What is the difference between General Partners and Limited Partners?
Real estate investments are comprised of two types of parties, General partners (GP) and Limited partners (LP). General Partners are typically asset managers. They are responsible for managing the property themselves or via a third party. Limited partners are passive investors who do not make decisions about the day-to-day operations of the property or a property’s management.
What is a preferred return?
Preferred return is a designated amount of distributable cash to be returned to the investor before any return splits. For example, if a deal has a preferred return of 8%, then the first 8% returned on an investment (distributions from cash flow or capital events such as refinance proceeds or disposition) will go entirely to the Limited Partners.
What is the internal rate of return (IRR)?
The internal rate of return (IRR) is a measure of an investment’s rate of return. The term internal refers to the fact that the calculation excludes external factors, such as the risk-free rate, inflation, the cost of capital, or various other financial risks.
IRR is designed to account for the timeline of investments. A given return on investment received at a given time is worth more than the same return received at a later time, so the latter would yield a lower IRR than the former
What is an equity multiple?
The equity multiple is defined as the total cash distributions received from an investment, divided by the total equity invested. For example, if the total equity invested into a project was $1,000,000 and all cash distributions received from the project totaled $2,000,000, then the equity multiple would be $2,000,000 / $1,000,000, or 2.00x.
An equity multiple less than 1.0x means an investor is getting back less money than invested. An equity multiple greater than 1.0x means an investor is getting back more money than invested. In the example above, an equity multiple of 2.00x means that for every $1 invested into the project, an investor is expected to get back $2.00 (including the initial $1 investment).
What is a split, and what is a waterfall?
Following the payout of the preferred return, the “split” will be paid to both the general partners and limited partners, using a pre-determined payout structure. The split is how the returns are allocated between the GP and the LP after the preferred return has been reached. If the split is 80% to the LP and 20% to the GP, after the preferred return is paid, then the LP and GP split all other proceeds from distributions or capital events 80/20.
That split can change if a certain hurdle (or waterfall) is achieved. Example: A split could be 80/20 then go to 70/30 once the IRR hits 17%. Any returns higher than 17%, will then be split 70/30 LP/GP. The changing of the split by hitting milestones is a waterfall. In some cases, a firm might have multiple hurdles or waterfalls.
What happens to the money when an investor funds an investment?
Funds can be wired directly into the subscription account of the fund. The funds are typically held in an escrow account in the name of the LLC until the closing of the property. Escrow helps ensure that the funds are available, yet also kept safe. Escrow can be used in a variety of different types of deals but is especially common in the real estate industry.
What if there is a downturn in the economy?
Selling during an economic downturn effective “locks in” loses, which is why typically try to use a more holistic, forward thinking approach to investment. Instead of dumping our assets, the goal would be to continue to pay the preferred return and hold on until the market returns to a healthier state. Although there are no guarantees, value-added assets are better positioned to withstand down markets—housing is a basic necessity and, even during economic low points, demand for housing will continue to persist.
Can anyone invest in these offerings?
No, only non-accredited investors who have developed a substantial relationships with Smartland can learn about our 506(b) offerings. To invest in our 506(c) offerings, an individual, couple, or entity needs to be considered an accredited investor. Smartland’s offerings are classified as Regulation D, 506(b) and 506(c) and governed by SEC regulations. Therefore, Smartland must receive third-party verification for all investors. Self-accreditation is not sufficient. Accredited investors have higher incomes, high personal wealth, or have otherwise been “cleared” for these types of investments.
What is an Accredited Investor?
An accredited investor is someone who meets certain requirements regarding income and net worth, based on Securities and Exchange Commission (SEC) regulations. Limiting investments to accredited investors can help ensure that investors participating in private funds display a certain level of financial sophistication when evaluating potential offerings.
To be accredited, an investor must satisfy at least one of the following:
- Have an annual income of $200,000, or $300,000 for joint income, for each of the last two years, with expectations of earning the same or higher income this year.
- Have a net worth exceeding $1 million, not counting an investor’s primary home.
- The Investor is a director, executive officer, or general partner of the Fund, or a director, executive
officer, or general partner of the general partner of the Fund.
- The Investor is a natural person who holds, in good standing, one of the following professional licenses:
the General Securities Representative license (Series 7), the Private Securities Offerings Representative license
(Series 82), or the Investment Adviser Representative license (Series 65).
