In a typical commercial real estate transaction, a sponsor – a private equity firm, REIT, or individual – solicits capital from investors to raise the equity needed to close the deal. In most cases, this equity comes from multiple investors, each of whom contribute some amount of money to the deal. For the sponsor, tracking how much money each investor contributed, how much they are due, and how much they have earned can be a tricky task. Especially when managing multiple deals simultaneously. Occasionally, they must “commingle” funds.
In this article, we are going to discuss commingling. We define what it is, why it is important, and the pros and cons of doing it. By the end, readers will be familiar with the commingling concept and will know when to look for it in a commercial real estate transaction.
At First National Realty Partners, we work with a wide variety of investors in all of our deals and are very careful to follow all rules and regulations regarding the commingling of investor funds. To learn more about our current investment opportunities, click here.
What is Commingling?
Commingling occurs when capital raised from multiple investors is mixed together in the same account. This is very common in investment vehicles like mutual funds, trust funds, pension funds, and 401ks. Within the context of commercial real estate investing, there are two scenarios where commingling funds is common.
First, when a transaction sponsor raises money from many different real estate investors for a single deal, these funds may be lumped together in the same bank account(s) for the purpose of purchasing and managing the property.
Or, when a transaction sponsor is raising money for a real estate fund with the purpose of purchasing multiple assets, money could be commingled together for the purpose of managing the fund.
The reason that sponsors and fund managers commingle funds is to reduce the administrative burden of managing investor funds held in separate accounts. For example, imagine raising money from 50 investors to buy a single property and having to open an individual account for each one of them. Instead, sponsors use sophisticated software programs that allow them to track individual investor funds while commingling them in a single operating account.
Is Commingling Funds Legal?
Commingling funds from multiple investors for a single property or fund is legal. Where transaction sponsors – like a Real Estate Investment Trust (REIT) or private equity firm – can run into trouble is when investment funds are commingled with personal funds, personal accounts, or funds from other company accounts that are not meant for investment purposes.
For example, suppose a transaction sponsor invests some of their own money into a joint venture deal alongside other investors. Then, without investor permission, uses commingled funds to pay for certain personal expenses under the guise of paying themselves back for the money they invested.
Every situation is unique and it is always a best practice to consult a qualified real estate attorney when trying to determine if commingled funds are legal. However, the general test lies in permission and transparency. If investors are aware that their funds are commingled and provide their permission to do so, it is legal. But, if investor funds are commingled with personal funds and investors have not provided their permission, it is likely illegal.
Pros and Cons of Commingling Funds
There are pros and cons of commingling funds for both transaction sponsors and investors.
Pros of Commingling Funds
For the transaction sponsor, there are two major benefits to commingling investor funds. The first is simplicity. Opening and managing dozens or hundreds of bank accounts on behalf of investors would be a major administrative burden. This can be avoided by commingling funds in just a handful of operational accounts. The other reason it may be beneficial is that transaction sponsors may be able to obtain competitive pricing for property level contracts by leveraging the scale of a pool of commingled investors funds.
Real estate investors also benefit from competitive pricing because the reduced cost of operating a property increases the amount of money available to be distributed to them.
Cons of Commingling Funds
Transaction sponsors and investment managers have a fiduciary duty to act in the best financial interests of their investors. Commingling funds leaves them open to potential mistakes and the liability that results from them. To reduce the chance for error, it may make sense to open separate bank accounts for each commercial property or to place investor funds in dedicated escrow or trust accounts that are managed by a third party.
If the sponsor improperly commingles funds, investors will likely suffer the consequences through lower returns, poor property performance, lender consequences (like foreclosure), or less cash available for distribution. In short, the major con for real estate investors is that commingling funds raises the risk profile of an investment, which highlights the need to work with an experienced transaction sponsor who understands the systems and best practices needed to safely commingle investor funds.
Final Thoughts on Commingling Funds
The practice of commingling funds occurs when a transaction sponsor/investment manager combines investor funds into a single account.
In commercial real estate investing, commingling funds is perfectly acceptable when this practice is disclosed to investors and they have given their permission for it. Where it becomes unacceptable is when it is done without investor knowledge or when funds from business accounts are commingled with funds from personal. This is illegal.
Both investors and transaction sponsors benefit from the simplicity of commingling funds. But, it raises the risk profile of the transaction, which highlights the benefit of working with an experienced transaction sponsor who has the infrastructure, procedures, and systems to safely manage commingled funds.
Interested In Learning More?
First National Realty Partners is one of the country’s leading private equity commercial real estate investment firms. With an intentional focus on finding world-class, multi-tenanted assets well below intrinsic value, we seek to create superior long-term, risk-adjusted returns for our investors while creating strong economic assets for the communities we invest in.
If you are an Accredited Real Estate Investor and would like to learn more about our investment opportunities, contact us at (800) 605-4966 or firstname.lastname@example.org for more information.