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One of the ever-present considerations for emerging real estate operators and developers is whether the time has come to raise an investment fund. While the process of raising capital a deal at a time is often the most practical approach, it also comes with several limitations. An operator-fundraiser must devote significant time and resources to marshaling funds for each new transaction, is highly vulnerable to the changing whims or capital limitations of their investor base, and often cannot move as quickly or aggressively as their better-capitalized competitors. The allure then, of raising a pool of discretionary capital is obvious, and for many must feel like a vital step in taking more control over their company’s destiny.

Despite this view, the road to launching a fund can be turbulent, rife with challenges and substantial costs. In that context, a panel of real estate advisors & service providers at IMN’s 2024 Winter Forum on Real Estate Opportunity & Private Investing Conference discussed some of the most salient structural considerations for emerging managers experienced and brave enough to take the leap forward.

Anchin Partner James Lockhart asked panelists the question top of mind for many attendees. “When is the right time to raise a fund?” While the timing varies based on the firm, panelists all emphasized that fund formation and fundraising processes, once undertaken, is a continuum that does not start and stop based on the ebbs and flows of deal activity. “Every time we talk to a fund manager, they’re always thinking about the next one (fund),” explained Anchin Partner Zurab Moshashvili. “So that process, that seed, is always in the manager’s heads.” This is because to establish and grow fee income, investment managers must be very focused on scaling their assets under management. “Are the asset manager fees coming our way so we can keep the lights on? Or are there other fees coming our way from acquisition fee perspective,” Moshashvili elaborated. Alex Geer, CFO of investment manager Calibogue Capital, corroborated the statement. “We’re ALWAYS capital raising, right? This is a fundamental change for a syndicator to looking to become an established manager.”

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One of the main concerns for any emerging manager is their ability to cover the considerable overhead expenses required to operate a successful fund, even a small one. The panel re-assured attendees, arguing that institutional investors traditionally view such fees as an unavoidable cost of doing business.  “If you’re raising a small fund and you’ve got a headcount, you know, the fee may need to be higher. And I think in our experience, people have been receptive to that. Having said that, the better way to fix that is to just raise a bigger fund. Geer elaborated. “In our business, for instance, our founder was doing this himself out of his garage. And it was like pulling teeth to get a salary draw approved for himself and the fund. And once he had had headcount, that conversation just went away.  They were like, okay, you’re telling me it’s a 2% management fee.  It wasn’t 0.5% (like for a larger fund). Whatever it was, it’s just like, well, you know, he’s not just paying himself, like he’s got to pay people. I think people understand that this is an ongoing business model that you’re going to be working on forever, you’re going to be stuck. Unlike syndications, you can’t just wash your hands of a deal.”

Moshashvili went one step further. “You have to make sure that (costs) are obviously built into the legal documents correctly, right, so that fund administration costs are to be absorbed by the fund. But it’s also extremely important to make sure you set a cap where you allow yourself to bill back organizational costs to the fund as well. Those costs can be significant for larger fund investors, especially with investors who are more sophisticated, that read the documents, may have more comments.”

That does not mean that large investors won’t leverage such requests or others to drive better terms for themselves. Moshashvili went on. “From an asset management perspective, what we have seen is that if you’re going from friends and family and going to a little bit more institutional or larger funds, at that point they (an anchor fund) may be asking for a piece of the general partner or the investment manager from a revenue share perspective or other types of fees. So, they’ll write a $30, $40, $50 million-dollar check and that check can help you go get other investors, so you get to a $100 or $200 million dollar fund. But that $30 million or $40 or $50 million-dollar check doesn’t come for free.”

Excerpted from the original article published by Emerge RE News.