- The Investor is a “knowledgeable employee,” as defined in Rule 3c-5(a)(4) under the Investment
Company Act of 1940, of the Fund.
Your financial advisor should be able to help you determine whether or not you are an accredited investor. There are some exceptions to this rule (such as the income gap for explainable reasons), but generally, all accredited investors must meet these criteria.
Can an investor subscribe with an LLC or Self-Directed IRA?
Yes. It would simply entail a slight difference in how an investor signs the subscription agreement and fund the deal, with no added degree of difficulty. There are some things to consider, however, such as the UBIT (unrelated business income tax), which is why Smartland recommends seeking the counsel of a CPA, licensed financial advisor, or other trusted, licensed advisors.
Regardless of the entity chosen for the investment, it will still need to be verified as an accredited investor. For example, a multi-member LLC would need to have all members verify their status as accredited investors. This can create some complications if the net worth and incomes of the multi-member LLC vary significantly. When such variations exist, members may need to consider restructuring or reallocating their wealth.
Investors often do not realize that, by moving their IRA funds into a self-directed IRA, they can diversify their retirement portfolios by investing in real estate. For Self-Directed IRA, we have preferred relationships with vendors to expedite the onboarding and can accept retirement assets for investment.
What are the projected returns?
Typically, investors can expect to find projects that are structured as followed:
- Preferred return (pref): 6-9% (LP’s take 100% of distributable cash until they reach the preferred return.)
- Internal rate of return (IRR): 16-22% (a time-sensitive rate at which an investor’s money grows, annually, over the life of the project). Changes to expected IRR (both positive and negative) will be directly related to changes in exposure to risk.
- Cash-on-cash (CoC): 8-12% (a rate of return that determines the cash income on, or in proportion to, the cash invested measured annually)
- Equity multiple: 1.7-2.3x (on a $100K investment, LPs earn $170-$230K, including return of initial investment)
How frequently are distributions made?
Distribution frequency is project-specific and dependent upon the specifics of each operating agreement. Lenders govern some distribution schedules, and the timing can be monthly, quarterly, semiannually, or annually. Changes in the distribution schedule might also be connected to changes in risk, IRR expectations, and other variables. Each fund provides its’ own set distribution schedule. Please review the fund private placement memorandum.
How often will communications/updates be sent out?
Communications and updates being sent to investors will vary by firm. Some firms provide information quarterly, semiannually, or even annually. Generally, riskier and more speculative investments will provide investors with more frequent communications.
Smartland sends statements to investors quarterly. All updates and communications will be accessible from the investor portal. Any additional announcements that are made, including refinance updates, disposition updates, and others, would be sent via the investor portal as well.
Does the sponsor invest in their deals / Why are they investing such a small amount?
Good sponsors invest alongside LPs in their deals. If a Sponsor does not co-invest, their interests may not be aligned with the investor. If a sponsor has put together a strong deal, they should want to share in the success of a project. Sponsors often participate in multiple deals throughout the year, which is why sometimes their share in a given deal may seem relatively limited, on paper. Furthermore, most Sponsors are also the loan guarantors and require some liquidity in their personal balance sheets. Structurally, sponsors are exposed to greater degrees of personal risk than many of their counterparts.
Smartland invests in its deals alongside with investors. A small portion is contributed by the sponsors to illustrate the belief in and alignment with Smartland’s offerings. In other words, sponsor involvement is a way for them to “put their money where their mouth is” and demonstrate that they truly think the proposed investment is worth taking a risk on.
Can investors cash out of an investment at any time?
No. By their nature, real estate investments have a longer-term time horizon than that of stocks or bonds. Real estate investments are structurally illiquid because it can take a considerable amount of time to convert a real property into its cash equivalent. However, deals do allow for the sale or transfer of an interest in an investment. Each deal’s operating agreement will specify what needs to be done for the process to be completed. Reading these agreements, in full, will make it easier to determine how risky (and rewarding) a prospective investment might be.
How long does an investor need to commit?
The exit strategy for these investments is generally range from two, five, seven, and ten years, although this timeline may vary, depending on the property and specific business plan being executed. Changing economic circumstances can also affect the original hold time, so passive investors do need to place a certain level of trust in the management team to make decisions that will maximize all investors’ returns. Original timelines will be adhered to as much as it is possible to protect everybody’s investment.
