By Dr. Jim Dahle, WCI Founder
As you explore the world of private real estate funds, you begin to notice a few things. You notice that minimum investments are highly variable. You notice that some have adopted REIT structures to facilitate the use of 199A dividends, and some have not. Perhaps the biggest variation, however, is that some of the funds are open-ended and some are closed-ended. So, what's the difference?
What Is an Open-Ended Real Estate Fund?
An open-ended real estate fund is a fund that does not end. The fund can grow to any size depending on investor interest. It allows investors to contribute new money to it in an ongoing manner and to withdraw money from it periodically. It can be structured as a REIT (distributes a 1099) or as an LLC/limited partnership (distributes a K-1). An open-ended fund often has a bit more of a focus on income and regular distributions than closed-ended funds.
What Are Some Examples of Open-Ended Funds?
Most debt funds are open-ended, including all of the debt funds in my portfolio. There is much more variation on the equity side. Examples frequently discussed among white coat investors include:
- All DLP Capital Funds
- The Origin Income Plus Fund
- The Peak Housing REIT
- Fundrise REITs
- RealtyMogul REITs
More information here:
What Is a Closed-Ended Real Estate Fund?
A closed-ended real estate fund has a definite end point when the fund will no longer exist. Those kinds of funds have a pre-determined length of time where they will run, for example, 3-5 years or 8-10 years. They generally have a pre-defined size, and when that amount of capital has been committed, the fund closes to new investments. The fund company then begins raising money for a new fund. So, you'll see Fund I, Fund II, Fund III, etc.
Capital is called periodically and put to work as assets (properties) are purchased. When assets are sold, capital is returned to the investors. An investor cannot add new capital to the fund once it has closed. These investments tend to be very illiquid with no ability to withdraw your money until the fund managers are done with it. The investments are usually equity investments, and they may not provide any income whatsoever for the first few years. A large part of your investment return will come in the last year or two of the life of the fund.
What Are Some Examples of Closed-Ended Funds?
Most private real estate funds are closed-ended, and most are structured as limited liability companies or limited partnerships rather than REITs. Examples include:
- MLG Capital Funds, such as Fund VI
- Origin Growth Fund IV
- Origin Opportunity Zone II
- Wellings Real Estate Income Fund
- 37th Parallel Fund II
More information here:
Should I Invest in a Real Estate Syndication or Fund?
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Aren't Some Mutual Funds Closed-Ended?
This concept should not be entirely foreign to mutual fund investors. Long before the Exchange Traded Fund (ETF) revolution, there were closed-ended mutual funds. They were a limited pool of money invested into assets that were then traded on the markets. Although more liquid than closed-ended private funds, they often sold at a premium or discount to the Net Asset Value (NAV) of the underlying assets. You were investing in those assets and making a bet on what would happen to that premium/discount. The ETF creation/destruction features essentially eliminated that premium/discount problem, leaving closed-ended funds as a historical relic (dinosaur?)
The mutual funds you invest in now are probably all open-ended or ETFs. As of this writing, there are still 464 closed-ended funds from 93 sponsors trading on US markets, but there is only something like $300 billion invested in them. By comparison, VTSAX alone (without any other shares classes such as VTI) has $1.3 trillion.
More information here:
5 Major Things to Look for in a Real Estate Fund
The 5 Characteristics of My Ideal Private Real Estate Fund
What Are the Advantages and Disadvantages of Each Type of Fund?
Open-ended funds have a number of advantages over closed-ended funds:
- Capital is put to work (and begins earning returns) more quickly instead of being called periodically over months or even years
- Distributions can be automatically reinvested
- Much higher liquidity
- All of your money can be withdrawn at one time rather than returned in drips and drabs as assets are sold
- Easier to know the true value of your investment as it must be marked to market more frequently
- Fewer K-1s to deal with if you stay with the same manager (rather than being invested in Fund I, Fund II, Fund III, etc.)
- More income
- Shorter income distribution intervals
- Earlier income
However, closed-ended funds have their advantages:
- Less hassle for managers to run, resulting in lower costs to pass on to you
- Managers can invest for the long term
- Managers are never sitting on cash and feeling pressure to invest it in anything but their best ideas
- The internal rate of return (IRR) may be higher due to a lack of cash drag and pressure to produce short-term results
- Less income comes less frequently and, later in the life of the fund, increasing tax-efficiency
- Large lumps of depreciation are often produced early in the fund's life, and they can be used to offset income from other investments
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Although we own both types, my general preference is for open-ended funds. That is primarily a function of the reduced hassle, additional transparency, and additional liquidity rather than any need for income or large amounts of depreciation. I'd love to have fewer investments in my portfolio to maximize simplicity, and that is much harder to do when using closed-ended funds.
What do you think? Do you invest in open-ended funds, closed-ended funds, or both? Why? Which do you like better? Comment below!
Correct me if I’m wrong, for open-ended equity funds:
1. Market value is determined internally by the sponsor, not on quotes from an exchange. There might be a slight conflict of interest there. Public REITs may be down approximately 30%, but these open-ended funds, are close to even; suggesting that they haven’t fully discounted their holdings to the extent the public markets have.
2. May have ‘gating’ where redemptions are capped so that there isn’t a rush to the exits.
1. Absolutely a risk. Some funds do a better job getting independent appraisals than others.
2. Yup, also an issue.
Depends on the company offering the open ended fund. DLP keeps the price a $1 per share all year in the Housing Fund and at the end of the year uses auditors to determine value and then adds to your balance an amount to bring it back to “even”.
Origin does monthly determinations on their own (their share price moves) and at the end of the year they have an auditor come in and verify.
Definitely something to watch out for as not all companies do it the same and some could be doing shady things. You always have to do a lot of due diligence with these private funds.