The main legal aspects of the development of real estate funds



We previously wrote about some of the key points in forming your first multi-asset real estate fund, including structuring, type of target investors, and deciding whether to use a closed-end fund or an open-ended fund. Capital markets and real estate markets have shown their strength, creating opportunities for investors to invest as the country continues to open up. After setting up your first real estate fund, there are a number of additional considerations to consider when forming subsequent funds, especially if the total regulated assets under the funds are in excess of $ 110 million or if other jurisdictions are involved.

We asked Jonathan Niedell, President and Chief Investment Officer of Kairos Investment Management, to advise the new fund manager based on his experience in setting up numerous real estate funds. “Raising a follow-up fund often increases the AUM to the point that the manager is not exempt from registration,” says Niedell. “This requires significant investments in operating infrastructure, including investment operations, investor relations, cybersecurity, and regulatory compliance.”


In your first fund, you probably included investors with whom you already had a relationship. When moving from the first fund to the second or third fund, you may have a market track record, size or target capital raising sufficient to attract institutional investors, registered investment advisor platforms, and possibly placement agents. It is important to be aware of whether you are acting in any way that widely attracts and usually advertises investment opportunities in your fund. In such a case, Rule 506 (c) of the Securities Act contains requirements that must be met, such as taking reasonable steps to verify that all buyers are “accredited investors”. Following the more common Rule 506 (b) of the Securities Act, due to lack of offers or advertising, investors would generally be required to be “accredited investors,” but there would be no logistical hurdles to take reasonable steps to verify that that is a fact.


Another area that the next fund manager should be aware of is whether his investors are “qualified clients” or “qualified buyers.” If a fund manager is registered with the Securities and Exchange Commission or is located in certain states, it may not be able to charge a performance-based commission (i.e., interest accrued or promotion) from investors who are not “qualified clients”. “As defined by the Investment. Consultants Act 1940. “Qualified Client” has a technical definition that includes anyone with $ 1 million or more in assets managed by an investment advisor, or a person with a net worth of $ 2.1 million or more (excluding their primary residence).

Another consideration is whether it is necessary to prove that investors are “qualified buyers” because depending on the number of prospective investors and the fund’s portfolio, an exemption from registration under the Investment Companies Act 1940 may be required. Exceptions apply to funds in which all investors are “Qualified Buyers”. “Qualified Buyers” include an individual holding an investment of at least US $ 5 million and a legal entity holding an investment of at least US $ 25 million. Decisions about the type of investor base and the potential number of investors can significantly increase costs, disclosures, and complexity for fund sponsors.


While your first fund may have been mostly domestic, you may find it effective to raise capital outside of the United States. If you are attracting non-US investors, you will need experienced tax advisors to create an efficient and responsible tax structure. There are many potential ways to create an appropriate tax structure, including through the use of feeder funds from the United States or other countries or blocking organizations.

The right structure for your fund will ultimately depend on the personality, preferences and jurisdiction of your investors. For example, if you have a retirement plan investor, they will be structuring sensitive to avoid unrelated taxable business income, and if you have a German investor, the creation of a special purpose organization may be required under German law.

One way to create special tools for new investors is to create parallel funds. Parallel funds are separate funds that invest with the main fund, but are set up to meet the different tax, regulatory or other requirements of specific investors. If you are using a complex structure, you will need to accurately track and allocate expenses, including employee costs, across multiple funds.


If you have more than $ 110 million in regulated assets under management (RAUM), you will need to register with the SEC as an investment advisor. RAUM is the sum of the market value of all investments managed by a fund or family of funds managed by a venture capital firm, brokerage firm, individual registered investment advisor, or portfolio manager on behalf of its clients.

As an investment advisor, you are the “confidant” of your advisor clients (that is, the funds and accounts you manage). This means that you have a fundamental obligation to act in the best interests of your clients and to advise on investments in the best interests of your clients. It is your responsibility to show your customers the utmost loyalty and conscientiousness. You must not engage in any activity that is contrary to the interests of any client, and you must take steps reasonably necessary to fulfill your obligations. Unless you avoid a conflict of interest that could affect the impartiality of your advice, you must disclose the conflict fully and frankly. In addition, you must exercise reasonable care not to mislead customers and ensure that all material facts are disclosed fully and fairly to your customers and potential customers.

As a registered investment advisor, you must adopt and implement written policies and procedures that are reasonably designed to prevent violations of the Investment Advisors Act 1940, including: portfolio management processes, accurate disclosure, proprietary trading, client asset protection, security measures. to protect the confidentiality of customer records and information, sales practices, marketing, estimate and estimate of commissions, and business continuity plans. You must take other steps, including preparing and periodically completing an ADV form, and adopting a code of ethics., complying with the required clauses in your consulting contracts with clients and passing the SEC compliance checks. Registration requires significant investment in infrastructure, including system, regulatory compliance, cybersecurity, investor relations, among others.


Depending on the size and complexity of your fund (including a waterfall of cash allocation or liquidity rights, number of investors, information rights, and other obligations to investors), it may be necessary or appropriate to involve an external fund administrator. The fund administrator can assist you with the logistics of your fund and provide services that include partnership accounting, financial reporting, capital requirements processing and allocation, investor capital account maintenance, treasury services, audit and tax support, and coordinated execution of all investor results. As your investor base grows, you will likely also need experienced investor relations staff to handle reporting, outreach and investor relations.


As you move from your first fund to subsequent, larger funds, you may need to hire more staff, including fundraising teams, to invest the funds raised. Experienced employees often expect to be able to participate in fund investments (no fees or carry-over) and share in the profits, either through a sponsor’s equity stake or by participating in certain sponsor fee income. Establishing a capital market incentive program will require coordinated corporate planning, securities planning, employment and taxation.


This article discusses some of the main considerations when moving from your first real estate funds to subsequent funds.

© 2010-2021 Allen Matkins Leck Gamble Mallory & Natsis LLP Review of National Legislation, Volume XI, Number 204


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