It is no surprise that private equity real estate funds that are normally laser focused on large institutional investors are expanding their target audience to include high net worth individuals (HNWIs). Globally, HNWIs hold an estimated $74.0 trillion in wealth. They also have an avid interest in real estate with average allocations of nearly 15 percent of investment portfolios, according to the Capgemini World Wealth Report 2020.
The vehicle of choice for raising capital from this elite cohort are feeder funds, which are gaining in popularity even among Hollywood A-listers. Effectively, feeder funds are used to aggregate a pool of capital that invests in the master fund alongside institutional investors. Unlike other vehicles, such as non-traded REITs and crowdfunding platforms that cater to accredited investors, feeder funds are generally structured for participation by qualified purchasers who have $5 million or more in investable assets.
HNWIs have been allocating more money to real estate over the past decade, and feeder funds often provide access to some top shelf investment opportunities. “It has provided a new opportunity for these folks to get into real estate that just wasn’t there before,” says Jason Burian, CPA, office managing partner at CohnReznick in Chicago. The typical minimum buy-in for feeder funds ranges between $100,000 and $250,000. However, in some cases minimum amounts are as low as $25,000 or upwards of $1 million.
Growth in feeder funds is being fueled from all sides. Fund managers are looking for efficient ways to raise more capital and quickly close funds in a competitive market. Investors want access to institutional quality private market strategies, and the money managers who typically sponsor and manage the feeder funds view them as a way to better serve their HNWI and ultra-HNWI client base—and garner additional fees in the process.
“One of the things that money managers are selling to their clients is the ability to access opportunities that they couldn’t access on their own,” says Roger Singer, a partner with the law firm of Gibson, Dunn & Crutcher. Another advantage for the money manager is that it allows them to give their clients access to private equity investment fund opportunities, while also keeping their client list confidential, he adds.
Although the feeder fund structure has been around in the private equity world for many years, it has expanded on the real estate side over the past decade. These days, feeder funds are common across the spectrum of private equity fund managers, including the likes of Blackstone, Starwood and Oaktree Capital. Part of that growth is due to the attractive returns real estate funds have generated in the low interest rate environment. It also is gaining more attention as HNWIs have increased their focus on real estate as a means to diversify investment portfolios.
Money managers and registered investment advisors (RIAs) have responded to the growing appetite clients have shown to diversify portfolios outside of the stock market with greater allocations to real estate. Some of the bigger sponsors include UBS, JP Morgan Private Wealth and Morgan Stanley Private Client along with of host of others. In some cases, the bigger name sponsors are raising feeder funds upwards of $1 billion. However, even smaller money managers can form small feeder funds that start at about $25 million.
“As demand from the high net worth retail channel has increased alongside growing interest from general partners in diversifying their sources of capital, we’ve seen an increase in the use of private market feeder funds,” says Kunal Shah, managing director and head of Private Equity Solutions at iCapital Network. Expansion of feeder funds has been further fueled by tech that has automated many of the administrative and operational processes associated with fundraising, adds Shah.
Feeder funds have primarily been the domain of larger industry players, such as private banks and wirehouses seeking to provide their HNWI clients with exposure to private market strategies like real estate. However, the independent wealth management groups also can access private real estate feeder funds through technology platforms like iCapital. iCapital announced in June that it had entered into an agreement to acquire the alternative investments feeder fund platform from Wells Fargo’s Global Alternative Investments division.
Private equity fund managers also like the ability to expand their investor base, without taking on the extra administrative requirements and incremental cost that comes with catering to individual investors. “It is something that almost all sponsors are considering as an avenue for fundraising,” says Frank Falbo, a partner at Mayer Brown LLP in Chicago. Some sponsors might have an aversion to retail fundraising due to the administrative burden. Feeder funds sponsored by a third party create a central point of contact for the individual investors. That point person relays information, reporting and documents and fields any questions. “That is a real benefit that sponsors are looking to take advantage of in using these kinds of vehicles,” says Falbo.
Advantages for investors
The lure of feeder funds for investors is that it gives them access to institutional level funds and fund managers that they otherwise wouldn’t be able to invest with on their own. “High net worth individuals could always invest in real estate in a variety of ways, but they didn’t always have access to the institutional quality managers, and that’s because the institutional managers were looking to raise larger capital amounts and weren’t geared towards individual investors,” says Singer.
Feeder funds also offer returns that generally stack up favorably compared to other real estate investment vehicles, such as mutual funds and public and private REITs. In some cases, feeder funds might boost returns by 1-2 percent percentage points when comparing vehicles with similar strategies. In part, that is because the private funds don’t have the same overhead as some of the public REIT stocks or mutual funds. “Especially in a low yield environment, investors are looking for something with an interesting story,” says Singer.
In some cases, feeder fund sponsors may be able to negotiate more favorable terms or qualify for better fee breaks in an aggregated vehicle that they may not get on their own. Investors also may get the benefit of consolidated reporting across their portfolio by using this platform with that party, such as an investor advisor or broker-dealer, notes Falbo. That advisor also might provide an additional layer of oversight protection, he adds.
Additionally, feeder funds can be structured to offer tax advantages. In one case, the master fund was raising $50 million and had a sliver of $7 million remaining that was needed to close out the fund. The fund manager had one anchor investor who was willing to come in with $4 million. That particular investor wanted a REIT structure, but the master fund wasn’t going to be structured as a REIT. So, the fund manager engaged an RIA to structure the feeder fund as a REIT to attract that one investor, as well as fill the remaining $3 million with other HNWI investors. “So, there are opportunities where you can use the feeder to not only attract smaller investors, but also to make special cases for large investors that have a different tax strategy than what the master fund has,” says Burian.