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Self-Directed Regulation D Real Estate Fund Investments

January 3, 2019


You’ve set up a self-directed IRA account at Nuview Trust Company and you have or are in the process of deciding how to invest your IRA funds.  For many investors they are interested in having exposure to real estate as part of their IRA portfolio.  Through your self-directed IRA you may choose to invest directly in buying or owning a piece of real estate, while abiding by the limitations set for IRAs (generally restricting you from buying something for personal use or from transacting with certain members of your family).  For many investors they choose to invest in a “fund” that is limited to real estate investments to achieve exposure to real estate.

There are a variety of ways to invest in real estate through your IRA.  The focus of this article is investing in Regulation D (Reg D) private placement Funds.  Regulation D is a United States Federal Program created under the Securities Act of 1933, which allows funds to raise capital the sale of equity or debt securities.  Reg D private placements are generally available to accredited investors.  An accredited investor is generally defined as a person with an income of greater than $200,000 over the last two years (over $300,000 if joint) or having a net worth greater than $1,000,000, excluding the equity of a personal residence.

There are many types and nuances to various funds and beyond the scope of this article.  Some funds focus on a single piece of real estate and may have a life of 3-5 years to purchase, develop and ultimately sell real estate.  Other funds may focus on a pool of real estate, either through direct ownership or lending with collateralization of the real estate.  Let’s focus on an example fund to highlight how a fund may be organized and some of the aspects that are important to understand when deciding which fund you may be interested in investing in.

The Sortis Income Fund, LLC (SIF), is a Reg D private placement available to accredited investors.  This fund is organized as an LLC and investors become members (this is an example of equity ownership vs. debt ownership).  In the case of the SIF, this is an unlevered fund.  Leverage is very important for at least two reasons.  Leverage occurs when a fund borrows money, generally pledging its assets to obtain a loan.  The money borrowed is often at a low interest rate and allow for investment at a higher interest rate to provide a greater return to investors (equity owners).  However, the lender is now in 1st position on the fund assets and in any sort of liquidation they are the 1st ones to receive proceeds with investors receiving whatever is left.  In a real estate fund with leverage, rates of return can be higher in the good times, but in the tough times when real estate values decrease, investor principal is at much greater risk (remember the lender gets paid back first in liquidation of any real estate).  Also, using leverage in a fund, creates unrelated business income taxes (UBIT) for IRA owners.  The borrowing of money (leverage) for reinvestment to drive a higher return to investors creates UBIT and provisions must be made for paying that tax.

The SIF is a fund, with experienced sponsors, and owns 1st position, short-term, commercial, real estate mortgages.  Interest is paid out quarterly or reinvested at the investors’ discretion.  Reporting is transparent.  The words in bold below are meant to stand out as key components to consider when evaluating any real estate mortgage fund.

  • In the SIF, a fund that holds real estate backed loans, it is critical that the underwriting process for loans is extremely robust and managed by experienced, licensed Loans need to be originated and serviced over their life, with the proper regulatory licensing.  Also having loan deal flow is important as it allows the fund to select and underwrite loans from start to finish.  Many funds available for investment buy loans from third parties.  This can be challenging from a start to finish underwriting process and it requires paying a portion of a funds yield to the source of the loans (versus returning that yield to the investor).
  • It is important to select a fund that is in first position on underlying real estate collateral. Being in 2nd position, behind another lender can create higher yields, but comes at a much greater risk profile in the event real estate values decrease or challenges occur with real estate collateral where the 1st position and 2nd position holders have different strategies or agendas in resolving loan issues that arise.  It is also important to understand how much a fund will lend on the value of real estate (called loan-to-value or LTV).  The SIF maintains an LTV, on average, of less than 70%.  This provides protection for an investment in the event real estate prices decrease.  It is difficult to achieve this sort of protection in the stock market.
  • The length of loans in a real estate fund often dictate the liquidity of the fund. In the case of the SIF, typical loans are 12 months with no prepayment penalties.  The average borrower maintains their loan for 4-8 months.  This provides frequent liquidity and the SIF can meet quarterly distribution requests up and to the entire invested balance subject to available liquidity, which is much more likely with short term lending.  Many funds require significant notice timelines in order to exit that make liquidation of an investment extremely difficult in a timely manner.
  • The SIF offers quarterly dividends of earnings or reinvestment at the account owners’ discretion. This allows flexibility for the IRA owner to grow their SIF investment or take the earnings back into their IRA for investment in other qualified investments.  It may be important to ensure a fund provides flexibility to allow for a distribution in the event an IRA holder needs to take and annual required minimum distribution.  Or if the IRA holder is in a phase where they are drawing out funds in retirement and cash flow is required to support that distribution.
  • Commercial lending does not have the same compliance demands as consumer lending and it provides less risk to investors that loans may be non-compliant with laws and regulations. Compliance and deep lending knowledge are always required, but a focus on commercial lending helps mitigate the risk associated with consumer lending.
  • Returns can vary, but you generally see net yields on these types of funds range from 8-12% annually (after management fees). This can be impacted by many of the factors noted above with higher yields being associated with higher risk.  As a frame of reference, the SIF has returned a net yield to investors of over 10% over the last two years, while maintaining a positive position in all the risk factors noted above.  In evaluating a return on a fund, it is critical to consider the items noted above, especially thinking through scenarios where real estate values may decrease.
  • Reporting should be transparent. For example, the SIF provides quarterly reporting that includes a letter on the state of the Fund and its activity.  It includes a quarterly balance sheet, income statement and the math behind exactly how the management fee is calculated.  This type of fund is carried at cost, so providing updates to the IRA custodian is simply a function of taking a quarterly statement that shows your current balance (original investment plus any earnings that have been reinvested).  Any fund should provide you with periodic financial reporting.

In summary, if you are seeking to diversify through exposure to real estate through your self-directed IRA at Nuview Trust Company, Reg D private placement funds can be a valuable resource for accredited investors.  However, investors should carefully consider the parameters of a fund noted above, along with the experience of management and their track record of performance.

Jef Baker
Fund Manager
Sortis Income Fund LLC





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