A Real Estate GP's Primer for Raising Your First Fund

The pros and cons of building a war chest

Tired of scrambling for capital on every deal?

A Blind Fund may be the answer.

The war chest can be alluring, but the money may burn a hole in your pocket.

At least it did in mine.

Here’s a primer on raising your first REPE fund:

The Basics: You Call the Shots

When people say “Fund,” most mean what's called a Blind Fund, where investors commit capital for properties you haven’t found yet.

Unlike individually syndicated deals where LPs can choose whether or not to invest, fund investors are legally bound to send in capital when called by the GP (up to a given commitment amount).

Which is the key benefit of raising a fund: you have discretionary cash in the bank.

This allows a GP to make stronger offers and, in theory, get better deals than the usual smoke and mirrors of going into contract and then scrambling to fundraising behind the scenes.

This total GP control extends beyond the purchase, and unless you bring on a strategic LP with decision rights, every capex budget, loan and exit, is your call.

Which is amazing, but it's a lot on your shoulders.

How many deals should you do before raising a fund?

Common question with no fixed answer.

There is no proscribed number of one-off deals a GP has to do before raising a fund.

In my case, my partners and I raised a fund after our fourth individual deal. But we also linked up with some gray hairs to boost our credibility, with mixed results (see my previous threads on “Cautionary Tales of Fancy Models”).

Raising your first fund is actually more about fundraising acumen than track record, since your early deals won’t likely be round tripped for several years.

Which means you have to absolutely nail delivering on early milestones and LP communication in your first deals.

And before putting down the cash for your fund docs, make sure to poll your current investor base to gauge their appetite for a blind fund.

Just because someone invested in a couple deals, doesn't mean they'll write you a blank check.

Investment Strategy: The Tighter the Better

Whatever your geography, product type and strategy, the tighter your box and the more homogenous the deals you plan to do, the better chance you'll have raising a blind fund.

Remember that investors are waiving their right to give deals a thumbs up or down, so the more specifically you can describe your target property, the better investors will understand exactly what they’re investing in.

And the easier it will be for them to say yes.

Bonus points for your target acquisitions to be similar to recent deals you've done.

So don't say: "multifamily in the Mountain West."

Say: “100-300 unit Class B multifamily, 1980 - 2000 vintage, light value add, secondary markets in Colorado, Utah, Idaho and Nevada where we can grow ROC by 150bps in the first 24 months”

This tight box means you may have to pass on good deals you would have otherwise chased.

Can you do a deal outside the fund?

Of course, there really are no rules in real estate.

But, is complicated.

Fund Size: Not too big, not too small, Just Right

This is a tough one, especially when you read about nine and ten figure funds being raised by the big guys.

Remember this is your first fund, not your last.

You want to raise enough to get real diversification and warrant the cost and effort of a fund, but shooting too high sets you up for disappointment even if fundraising goes well.

An oversubscribed $20 million fund is a better story than a $30 million fund where you fell short of your goal by 40%.

More importantly, do the math with your target deal size to make sure you can buy a minimum of six, but ideally 10 deals to get some benefits of diversification.

Our first fund was $11 million in equity, leveraged to buy about $25 million.

Which is TINY by most measures, but we had a very targeted strategy to buy sub-institutional multifamily and mixed use properties in San Francisco where $2-3 million deals were underbid.

We bought ten over a 12-month period.

Fundraising Nuts and Bolts

In your fund docs, you will identify a time period during which you can accept capital commitments, usually 6-12 months for smaller funds.

You want enough time to fill out the fund, but extended fundraising periods get tricky if you're buying at the same time and have to sort through pro rata ownership, tiered preferred return timing and other fund admin headaches.

And whenever the clock officially starts ticking, make sure you've already spent a few months meeting with LPs, refining the pitch and collecting soft commitments.

You want to hit the ground running.

During this fundraising period, you'll also be building the pipeline and (with luck) identifying your first few deals.

That pipeline is an essential slide in your fundraising deck, so make sure the acquisition team isn't lounging about during the calm before the storm.

This can all be done in unison and it's a lot to juggle.

But fundraising momentum picks up when you can start adding addresses to the pitch.

It’s a crazy, exciting time and the energy builds on itself.

