What Is a Semi-Blind Real Estate Fund—And Is It Right for You?
In one of my previous articles, I discussed the merits of investing in one real estate deal versus investing in a private real estate fund. Today, we’ll dive into a related topic: semi-blind real estate funds. As the name might suggest, a semi-blind real estate fund is one in which an operator begins raising money from investors without first identifying all of the assets that will comprise the fund. Each fund is usually different and the mix of assets depends largely on the current circumstances of the external market and the operator’s own deal flow.
Evaluating the Operator
While it’s true that you have no way of evaluating all of the assets that will be in the fund, you can (and should!) carefully evaluate the track record of the person running the fund—known as the operator—and their team.
As part of this process, you’ll want the operator to explain their criteria for purchasing deals usually in terms of returns, geographic locations, market fundamentals, and success of similar deals that meet those criteria.
You then need to ask yourself:
• Does the fund’s vision align with what I’m looking for in an investment?
• Does the operator’s track record align with the current business model presented for the fund? In other words, if the operator has been a world-class operator in low-income housing, but has never operated a high-end apartment complex, then maybe there’s cause for concern if the fund’s focus has suddenly switch to luxury apartments.
It’s important to note that most managers don’t start out in funds. Rather, they start with single deals, build a track record with investors, and then move into the fund space when they have more experience and a reputation of performance.
Reviewing the Offering Documents
After identifying a manager and model you’re comfortable with, it’s time to start performing due diligence on the fund, beginning with a review of the legal documents. These documents go by different names: You may see a private placement memorandum (PPM), subscription agreement, or just offering documents. Regardless of what they’re called, these documents are standard with almost any security, so if the operator doesn’t have them readily available for you, this is a huge red flag. You may hear an excuse such as, “My lawyer is still working on the documentation.” If you do, run—don’t walk—the other way because the operator should not be raising money without the offering documents ready to go.
It’s simply unethical to pitch a deal without the exact terms finalized. I have had conversations with highly respected investors that indicated that a lack of documentation can be a red herring for a possible Ponzi scheme.
It is critical that you understand the terms of the fund, paying close attention to the fees, what preferred returns are in place, and the overall timeline of the fund. I’ll cover fees and preferred returns, which are pretty standard across the industry, in a separate article. However, the time period of the fund can vary greatly based on the operator’s business plan. Since most funds don’t provide an option to sell your shares, you should be prepared to stay involved in the investment for the entire term, including any options to extend beyond its original intended time period. Some funds can last up to 10 years, so it’s important to know what terms you are agreeing to.
Finally, make sure that the offering documents match the marketing material for the fund. If anything feels “off” or out of sync, ask probing questions until you’re satisfied with the answers.
Scrutinizing the Operator’s Professional Team
The attorney writing the offering documents should have a specialization in securities. That’s because if there is an error in the language of these documents, it puts the entire fund in jeopardy, including the full value of your investment.
To learn more about the attorney used, visit their website to find out what clients they service—and then ask your network what they know about those clients. Chances are, if the clients have a stellar reputation, your operator is choosing a reputable attorney, which reflects positively on the operator. On the other hand, if those clients are currently being investigated by the SEC for securities violations, you may need to dig deeper. Any red flags found during due diligence should be brought to the attention of the operators, and their response to uncomfortable questions is crucial for them earning your investment.
Similarly, the CPA used by the operator should be experienced with the types of investments that will be included in the fund. Most of the time (with the exception of tax season, when they will very likely be too busy to engage in meaningful discussion), if you reach out to the CPA directly, you may be surprised to see what kind of unbiased information you can obtain. Even though the fund operator is a client, the accountant is typically bound by their own professional obligation to provide truthful information.
Not all fund operators use one because it adds an extra cost to the fund, but having a third-party auditor look over the fund’s financials can provide a valuable security blanket for your investment.
Although not standard, some operators use a financial custodian to handle the money that flows in and out of the fund. Typically, this is handled by a bank that has a relationship with the fund operator, and it adds an extra level of protection to your investment.
Are Semi-Blind Funds Worth the Risk?
This fund model provides undeniable advantages for operators, including maximum flexibility in trying to source deals. And in a very competitive market, use of this model can make the difference between them landing a deal or not. In theory, an operator being able to source better deals should benefit the end investor, as well.
At the end of the day, the decision to invest in a fund should be about the due diligence that’s performed and the trusted relationship between you and the operator—which is the case regardless of whether you’re considering an individual investment or a semi-blind fund.
Your decision comes down to the total package: What is the operator’s track record executing on similar funds? How much do you trust the team that’s in place (including financial professionals used)? And how does the model fit into your current investment portfolio?
If you liked this article and wish to continue on your path in learning about alternative investments, please make sure to check out my other educational articles as well as my book, The Alternative Investment Almanac: Expert Insights on Building Personal Wealth in Non-Traditional Ways.
Disclaimer: The information presented in this article is for informational purposes only and does not constitute professional financial or investment advice. The author does not make any guarantees or promises as to the results that may be obtained from it. You should never make any investment decision without first consulting with your own financial advisor and conducting your own research and due diligence. Even though, the author has made reasonable efforts to ensure that the contents of this article were correct at press time. The author disclaims all liability in the event that any information, commentary, analysis, opinions, advice and/or recommendations contained in this article results in any investment or other losses. Your use of the information in this article is at your own risk.