Investing in Commercial Real Estate Funds vs. Individual Deals – Understanding the Difference


Key Takeaways

Key Takeaways

  • The benefits of a private commercial real estate investment are well known and the asset class is a popular choice for investors seeking passive income.
  • Within the asset class, there are two common choices that can be used as investment vehicles, private funds, and individually syndicated deals.
  • In a private equity fund, an investor allocates a certain amount of money to a manager who deploys the capital into commercial real estate assets on their behalf.  This structure provides an investor with diversification and a degree of liquidity, but they often don’t know exactly what their money is being invested in.

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The benefits of investing in commercial real estate (CRE) are well established – portfolio diversification, recurring cash flow, tax reduction, and the ability to increase one’s net worth.  For these reasons, this asset class is popular among individual investors looking to achieve these outcomes.

At a high level, commercial real estate investment opportunities can be grouped into two buckets:  funds and individually syndicated deals.  The desired outcome for both options is the same – a high return on investment – but the structure, approach, and methodology used to get there are very different.  

Commercial Real Estate Fund – Benefits and Risks 

A commercial real estate fund is an investment vehicle that raises capital on an ongoing basis for commercial real estate investments.

Typically, the fund is created by a General Partner (GP) who raises investment capital from Limited Partners (LPs).  This capital is combined with debt to purchase real estate assets on behalf of investors.

From an investment standpoint, funds are often created in a “blind” or “semi-blind” structure, which means that investment capital is raised for general acquisition purposes.  At the time an individual investor allocates their own money to the fund, they may not know how it is going to be deployed.  Instead, they place their trust in the fund manager to use it for the most promising investment opportunities.

For individual investors, there are a number of benefits to the fund structure:

  • Tax Efficiency:  Legally, the fund structure is created as a “pass-through” entity (LLC), which means that income and expenses flow through it to individual investors.  There are a number of tax benefits to this structure including deductions for interest expense and depreciation.
  • Liquidity:  Although not as liquid as stocks, exchange-traded funds (ETFs), or bonds, fund investors are provided with some degree of liquidity that allows them to access their capital if needed.  However, it should be noted that liquidity can vary from one fund to another.
  • Diversification:  The investment capital in a fund is used to purchase many different assets in multiple locations, which provides investors with a diversified portfolio of assets.  
  • Asset Quality:  Because investment capital is pooled from many individuals, funds are used to purchase high quality assets that would otherwise be unaffordable for any individual investor. 

While the benefits of investing in a fund can be significant, there are also a number of drawbacks that investors should be aware of:

  • Knowledge:  Fund investors may not know exactly how their capital is going to be deployed.  They may have a general sense based on the fund’s strategy and objectives, but they likely won’t know what specific assets are being purchased.
  • Control:  Fund investors have no control over the investment selection, financing, and management processes.
  • Manager Performance:  A fund’s manager / investment advisor can have a material impact on investment returns.  If they are ineffective or make poor investment choices, performance can suffer.
  • Fees:  The fee structure in a fund can also have a material impact on investment performance.  Often, there is an upfront “load” that can decrease an investment’s value right off the bat.  In other words, the fee structure is not always aligned with investment performance.

While a real estate fund can be a good fit for the objectives of many investors, they aren’t for everyone.  For those looking to exert more control over the construction of their real estate investment portfolio, an investment in an individual syndicated deal may be a better option.

Individual Deal – Benefits and Risks

An individual real estate deal, often referred to as a “syndication” is one where a sponsor is raising money for the purchase of a specific property.  The structure is similar to a fund in the sense that there is a General Partner (GP) who is responsible for identifying, financing, leasing, and managing the property and a group of Limited Partners (LPs) who contribute capital to the investment and play a passive role in its management.  

For accredited investors seeking passive income from a commercial property, there are a number of benefits to the syndicated deal structure:

  • Knowledge:  In a syndicated deal, the investor knows exactly where their money is going.  They know where it is located, what the property type is, who the tenants are, what amount of rent they pay, and can perform their own due diligence on all aspects of the property before committing money to it.
  • Incentive Alignment:  The fee/return structure in an individual syndication typically aligns the financial incentives of the sponsor with those of the investors.  If the sponsor delivers a high return, they stand to benefit alongside their investors.
  • Tax Benefits:  The purchasing entity is formed as a Limited Liability Corporation (LLC), which has the structural benefits of a corporation, but is taxed like a partnership.  This provides a high degree of tax efficiency for individual investors.
  • Quality:  Pooling capital with other investors provides an individual investor with fractional ownership of an institutional quality asset that they could likely not afford on their own.

Like a fund, there are also a number of risks to investing in an individual deal.  They include:

  • Diversification:  Individual deals do not offer the same amount of diversification as a fund.  An investor is placing their capital in one property, in one location, with one manager.
  • Liquidity:  Individually syndicated deals often require capital commitments of 5-10 years, during which time an investor’s funds are illiquid.
  • Market / Credit Risk:  The individual deal provides more concentrated exposure to market and credit risk, which could materially impact investment returns.

Comparing the risks and benefits of an individual deal to those of a fund naturally begs the question, which is better?

Fund vs. Deal – Which is Better?

It can be tempting to classify either a fund or deal as the “better” investment.  The truth is that one isn’t necessarily better than the other.  Rather one may be a better fit for an investor’s personal objectives.

For investors who place an emphasis on liquidity and diversification, but don’t mind not knowing which real estate properties their money is being used to purchase, a private equity fund, private REIT, or mutual fund may be their best option.  

Conversely, for investors who prefer to know exactly where their money is going, an individually syndicated deal is likely the better fit.  

In either case, it is important that individual investors spend a significant amount of time performing due diligence on the investment manager to ensure they have a stable track record of delivering strong returns.

Interested In Learning More?

First National Realty Partners is one of the country’s leading private equity commercial real estate investment firms. We leverage our decades of expertise and our available liquidity to find world-class, multi-tenanted assets below intrinsic value. In doing so, 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 Investor and would like to learn more about our investment opportunities, contact us at (800) 605-4966 or for more information.

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