Creating a Private Equity Fund: A Guide for Real Estate Professionals

By: Jan A. deRoos, Ph.D., HVS Professor of Hotel Finance and Real Estate at SC Johnson College of Business, Cornell University and Shaun Bond, Ph.D., West Shell Jr. Chair in Real Estate at Lindner College of Business, University of Cincinnati

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Setting up a private equity fund can be a big and confusing step for many real estate professionals. To help demystify private equity fund formation and operation, the NAIOP Research Foundation commissioned this white paper. It is geared toward those who have limited familiarity with the process and want to learn the basics. The authors provide step-by-step guidance, along with an example of a fund waterfall and a case study of how one company successfully used a series of private equity funds to seek out opportunities during the financial crisis when other sources of funds were limited.

The report examines the following:

• The real estate private equity fund industry has grown into a multi-billion dollar global business. However, scale is not necessary to be successful; smaller fund managers can create value and returns for all parties involved.
• Real estate funds can allow sponsors (managers) to diversify and expand funding sources, invest in larger, higher-quality projects, obtain better terms from banks, and earn fees from the fund, including promoted interest.
• Fund managers must go into the endeavor prepared. They must consider the amount of equity capital to be raised, including fees; be aware of the amount of time required to launch and maintain the fund; and have a clearly articulated investment fund strategy.
• Sponsors typically collect compensation through promoted interest and an assortment of fees. However, sponsors should not see their fund as a vehicle for generating fees at the expense of their investors. In addition, and as this paper details, sponsors should also be aware of securities laws and other regulations, and how to properly produce offering materials.
• The most important aspects of setting up a private equity fund, no matter the strategy, are to have solid, trustworthy fund leadership and a transparent communication style. The fund manager’s reputation is essential to attracting investors and successfully managing the risks.