can close quickly, because we've already had commitments for the funds to close. And we may not even need lender financing, because we'll be raising that money from our investors. So that's from the asset side, you want to identify what the asset is going to be, is it going to be apartments? Is going to be retail centers? Is it going to be crypto currency? Whatever it might be, identify that, but then also think, well, what if we're only going after retail, but we come across an office building that's distressed that we can pick up and it makes sense? Do you want to widen the parameters of your fund? Whatever you decide, make sure it's transparent to your investors in such a way that you, as the operator, have the leeway to include office in your retail fund. So you have to take these things into consideration when you're putting together your fund.
WHITNEY SEWELL: Any kind of timeframe restrictions, or the duration of the fund, things like that we should be thinking about?
BRIAN HAMRICK: That's always important, because let's say you're buying apartment buildings, well, what is your window of time that you need to be able to acquire these? Is your fund only going to be open for a year? If you're going to acquire these assets, achieve the upside value, and dispose of them within three years, five years, 10 years, you need to figure that out, because you're on a staggered schedule. You don't know when you're going to find the asset, you don't know when you're going to close on it, you don't know how many assets you're going to find, and over what period of time, you need to build that flexibility into your fund to say, you know what, this may not be your traditional three to five year fund, this may be a seven year fund or a 10 year fund, and you have to really think about it in that way, as to, well, how are you going to get your investors in? And how long do you need to let them know that they're going to be in that fund?
WHITNEY SEWELL: They definitely are going to want to know, right? They're going to want to know when all these things are going to happen, and so you better have an idea about this time period that you're projecting, but you know, thinking about those investors, you have to project some kind of return, right?
BRIAN HAMRICK: I always say that's a marketing question. You have to know your investors, what are their timeframes? I have investors who are in their 70s and they've told me, I don't want to invest in something for 10 years, because I may not be around for 10 years. Does that mean I need to make it a five year fund? And would that even work with the type of asset that I'm buying under the parameters under which I'm buying them? The returns are always different. And like I said, you talk to 10 different fund operators, you're going to get 10 different answers. So I've talked to operators in the note world, who basically (say to their investors) you invest with me, and you're going to get a straight up 8% return. If you invest over 150,000, I'll make it 9%, and that's it. It's just a flat return, there's no equity upside to that. And then you have other people who structure their fund much like we might structure our syndications, where you have a cash on cash preferred return each year, and then IRR, internal rate of return or annualized return, that's 18 to 20%, once you liquidate. The problem is, because it's a blind pool, you don't know exactly what asset you're buying, so you're not able to run the numbers comprehensively before you raise that money, you don't know exactly what the returns are going to be, so you have to make sure you build in all kinds of cushion and take into account all kinds of variables to be able to get to a return that you know your investors will get excited about. Because again, it's always a marketing issue. You don't want to come out with a 4% preferred return and 5% annualized return, because investors will just say “I can go to Whitney and do much better”. So you want to make sure it's sexy enough for your investors, but not overly sexy in which you can't deliver.
WHITNEY SEWELL: Are there any other specific ways to project those returns for investors?
BRIAN HAMRICK: The easiest way is just a straight up, preferred return, such as 8% to 12%. That's what you're going to get, it's a five year fund and we'll get you your money back at the end of five years. That's the easiest way because it requires very little bookkeeping calculations. As you get into more detailed returns with preferred return, cash on cash, annualized return, once you dispose of the assets, then there's a lot more bookkeeping, and you know, it's very easy with a cash on cash return to say, all right, when this investor invested on this date, their cash on cash return starts there, they get a certain percentage prorated for the amount of time they've been in. But when you get to the annualized return, which is once we've disposed of all the assets in this fund, we've paid back our investors, and now we're going to pay out the profit, you need to be able to make sure that the people who got in early and the people who got in later are being compensated equally, or their compensation is balanced, because you don't want to have a lopsided fund where the later you get in, the more profit participation you're going to get in the backend. So that was something that I really had to struggle with, to figure out mathematically, well, how do we make sure that someone who gets in early is going to have the same annualized return or internal rate of return as someone who gets in late? And that was probably the biggest challenge, and do you want to hear the answer?
WHITNEY SEWELL: Yeah, of course.
BRIAN HAMRICK: Okay. So what you have to do is you have to take a weighted ownership ratio for each investor. You're basically weighting the number of days that they're in the investment with the number of units or shares that they've purchased. And then that gives them a percentage of ownership that is then applied toward that annualized return when it comes time to pay that out.
WHITNEY SEWELL: Now do you use some kind of software that helps you to calculate that?
