Episode 66 – How to Start a Real Estate Fund: A Step-by-Step Guide Using Reg D, 506b, and 506c

If you finally want to do it, you know a lot about real estate, and you think it’s time to start a Real Estate Fund? How do you go about it? And what’s the process? Let’s talk about it.

So just how do you go about starting a Real Estate Fund? You know a lot about real estate, and maybe you’ve invested quite a bit yourself, but everything’s owned by you already. And you want to grow, you want to make more money, you want to own more properties, or be a piece of that. How do you start a Real Estate Fund?

Well, it always starts with two things that you are always doing as a syndicator: you are always looking for investors, and you’re always looking for deals. Those two things are never gonna go away, those are the most important. Those are the fuel for the fire. Without either of those, there is no deal, there is no real estate fund. No investors, no fund. It’s just as simple as that.

So you’re always looking for investors and deals. I like to think of it as a funnel, because you’re working on these things all the time. And you’re sifting out to see what exactly you’re going to be working on. As deals come in, you need to start identifying and choosing which ones are possibilities. And at the same time, you get investors who are thinking, “Hmm, I’d invest in that.” So investors are starting to think that they’ll invest in that and you get an idea of who those people are. Those are your prime candidates for being future investors with you.

As soon as you think you have those best properties, you now go into this phase called underwriting. This is the financial analysis model. But more than that, because underwriting is financial analysis, but also with the component of: Do you personally want to take this project on? Does that meet your criteria of what would be worthwhile? And are you willing to put your name on it? So underwriting becomes the key thing.

At some point, a deal is found. And you’ve identified that one deal that you want to work on, you put the deal under contract. And you’re done. Right? Wish it was so. Well, you’ve got two things going on now at the same time. You’ve got this deal that just went under contract. But you’ve also got the security to worry about, so you’ve got a contract, you need to close and you’ve got a security that you need to fund.

You’re always going to have the same process. And in order to get the deal done, as it relates to the contract, you’ve got your due diligence, you might have some additional financing like a loan. And then ultimately, you have a closing. But your question for being here is probably more on the security side. What exactly do you need to do in order to do this security?

You’ve got people who are raising their hands, right? You have those people who are raising their hands saying they’re interested, but how do you get them from here, all the way down to here? Well, it starts with you needing the proper documentation. Now that you’ve already identified those people and you’ve got those soft commitments, you need the paperwork that lets you do this legally.

You need a PPM. The PPM is what you give to your investors. It describes the entire investment, it describes the terms that are going to be taking place. It lets your investors know what the risks are, what the conflicts of interest that naturally exist in your deal are. It gives them a firm basis so that they understand what they’re going into. And lets them know also how they can get a hold of you and ask additional questions.

You also need the operating agreement. The operating agreement is the rules for the road, it’s what tells the LLC that probably is the basis of your syndication or fund exactly what it can do and what it can’t do. It is the manual, it is the law. It is what takes place. The PPM explains the operating agreement, but the operating agreement itself is what actually rules the day.

But your investors don’t sign the operating agreement, almost never. So they sign another agreement called a subscription agreement. And what that does, it binds them to the operating agreement. It says in exchange for this money that I’m about to give you, I am entering into this operating agreement as a member of this LLC. And that’s what that does.

So now you’ve got all of your legal documents together, but you’re still not at the closing window yet. Because down here, you still don’t have any money, you don’t have their money. So you’ve got the documents in place, this really now becomes a process of what I call latching. So you’ve got the people that have raised their hands, you’ve got the documents, you need them to latch on to your investment and commit in order to do it.

Your syndication attorney is going to take care of the documents and make sure that those are all getting done. But this latching period is what really takes place to make sure that we latch properly, get your investors lined up, get that money in, get those signed subscription agreements, if you’re doing a 506(c) offering, get the verification that they’re an accredited investor, and then get their dollars so that at the end of the day, you can go to the closing table as well with that money that you have that you need.

This is the broad picture on exactly how you start a real estate syndication. Now under a Real Estate Fund, what you’re necessarily doing is you’re just not doing this part quite yet. So here you’re still underwriting deals. And you’re coming up with your founder investment theory. But you’re not necessarily doing that. But you still need to do those other things, you need to get these documents in place to latch those investors.

At the end of the day, now you have this big pool of money. And I apologize that I don’t know how to draw a pool. But this big pool of money as you’re closing. When that happens, as soon as you start making sales, you’re filing your Form D with the SEC, and you’re notifying the states of where your investors are coming from. And that’s how you start a Real Estate Fund.

As you’ve got this pool of money, now you’re putting it into deals. You’re buying different assets for them. And then you’re just using the money as you need to, you’re using that money in order to make those investments. And the returns are going to your investors in the way that you promised them. So they’re getting that money back. And then it’s just a matter of keeping constant communication, making sure they’re happy and know what their money is doing for them so that they keep investing with you in the future.

And this is how you start a real estate fund. I thought it was helpful to draw this out. And I thought it was helpful to also draw it out as a syndication versus a fund, because the only difference really is you may not have a transaction going at that time.

My name is Tilden Moschetti. I am a syndication attorney with the Moschetti Syndication Law Group. If we can help you put together a syndication or a fund, be happy to talk to you about it. We specialize only in Regulation D and in rules 506(b) and 506(c). We’d be happy to work with you. We’ve worked with people of all levels, people who are just starting out who’ve never put a deal together before but know that they want to and are committed to the process, as well as large private equity funds with over a billion dollars under management. So we service everybody in between. If we can help you, please don’t hesitate to give us a call.