Deployment: Steady as She Goes

As with fundraising, you'll set period during which you can deploy funds, generally 12-24 months for a smaller fund.

Don't cut it too short to avoid becoming a forced buyer, but too much time and LPs may worry that you'll lose focus, the market will shift, or maybe there aren’t enough good deals out there and you’ll be forced to settle.

Managing your new war chest is tricky in the early months, especially if you’re buying with cash and levering up afterwards, which the fund structure allows for.

Deal Terms: Keep it Simple (Stupid)

There is more disagreement on deal terms than perhaps any other topic in REPE, and I will not resolve that debate here.

So if you’ve found a set of deal terms that your LPs like and your team is happy with, don’t fix what ain’t broke.

For our first fund, we took an extreme approach:

- No management fee
- 1.5% acquisition fee
- 8% pref
- 50/50 carry split

We did this because our gray-haired partners had raised on these terms before and their LPs - who made up most of our capital - were OK with them.

I will tell you that these terms did not ultimately work well for LPs or the GP. But that's another post for another day.

All the rest

These details really just scratch the surface of actually raising a fund. It's a tremendous undertaking even for a relatively small amount of capital.

And you quickly see why people raise really big funds.

But this info should be enough to get the wheels churning and help you decide if exploring a fund is right for you.

You’ll need attorneys to guide you though this process, and I strongly suggest that you pay more than you’d probably like to for an experienced, well-regarded firm.

Among other things, they’ll provide a bit of credibility for newer GPs with a skimpy track record.

There’s also a bunch of investment management theory you should bone up on including cash drag, portfolio allocation among others.

You’ll also want to examine your borrowing capacity, because you’ll probably be signing for a lot more debt than your piddly balance sheet (or wife/husband) is ready for.

This is another reason we partnered up, which is a viable, but complex option.

Exit decisions are also tricky in a fund, as you’ll have to balance IRR and Equity Multiple (you get paid on the latter), while knowing that you likely won’t see any carry until the very end of the fund.

So make sure you can keep the lights on until then.

Lastly, if this all sounds fun and exciting and you're already asking Chat GPT to draft a "real estate private equity fund legal documents template," let me leave you with a few lessons from someone whose first fund did not go well, despite having good market timing:

1) Capital Deployment Pressure is REAL.

Especially after spending years struggling to raise capital, having a fund to deploy can be the quickest way to lose the discipline forced by having to pitch each deal individually.

I'd say we did an OK job resisting the temptation to spend the money because we had it, but there were a couple deals we probably would not have bought one-off.

2) Don't Estimate the Back Office

Fund admin, tracking capital accounts, K1s, cash management, project management - these are all multiplied when you have a fund.

Is it easier than buying a dozen one off deals?

Maybe.

It certainly is easier on the acquisitions team, but if your asset management group, back office and accountants aren't ready, they'll drown and that can get perilous.

3) Diversification isn't a free lunch

A primary benefit of a fund over one-off deals is supposed to be diversification. Which makes sense.

But, just like a lousy deal can be made up for by a bunch of winners, that lousy deal can sink an otherwise promising portfolio.

In our case, it wasn't specifically a bad deal that did us in, but a series of expensive capex projects that forced us to sell a large asset before realizing its potential.

4) Don't underestimate giving up control to a strategic partner

Especially for your first fund, it may be tempting to seek out a strategic partner to boost your credibility and fundraising capacity.

That's what we did, and at first it worked out pretty well.

But in time, we discovered that our new partners, who we had hoped could mentor us in fund management, weren't cut out for the rigor of high-speed, high stakes decisions under uncertainty required to manage real estate investments.

They weren't bad guys, but the partnership floundered and our original team spent more time fighting about what to do about our new partners than we did about making good investments.

This can even be true if a single large LP offers to bankroll a chunk of your fund in exchange for certain decision rights.

5) The lock-in effect

By definition, most funds lock you into a single strategy for a given amount of time, which may limit your ability or inclination to keep your eyes open for market shifts and new opportunities.

(This doesn't apply for large, institutional funds which can spread across strategies and geographies).

Specialization can be a powerful feature of an investment platform, but if you're inclined to be more opportunistic than strategy-specific, a fund may clip your wings more than you're comfortable with.