BRIAN HAMRICK: I use Excel, so I've got an Excel spreadsheet, I'd be happy to share my template if anyone's interested, they can go to my website or email me, and I'll share it. I'm also going to have a White Paper ready by the time this comes out. Again, I'm not an attorney, but I have done it and I've talked to many people, so I'd be happy to share what I know about the topic.
WHITNEY SEWELL: Can the shares or the value of the shares change in any way through the life of the fund? Or does it have to stay the same?
BRIAN HAMRICK: Well, the percentage ownership as an investor is changing constantly, because as new investors come in, they're bringing in more funds that change the investor structure. The value of your share can also change as the fund acquires more assets. That certainly happens. And you just reminded me of another way that one of the fund operators (I spoke with) values the investor equity. Rather than just have a straight up share or unit price that is fixed at a specific amount, as they bring in new investors, they will actually revalue those shares. So a share that might have cost $50,000 a year ago, might be worth $86,000 now. That's a little bit more detailed, because then they have to get valuations on all the assets (owned by the fund) and really make sure that they're clear on each individual asset and its value and how it's changed over time. That is one way that I've seen people do it, is to revalue the shares as new investors come in, much like you see in the stock market.
WHITNEY SEWELL: Are there normally waiting lists for a fund like this, or do you have soft commitments versus hard commitments? How does that work?
BRIAN HAMRICK: That’s another tricky part, because, again, you're going out and soliciting investors, bringing investors into your ecosystem, without having identified the asset yet. You've identified the asset class, but not the asset. So it's a delicate balance to get investors excited about that, get them on a waiting list, get them to subscribe to a waiting list and make a soft commitment, and a soft commitment is just that, it's not a hard commitment where their money is ready to go, it's just I'm in line, I'm interested in investing, and when you get to me, we'll see if I actually have that money to invest. The delicate balance is if you get too many investors in line with their soft commitments, but you don't come through with the product and the pipeline isn't there for what you're trying to raise money for, those investors might get discouraged and go invest elsewhere. So there is a delicate balance, and you have to be very mindful of not over promising to your investors as to how quickly you're going to be able to deploy the money. And that brings up another very important issue where people do get in trouble quite often when creating these funds, is they raise the money (and have investors wire money into the bank account) before they actually have the assets under contract. That's a problem, because then you're paying a return, preferred return, on assets that haven't even been purchased yet or identified. It's preferable at least to set it up so that you're actually bringing the money into your fund as you have the opportunity to deploy that money.
WHITNEY SEWELL: When in someone's career should they consider a fund like this? You obviously need that relationship with investors, right, before probably you do a fund like this, but what's your take on that?
BRIAN HAMRICK: Well, I think a syndication is much more preferable, having done both, it's much better to identify the asset first, figure out the value, figure out the returns, and then go to the investors. The reason you would consider a fund is if you have a pipeline of opportunities, or you anticipated pipeline of opportunities that you want to move quickly on. You know, there's a lot of talk about distress in different sectors of real estate, and if you have some sort of pipeline to help out in that area, then it's a good idea to maybe start a fund, because then you won't be bogged down each time on each individual asset, trying to raise money for it, you'll have raised the money (or soft commitments) for a pool. And in this case, it would be a blind pool, you don't know exactly what the asset is, you might know the asset class, and it could be an open ended rolling fund, where you don't know when you're going to close it to investors and it's rolling in the sense that you'll bring investors in as you have opportunities to deploy the money.
WHITNEY SEWELL: I want to talk about 506B versus 506C, just briefly, because we've talked about that on the show a lot and so most of the listeners are going to understand some of the differences there, but as far as a fund is concerned, if you're doing a 506 B, you have to have that preexisting relationship when you start the fund, right?
BRIAN HAMRICK: Yeah, absolutely. That's something else to take into consideration too. What is the raise? How much are you raising? Is it a $1 million fund? In which case maybe as a 506B, you have those preexisting relationships. Is it a $20 million fund, where maybe you're better off with a 506C, so that you can go out and bring in new investors, accredited investors who you don't already have a relationship with? And that's a big question to what is the limit? What is the amount that your fund is going to raise?
WHITNEY SEWELL: I was thinking too, if the whole period was two years or five years for this fund, you may want to be able to bring new people in over that long period of time.
BRIAN HAMRICK: Absolutely, and that's part of the calculus that you have to put into the thinking process, who are my investors, of the investors that I have exposure to? Are they going to be able to help me with a $10 million fund? Do I need to go wider?
WHITNEY SEWELL: How soon are distributions paid? I mean, I know you talked about that a little bit also, but just, you know, for the investor who's listening, he's thinking about investing in a fund, you know, how soon should he expect a return?
