Money is a finite resource. Investing in commercial real estate is expensive, so chances are good you’ll run out of your own capital quickly. Learning when and how to properly raise capital is crucial if you’re looking to grow. In fact, most of the largest investment and development groups utilize raised capital from investors in order to continue to scale. Real estate investors must approach their activities as a business professional to establish and achieve short- and long-term goals.
Investment capital is the money you use to fund your commercial real estate investments.
That capital can be raised to cover:
- Down Payments
- Closing Costs
- Renovations
- Tenant Improvements
- Operating Costs
Raising capital refers to sourcing funding from external sources, such as corporations or private investors. This capital can come in the form of debt or equity financing.
Equity
Equity is the amount of money that you would receive from selling an investment. Lenders will typically require you to have around 20%-30% equity in the deal. The higher your equity is in a project, the lower your risk will be. Equity finance requires no repayment, meaning you can put much more into your private lending service. Equity financing comes with more risk, so if you’re getting ready to set up your service these offers may be rarer than debt financing.
Debt
Debt is capital borrowed from a lender to purchase an asset. Investment groups will utilize leverage to buy larger properties than they could with only their equity contribution. The higher your debt is in a project, the higher your risk will be. When you’re paid debt finance, you must pay back this investment in your private loan service with interest. This means you’ll need to factor in any necessary interest payments when budgeting, but repayment terms will likely be forgiving.
When taking on investors, you need to decide early on how the deal will be structured. This structure will vary depending on how you approach the capital raise. Not only will you need to choose a legal entity, but you should also have an operating agreement that governs the deal.
Operating agreements typically cover:
- The Equity Structure
- Management and Operations
- Voting Protocol
- Books and Records
- Transfers and Liquidation
- And Distributions
Below are the most common deal structures in commercial real estate.
Joint Venture
A Joint Venture (JV) is a partnership between two or more entities. Each party will be actively contributing to the deal. There are different reasons that groups may choose to joint venture instead of one of the other partnership structures, such as one of the partners already owning the land or tax purposes.
Limited Liability Company
The Limited Liability Company (LLC) is the most common structure I’ve seen. Investors will take the LLC route because of tax benefits and the liability limitations the structure offers. Many investors will own each property in its own LLC so that if one investment goes awry or faces a lawsuit, the other properties won’t get dragged down. If you’re planning on investing in real estate with a few close friends, this may be the best option for you.
Limited Partnership
A Limited Partnership (LP) is an entity that requires two or more people to form. These partnerships are made up of General Partners and Limited Partners, each with their own responsibilities and contributions. General partners typically operate the deal while limited partners contribute capital. Unlike an LLC, partners can be personally liable for any mishaps on the deal.
Syndication
A syndication may be formed as any of the entities above. The main difference here is how the capital raise is treated. If you intend to raise capital from third-parties, you’ll likely take the syndicate route and the investment will be treated as a security.
You will have to adhere to very strict rules and regulations with regards to how and from whom you can raise capital. Syndicates may be further classified as:
506(b) – Operators can raise money from accredited investors and up to 35 unaccredited, but sophisticated investors. You should have the ability to prove a pre-existing relationship with each investor.
506(c) – Operators can raise capital from anyone, including investors without a pre-existing relationship, but must take reasonable steps to verify the accredited investor status of each investor.
CONCLUSION
Raising capital as a private investor is key to establishing your firm, scaling your fund, growing your brand and business, and finding more profitable deals. With backing from established investors, your firm’s reputation will flourish, and further investment will be easier to find and secure.
According to the experts, networking is a skill you’ll need to hone since you’ll be using it regularly while you want to connect with a private lending firm. For those starting to form a list of potential investors to raise capital, get your foot in the door at events hosted by private lending spaces. Pitch slowly and continuously to varied investors by building up a picture of your practice. Diversify your practice and align these deals with investors who are interested.
Finally, don’t be tempted solely to fund deals with capital raised. Raising capital helps with day-to-day operations, but is vital for long-term success. Focus on your growth, finding new leads with modern solutions, and raising capital as a secure fund for when opportunities present themselves.
As informed investors we should understand the risks associated with real estate investing and that there is no guarantee. Please do your due diligence.
