Real Estate Blind Fund: Red Flags

Syndications vs. Blind Funds

Most of the real estate opportunities that I review regularly are syndications. This is when you invest in a specific asset. It may be a single apartment community or a single apartment building. However, there are also funds. You can think of them as similar to mutual funds. This is where a fund manager sources the assets and then operates them. And as an investor, you don't know which assets that fund manager will invest in. This is called the blind fund, and that's the type of fund that I've recently reviewed. Now, there's nothing wrong with a blind fund in and of itself. The key is that you have to fully trust that the fund manager is going to execute their plan and their investment thesis. So, not only do you need to understand that investment thesis and believe in it, you need to fully vet out that fund manager because you will have no say in what assets that the fund manager invests in.

I recently reviewed one of these blind funds that were investing in a particularly hot area of the country. What I found were several red flags. Let me start with the first one.

Red Flag #1: Aggressive Return Projections

The first red flag was that the fund was projecting a 20% return. Now a 20% return can, and certainly has been achieved in real estate investing. However, in order to get a 20% return in real estate, chances are that fund manager is using a very aggressive set of assumptions around their business plan. I prefer to take a much more conservative view in analyzing investment opportunities. Using numbers, more conservative means that the projected returns are likely lower. This provides a greater confidence level that those returns can be achieved and offers upside to outperform. Now, this fund was raising a hundred million dollars, which is a fairly large sum of money. I wondered how exactly are they raising that much money?

Red Flag #2: Large Upfront Fees

Well, when I looked into it, they're offering broker dealers a 10% commission. A broker dealer is somebody who is not involved with the fund other than they bring in investors to the fund. Now a 10% commission is significant. It's great if you're the broker dealer, but if you're an investor, that means you're 10% down on the day you invest. As a fund manager, that's a 10% hole that you're starting from. And to get another 20% on top of that as was projected means that overall you're looking at something closer to a 30% return. Is that aggressive? Probably!

Red Flag #3: Investments Sitting in Cash

The next thing I noticed is that all of the a hundred million dollars was being raised upfront. Now, that money would sit there until the assets could be sourced and the money put to work. So if it took a year to invest the entire fund, that's a year that a lot of that money wasn't being put to work and making money, making it even harder to deliver the annual return percentages that are promised.

I know some funds will take that money and invested in things like hard money loans, which are in for just the short term and can create returns. But today those returns are only about 10%, even that although helpful really doesn't help you get to the 20%, let alone digging out of that hole that we talked about earlier. When I discussed this with the fund manager, I uncovered the biggest red flag of all. They said that they were already in the mode of purchasing properties outside of the fund and then would move them into the fund once it was invested in. So I asked to see what some of those assets were and they sent me some information.

Red Flag #4: Unrealistic (and misleading) Purchase Prices

Well, believe it or not, some of these assets were exactly in an area that I had been spending a lot of time looking at. In fact, one of these is one that I've even analyzed that particular property. I've spoken with the broker. What I was amazed at is the price that they were able to purchase it at. When I asked if they had purchased the asset at that price, the answer I got was, "Well, no, all of these are in various stages of being analyzed or negotiated." Well, I know that you can't purchase that asset anywhere close to that price that they were suggesting. I've spoken with the broker, I know the market and it was just too far below the market and not going to happen. It was all bologna!

Sure. If you could do that, that would be great, but it's not real.

So, what did I do?

Will this fund ever perform as it was projected? I don't know. And in fact, I may never know because I didn't invest and I'm okay with that. I sleep well at night knowing that I didn't believe in it and I didn't invest in it.

I like to invest in real estate assets where I understand what it is I'm buying, what the purchase price is, what the business plan is. And most importantly, who the people are that are going to be executing that business plan. Will I ever invest in a blind fund? Yeah, I probably will, but it's going to be one that I fully understand the investment thesis and the fund manager has a track record of success using that investment thesis. If you want to learn more about real estate syndications, you should go grab my ebook below at SpireInvestmentProperties.com/secret