BRIAN HAMRICK: You have to be very clear on that. If you're buying distressed property, and let's say you go back to the retail example, if you're buying distressed retail centers, that may have nonpaying tenants or vacant storefronts, you're not going to be paying out in the first six months, maybe not even in the first two years. So you have to be very clear with your investors as to what to anticipate. And I've seen it where sponsors over raise, and then start paying out as quickly as possible. I think that's a problem when it comes to a fund, because you certainly don't want to be paying investors out of money that you're raising from other investors, you need to be paying them from the asset itself, and the cash flow that's coming from that asset. Its not always possible to start paying quickly, and again, that's a marketing issue. I mean, are investors going to say, well, sure, I'll wait three years for you to start making money, but I'm not going to be happy with a 6% return, I'm going to want that 20% IRR or annualized return, or whatever it may be. So, again, there's no one answer, but you do have to think through what is the timeline? How should I set my investors expectations as to when they'll start seeing some money?
WHITNEY SEWELL: And how does an operator like yourself make money in a fund like this versus a normal individual deal syndication?
BRIAN HAMRICK: Great question. It's very similar to syndications, I mean, an equity share, if you pay a preferred return, you get the waterfall distributions after that preferred return is met. I think it's important to make sure your investors know that they're getting paid before you do, whether it's a syndication or a fund, but I do think that even though I've not done an asset management fee, or any sort of management fee on my syndications, on the fund it's a little different, because the fund is more work. So that's another way that you can pay yourself is through some sort of asset management fee.
WHITNEY SEWELL: So Brian, what's been the hardest part of operating a fund or syndicating a fund like this?
BRIAN HAMRICK: Meeting investors’ expectations and maintaining that balance between keeping your investors excited about investing, and actually having that pipeline of supply for them to invest in, that's been the most difficult part. And you really have to think about your investors and consider them from every aspect, every viewpoint, to make sure that they are being rewarded for taking this leap with you, because it is a blind pool, they're not exactly sure what they're investing in, nor are you, when you put it together, so they're really investing with you as the operator. And you have to be aware of that and treat it with respect.
WHITNEY SEWELL: And what about preparing for a downturn when operating a fund like this?
BRIAN HAMRICK: It's the same as with a syndication. How do you prepare for a downturn? You don't over raise, you don't raise money that you can't deploy right away and you try to keep your liabilities limited as much as possible. If you do over raise in order to have operational funds, that's important to make sure you have enough money to operate, because there are expenses to keep that machinery working smoothly.
WHITNEY SEWELL: And what about just your prediction for the real estate market over the next six to 12 months?
BRIAN HAMRICK: I've heard all kinds of predictions from all fronts, we're heading into a great recession, the housing market is going to collapse. I don't believe the negative. All that could certainly happen. The negative could certainly happen. I think it's going to be asset by asset, location by location. I've heard about a lot of distress in apartment assets across the country, but I have to say here in Grand Rapids, Michigan, my apartments are humming along very nicely. We've worked well with our residents. We've helped those who have had trouble, and we're doing very well, we're doing as well this year as we did last year, before the pandemic. But I know there are places where they're lucky if they have 70% of their collections. I think it really depends. I think residential is going to stay strong. I don't anticipate a housing collapse like some do. I think residential will be good. I think the asset classes that have held up really well, like Self Storage, will continue to perform really well in markets where it's not been overbuilt. I think senior housing has really hit a lot of trouble and a lot of speed bumps lately, but that's going to come back in the next couple years because the demand is going to be there, but I do think there will be some distress in the mortgage world, both commercial and residential. I think that there will be opportunities for non performing notes.
WHITNEY SEWELL: What about the number one thing that's contributed to your success?
BRIAN HAMRICK: Finding rock star partners, partnering with people who really know their area, the asset class and are real troubleshooters and know how to get things done.
WHITNEY SEWELL: So real trouble shooters, not troublemakers, right?
BRIAN HAMRICK: The troubleshooters know how to keep the troublemakers at bay.
WHITNEY SEWELL: That's right. So Brian, how do you like to give back?
BRIAN HAMRICK: Well, you host your podcast and I feel like we're both giving back to our audience through the podcast, because we've had a certain amount of success in this area, and it's important for us to share that as much as possible, and that's why I prepared what I shared with you today. I share a lot of information on my podcast with the people I interview and I'm looking forward to interviewing you soon. I am philanthropic, I can't say I'm at the level that you are, I'm very impressed with the work you do, but I just think helping people get to that next level, that's how I love to give back.
WHITNEY SEWELL: Awesome. Well, Brian, how can people get in touch with you and learn more about you?