What is a K-1?
Similar to 1099, a K-1 form helps account for the amount of tax that will need to be paid at the end of the year. Each investor receives one per investment. K-1 forms are most commonly used in partnerships and in (non-personal) real estate ownership.
What is a 1031 exchange? Will I be able to 1031 exchange from one deal into the next?
A 1031 exchange involves reinvesting the proceeds from the sale of one property into another project within a certain timeframe to avoid paying tax on capital gains. To put it simply, this strategy allows an investor to “defer” paying capital gains taxes on an investment property when it is sold, as long another “like-kind property” is purchased with the profit gained by the sale of the first property.
Smartland investors cannot use a 1031 exchange since they are purchasing units of Limited Partnership and not the property itself. The 1031 exchange is only available for the direct property owner.
If Smartland offers the Limited Partner’s the opportunity to participate in a 1031 or similar exchange, this election will take place at the time of disposition of any single asset within the Fund. Liquidity/Dispositions How are taxes treated? Smartland is not a tax advisor and we recommend you reach out to your tax advisor to understand the effects for you. You will receive a single federal K-1 and a single state K-1 for each income tax state we own assets in. We will continue to operate the assets in the most tax advantageous way possible, including the use of Cost Segregation Studies.
What is a supplemental loan?
Due to the nature of value-add syndication, it is very common to create significant value in property through renovations, tightening operational efficiencies, and other common improvements. In the case that these sorts of value add-ons are achieved, the sponsor may consider going back to the bank with a now higher assessed property value and either refinance the property or obtain a second/supplemental loan.
The choice between these two options depends on market conditions and what interest rate can be obtained vs. the current interest rate. This allows the sponsor to pull out equity and return it to investors, tax-free.
While there is dilution (8% pref now based on the remaining equity in the deal as opposed to initially invested equity) typically associated with an equity event, the event also increases the cash-on-cash (CoC) & IRR on the project.
The main reason managers refinance property is to take advantage of the savings from a lower interest rate and longer loan terms, which simultaneously reduces long-term debt as well as monthly payments. Even just a small change in available interest rates can significantly add up over time and do far more than offset the cost of refinancing. Smartland can also take out tax-free cash to renovate the property or distribute capital back to investors
What is amortization?
When a mortgage is first taken out, whether, through a refinance or a home purchase, the balance of the loan is at its highest point. That means the amount of interest to be paid on the loan is also at its highest point.
A 30-year mortgage has 360 monthly payments. If a borrower took out a $360,000 mortgage to buy a home, and it was not amortized, each month’s payment would include $1,000 in their principal paydown, plus the interest due on the balance. Over time, the amount of interest due each month would continually decrease until the entire mortgage has been paid.
It would quickly become a hassle to pay a different amount each month (in addition to potential cashflow problems). Amortization fixes this problem by only paying a small portion of the principal balance at the beginning of the loan term and a large portion at the end. This way, the payments balance with the large interest portion of the payment at the beginning, and the small interest portion at the end. Over the course of the loan, the monthly mortgage payment of principal and interest remains the same.
Amortization does not apply to other costs of property ownership, including property taxes (which can change over time), insurance, and others.
How does a Fund work?
A private real estate company (the sponsor) establishes a Fund with certain parameters, then raises money from investors to capitalize the fund. The sponsor uses the capital to make investments under the fund. The money can be deployed anywhere in the capital stack; funds can be used in the mezzanine debt, bridge loan, or senior loan positions of the capital stack. The distribution of these funds will depend on what is established in the private placement memorandum (PPM). A fund allows an investor to spread the risk of the investment across all future deals instead of putting it all in a single deal.
What are the benefits of investing in a Fund?
The obvious benefit of a Fund is diversification. The investor in a Fund is instantly diversified across multiple assets, rather relying on a single property to appreciate. A Fund portfolio can contain 10 to 20 separate investments spread across a broad geographic area and multiple different types of properties, which can lower risk, compared with just owning a single asset. The other better performing properties mute the effects of a poorly performing deal. Additionally, investing in a Fund can help eliminate many of the stresses and hurdles that you’d find when investing entirely on your own.
What is the difference between a REIT and a Fund?
