Development funds focus on purchasing either raw land or an infill parcel of land and working to construct new assets on that site. Development projects not only serve to provide for new assets in a growing market, but also play a vital role in the revitalization of communities across the United States. A central strategy of a development fund is to recognize the shortage of a particular asset class in a local community such as multifamily, retail, senior assisted living, or hospitality. As these acquired properties are developed to reach their highest and best use, the value increases significantly as well. As one might expect, the construction and/or development phase of these projects do not provide any cash flow to the investor because the assets are not operational or stabilized. With this in view, investors in development funds should anticipate most of their return coming from growth of principal when the property is sold. Cash might begin be generated during the hold period of the investment, but it is limited in nature. Thus, development funds are considered a growth investment and are more suited for investors seeking growth rather than cash flow.
Debt funds pool capital from investors with the objective of originating senior real estate collateralized loans for qualified borrowers. Unlike funds that seek to purchased distress assets, debt funds make their money through the interest rates and fees that they charge to the borrowers. These fees include items such as original fees, early termination fees, exit fees, etc., and serve to increase the total return to fund investors. Taking a debt position is a hedge against risk by requiring that the loan be backed by a hard asset as collateral. Many investors prefer this type of investment strategy due to the long-term and anticipatory nature of the cash flow that is paid by the borrowers. Debt funds provide investors with consistent cash flow during the hold period but offer limited growth of their principal at the end of the investment.
The world continues to rely on oil and natural gas to meet its current energy needs. While other forms of energy continue to make advancements in their effectiveness and efficiency, they have not progressed to the point that oil and natural gas are no longer a critical part of every life. Oil and gas funds seek to leverage the strong global demand for these products and to provide investors with higher levels of return through investing in various oil drilling programs, saltwater disposal programs, and royalty programs. The potential for high returns does not come without a price, and for these types of funds, the price to be paid is risk. The price of oil changes almost daily, thus, oil and gas funds are subject to greater volatility than other funds. The volatility and risk are mitigated by the potential for higher returns and by the tax advantages that come with oil drilling programs. Oil and gas funds provide much needed capital to these types of energy operations. Investors in such funds can benefit greatly from the tax advantages related to oil exploration and the potential return on their investment. These types of investments help our nation in its effort to become more energy independent. When investing into a drilling program as a general partner, investors receive a tax write off between 80 percent to 90 percent of their investment due to the intangible drilling costs (IDC) that are associated with the program. Once the IDC is captured, investors revert to a limited partnership interest to protect their non-invested assets from partnership liabilities such as environmental contamination. Apart from any returns that the fund provides, this deduction gives investors a significant opportunity to offset taxable income and reduce tax obligations.
Each real estate fund has its own investment strategy and provides potential investors with as much information as possible. It is important to note that real estate funds are usually operated as blind pools wherein the investors do not know at the time of investment the goals of the fund in terms of potential asset classes for purchase. Because investors do not have a comprehensive list of every future asset, it is important that they understand the strategy and criteria that the fund employs when selecting assets to acquire as part of its business model. Since real estate funds are blind pools, investors are putting their trust in the strategy that is set forth by the fund and the ability of the fund’s management team to execute that strategy. To this end, investors should take the time to thoroughly understand the nature of a fund by reading through its Private Placement Memorandum (PPM) prior to making an investment decision. Studying the details of any offering and the sponsor’s prior success ensures that investors have the visibility, the understanding, and the confidence that a fund is a suitable investment for their individual investment needs.