Investments in real estate funds are speculative – like all investments – and often rely on several economic conditions, including the expertise of the management team organizing the fund.
In most cases, your investment earns value after the properties/mortgages that are owned by the company receive income (ie. rent, sales, or mortgage payments). This means that any conditions, such as a decline in the rental market, a rise in interest rates, property depreciation, or a rejection of government zoning approvals can negatively impact your investment.
Unlike a public market, like stocks traded on the Toronto Stock Exchange, most private investments are not liquid. This means it would be difficult to sell or immediately value your shares of a private real estate fund unless outlined in the initial purchase. If you wanted to withdraw your investment early-on, typically a new investor would be required to take your place, which never has a guarantee that there will be a demand for the resale of your investment.
In the chance of poor economic conditions, you may even need to hold onto your investment for an indefinite period of time while the management team determines another strategy.
Most real estate funds are sold through the exempt market, which means they are not subject to the same disclosure obligations as investments on a public exchange. Typically, there is less information available on performance unless otherwise provided by the company.
There is never a “guarantee” that a real estate fund will earn you any income or profit. All investments carry different levels of risk, and the higher the potential rate of return, the higher the risk of the investment. Additionally, it’s important to note that just because your investment is ‘backed’ or ‘secured’ by a piece of land or building, that value can always change in poor economic conditions.
The biggest differentiator for a private investment is the management team’s ability to execute and operate the fund. Therefore, when you’re investing in real estate funds, you are also investing in the company’s management. As an investor, you should always do your research on the executive team and carefully review any disclosure in the prospectus regarding the company’s use of funds.
For most private investments, your rights as an investor would often be second (or further) in line from the other investors who provided money before you. This means that the lenders who provided money first would also be first in line to receive their money back from the fund. It’s important for all investors to clearly understand their rights and where they fall in terms of priority for payback.
In some cases, a private investments may ask you to commit to putting up more money when called upon if the financing company doesn’t have enough capital to cover its costs. It’s important to identify these terms before investing to ensure that you are not held personally liable.
If you have too much real estate fund exposure in your portfolio, it introduces an unbalanced risk which is more dependent on the real estate sector. Real estate is just one asset class out of several industries such as healthcare, gaming, start-ups, and natural resources. You can mitigate some of the risk in your portfolio by understanding where each investment would fit to best diversify.