With a REIT, an investor commits money upfront before the properties are purchased and, most of the time, don’t know what properties they are invested in. REIT investors will evaluate the company’s general ability to perform, rather than a specific property’s future potential. In this sense, REITs are similar to stocks (and in some cases, they are available to invest in via the stock market).
The theory is an investor buys a diversified pool of properties, but in practice, REITs don’t start with a pool of properties, and they must start paying dividends to their investors. So, REIT managers have the propensity to invest in properties quickly to generate dividends to pay the investors. There is an immediate demand for returns that will need to be addressed—this can sometimes lead to firms making less than optimal investments.
On the other hand, an entrepreneur-run private equity Fund seeks property that provides all the conditions of a great investment, including cash flow, location, job growth, rent growth, and view of the future so an investor can exit with a profit. Investors’ funds will not be collected until a favorable deal is sourced, and then a capital call will be placed. Keeping this in mind, funds are generally considered to be less risky (and easier to forecast) than REITs.
When does an investor commit funds?
Investors will commit a certain amount of capital through the subscription agreement. When Smartland issues a capital call, they will be obligated to contribute all or a portion of the committed capital. When sponsors compete on assets, there is always the risk that the deal may fall through. On a single-asset investment, if the sponsor cannot raise sufficient capital to fund the equity payment, they must withdraw. Fund structures have the benefit of committed capital, or “dry powder” ready to go. This may be cash on hand or other forms of liquid capital that are available on short notice through capital calls.
When does an investor start receiving the preferred return from the fund?
An investor’s capital will be called once Smartland is ready to close on an asset. Once the capital is deployed, the preferred return will begin to accrue. Smartland aims to start distributing a preferred return for each new round of the fund within 90 days of deploying capital and acquiring an asset or when cashflow is available.
For example, an investor whose funds were deployed in July would expect to begin receiving their preferred return no later than the following October. This allows Smartland the time to acquire and stabilize the property.
Can I take my money out of the fund?
No. An investor’s money will stay in the fund for the life of the fund. It is possible to transfer ownership of the shares in the fund, but they are not redeemable until the end of the fund’s operational cycle. This helps create stability for the fund and makes it much easier for the fund to successfully finance new properties or other investment projects.
Are assets in the Fund cross-collateralized?
No, the assets in the fund are not cross-collateralized. Each asset in the fund has its own operational procedures, and their financial operations remain separate. This helps reduce the risk of one underperforming fund from interfering with or otherwise negatively affecting the others (not keeping all the eggs in one basket).
Is the $100M Value-Add Fund an Evergreen Fund?
No, the fund is not an evergreen fund. This means there will not be a perpetual contribution schedule. The fund allows 24 months of capital raising with an expected hold time on each asset of 5-7 years. The fund does have the ability to go longer based on market conditions to ensure that Smartland does not sell in a down market.
What is the minimum investment?
Each offering differs for minimum investment. For our $100MM Value-Add Fund, the minimum for Class B investor is $250K and Class A investor is $1MM. Additionally, all investors must be accredited investors, meaning they meet certain income or net worth thresholds.
Can I invest with my retirement account?
Yes. Self-directed IRA, Solo 401k, and many other types of retirement accounts can be used for investing. As long as your retirement funds are in an account that allows for your investment discretion, i.e. Self-directed IRA, we can accept these investments. Be sure to speak with your accountant or financial advisor to discuss your possible investment options.
We do not anticipate making capital calls. When you are ready to commit to the fund, we will ask that your entire commitment be funded at that time. However, should additional capital be needed, we retain the rights to do so in the subscription agreement. Please refer to these legal documents for more details.
How will distributions occur as assets are sold off?
We will distribute the proceeds of sale of each asset in accordance with the waterfall outlined in the private placement memorandum. Both general partners and limited partners will have a pre-determined payment outline, making it relatively easy to determine what their future returns might be. For practical purposes, investors can expect to receive their share of the proceeds from the sale of each asset, as they occur.
Is the carried interest calculated at the fund or asset level?
All carried interest/waterfall distributions will be calculated based on the overall returns of the fund. General Partners will not take additional funding until the Class A and B equity hit certain thresholds of the waterfall.
Please see the private placement memorandum for a more detailed explanation
What is the life of the fund?
