In our recent article, What is a Fund of Funds (FOF)?, we broke down the basics of FOF investing. We explained that a fund of funds is essentially when one investment bundle invests in another bundle. For example, if you invest in a mutual fund (which is an actively-managed bundle of stocks and/or bonds), and that mutual fund invests in other mutual funds, you have a fund of funds.
But in this article, we want to specifically address fund of funds investing in real estate.
We’ll show you:
How real estate fund of funds work,
The pros and cons of FOF investing in real estate,
And how you can start investing in real estate with a fund of funds.
Whether you are a private investor or a fund manager, understanding how a fund of funds operates in real estate will help you to make more informed investment decisions. And this article will explain it all for you.
Fund of Funds in Real Estate
To understand how fund of funds investing in real estate works, you first need to understand how real estate investment funds work. The simple explanation is that a real estate investment fund
Pools capital from multiple investors,
Generates real estate-based income from the asset(s) held in that account,
And then distributes a significant share of that real estate income back to the investors.
There are several real estate investment fund types to consider, including:
Real Estate Mutual Funds: An actively-managed package of stocks or bonds that invest in real estate-based companies. By investing in a mutual fund, you own partial shares of multiple real estate companies.
Real Estate Index Funds: Bundles of real estate stocks or bonds that are not actively managed but follow broad market indexes instead. Index funds can be bought and sold on the stock market using the price set by the fund at the end of the trading day.
Real Estate Exchange-Traded Funds (ETFs): Very similar to index funds, ETFs are bundles of passive real estate-related investments that can be easily traded on the stock market. Unlike index funds, EFTs can be traded on the market throughout the trading day.
Real Estate Investment Trusts (REITs): A company that invests in income-producing properties and rewards investors with dividends from the rental income. Investors can purchase shares in the REIT, and dividends will directly relate to the number of shares owned.
Private Equity Funds: Partnerships of individuals who create a separate entity to invest in real estate jointly. The Securities and Exchange Commission (SEC) does not allow these funds to be marketed to the general public; instead, they are one of the high-net-worth investing strategies, reserved for sophisticated investors with extensive industry connections.
Real estate crowdfunding and real estate syndication: There are a few differences between syndication and crowdfunding, but the general idea for both models is that investors pool their capital to finance a specific real estate project (such as a house flip or a multi-family development). This is similar to private equity funds, but accessible to a much wider range of investors.
Any time one of the above-listed real estate funds invests in another one of the above-listed funds, you have a fund of funds.
Benefits of Fund of Funds Investing in Real Estate
Real estate fund of funds offers multiple advantages, including
Lower risk through diversification. Investing in a whole fund rather than deal-by-deal investing spreads capital among multiple assets. This way, if one asset struggles, your portfolio can be saved by the assets that are performing well.
Professional management. A fund of funds leverages the knowledge of experienced investment managers. If both the initial fund and the fund the first fund invests in are managed, you get two levels of professional management! And, because fund managers dedicate significant time to monitoring funds, they are well-positioned to make solid decisions on behalf of the fund(s).
Access to multiple asset classes. Through FOF investing, investors can hold ownership interests in multiple asset classes without hand-selecting each asset. Even within real estate, you might have single-family, multi-family, commercial, and industrial assets.
Potential Drawbacks of Fund of Funds Investing
In addition to all the benefits of real estate FOFs, there are a few potential downsides to be aware of, such as
Higher management costs. Conventional real estate funds impose fees for portfolio management. And because a fund of funds introduces an additional layer, there is another set of management fees.
Risks associated with over-diversification. When a portfolio is too diverse, the underperforming assets can offset the gains from the well-performing assets, dragging down the performance of the whole fund.
Difficulty in assessing underlying fund performance. It can be difficult to accurately evaluate the performance of assets in a fund because funds are typically made up of multiple assets or even multiple companies, each of which has multiple assets. Now if you have a fund of funds, you have a second layer that can conceal underperforming assets.
How to Start Investing in a Fund of Funds for Real Estate
If you are interested in investing in a real estate fund of funds, here are a few tips to help you get started:
Clarify your investment goals. Are you looking to receive passive income from your investment, grow the value of your portfolio through appreciation, or both?
Determine your investment timeline. Are you looking for a quick payout or a long-term path to wealth?
Understand your risk tolerance. Are you willing to take more financial risks in exchange for greater reward potential?
Decide on your current investment limit. How much can you invest now?
Choose the right fund of funds for you. Invest some time in researching FOFs with minimum investment requirements that meet your investment limit. Then compare the long-term performance of the FOFs on your shortlist.
Gatsby Investment’s Fund of Funds Real Estate Investing Options
Gatsby Investment is a California-based real estate syndication company with an impressive track recordof profitable real estate investments. With syndication growing in popularity, it will play a large part in the future of real estate investing, and we are excited to be among the innovators that are shaping this next generation of progressive real estate investments!
To that end, we now allow real estate funds to invest alongside our other investors in a real estate fund of funds structure.
With our fund-of-funds investing strategy, fund managers can buy debt or equity shares in carefully-vetted real estate projects. This is an ideal solution for fund managers who have capital waiting to be used or an abundance of capital from a recent fundraising campaign. Rather than allowing that capital to sit, uninvested, and lose value to depreciation, you can invest with Gatsby to increase returns for your investors. Our short-term projects, including single-family house flips and multi-family developments can get you in and out of a deal in under two years (as little as six months for some investments).