We anticipate divesting of all Fund assets within the first 5 years. However, we also anticipate several capital events happening much earlier, such as individual property refinances and dispositions in year 3 and beyond. We did not underwrite this in our projections because we always want to remain conservative. However, a capital event could return significant capital back to investors early in the life of the Fund
What happens if you cannot sell all of the assets before the fund ends?
Just like our single-property investments, we want to make sure that we sell our properties during the best possible time of a real estate cycle. Therefore, we have not defined an end date to the Fund. Nevertheless, we understand the return of capital is important to our investors, so it is never our intent to hold on to properties for too long. We anticipate fully divesting the Fund within 5 years from the launch of the Fund.
How are you benchmarking distributions/returns?
We will have a set of return parameters outlined for the fund and the Fund investment summary package that align with the asset type we have historically purchased. The benchmarks we use might vary by investment. Identifying these metrics and benchmarks in advance will help investors determine whether their expectations have been met. They will also help us know which sorts of changes we need to make, help us plan for the future, and help us also improve our investor’s future expectations.
What type of reporting will I receive?
You will receive quarterly email updates with quarterly financial reports uploaded to your investor portal. You will receive a K-1 anticipated to be provided by March 31st of each year, which will also be securely uploaded to your investor portal.
What is my liability as an investor?
Your liability will be limited to the capital you have invested in the Fund. In theory, all of the money that has been contributed will be at risk, though it is extremely unlikely that it will all be liquidated (even faltering assets in the real estate market can still be salvaged). All liabilities and exposure to risk should be clearly outlined upon the agreement.
Is this an evergreen fund or open-ended fund?
The $100M Value-Add Fund is a closed-ended fund. At Smartland, we have both closed end funds and open-end funds. An open-ended fund means that unlimited new shares can be issued, whereas a close-ended fund will issue a limited amount of shares. This helps create a greater sense of predictability, especially when it comes to ownership structure.
Will I be able to get my money out before you sell all the assets?
Your investment will be considered an illiquid investment, so anticipate that your capital will be committed throughout the life of the Fund. If you are unsure whether you can commit the capital for the prescribed investment horizon, you might want to reconsider investing. However, we will be distributing proceeds from sales and refinances according to the waterfall, and we anticipate achieving both throughout the Fund, likely creating early capital events.
What is the Purpose of the Smartland Value-Add Fund?
The Smartland Value-Add Fund was created with one singular purpose in mind: to reduce our investors’ risk while offering a very similar return structure to our single-investment offerings. Unlike our previous offerings, our investors’ returns will not be dependent on one property and or even one submarket. Instead, the fund will own multiple assets in desirable markets and risk will be spread over the collective returns of each. Smartland will still operate each property just as diligently and carefully as before, yet the risk profile will be mitigated by the pooled returns of each asset in the fund. This significantly reduces the investor risk-to-return ratio. Besides moving to a fund, are there any other changes from how you operated in the past?
Operationally, we are looking for the same type of assets to execute the same business plan.
When do I begin to accrue a return?
Accounts begin to accrue the first day of the following month after the date of Acceptance. However, distributions will not occur until later on. Additionally, once the investment has been made, the capital will be effectively “locked in” for the entire life of the fund.
When will distributions likely begin?
The Manager’s goal is to begin distributions by the conclusion of Q3 2022, but timing of any such distribution may vary for a number of reasons. The ability to attract investors, the ability to find desirable properties and projects, and other variables will directly when distributions can be expected to begin.
Must I be “Accredited” in order to invest in the Fund?
Yes. The Fund is offering Units to Investors under an exemption from securities registration afforded by Regulation D, Rule 506(c), which requires the Manager to take “reasonable steps” to verify that each Investor is “Accredited,” prior to allowing them admission to the Fund. There are eight (8) separate categories of Accredited Investors, under which an Investor may qualify, each of which is provided in the Fund’s Private Placement Memorandum, along with the documents the Investor must provide to demonstrate its qualifications to invest in this Offering. For more information, visit SEC.gov.
What is the duration of this Fund?
An investment in the Fund should be considered long-term in nature. Investors should be in a financial position that will enable an Investor to hold its Class A or Class B Interests for the duration of the Fund, which is projected as up to five (5) years, or longer. As a rule of thumb, you can plan for the life of the fund to be 5-7 years.