Over the last three weeks, we have been discussing an overview of fundraising for small self storage investors getting into the business or growing their business from my perspective.
This will be the last in this mini-series.
I have organized this large and complicated world of fundraising into three main buckets, syndications, joint ventures, and funds.
I have organized this way not as a legal or industry hierarchy, but more as how I relate to the various ways of using other people’s money to grow a self storage business.
Today let’s focus on the idea of “funds.”
Funds
Technically, to my knowledge, there is no legal definition of funds (remember, I am the definition of a layman, someone who knows very little about the law and in no way gives legal advice here).
What I call a fund is when a sponsor decides to raise money from investors that, for the most part, is for a blind fund. You are raising money for the future purchase or development of self storage projects under a pre-defined set of criteria an investor can see prior to investing in your fund.
This is opposed to raising money for a specific deal….” this facility at this location.”
These “funds,” as I call them, can either be funded with institutional or private money. In other words, you can raise money from people who manage other people’s money, or much like I have been calling a “syndication,” a sponsor could have individual investors put in the capital.
Technically, what I am calling funds are related to syndications, although for many reasons, I am separating funds form syndications.
This is not the place to get into the world of Regulation A, Regulations D, and/or Intra State Exemption (Rule 147). We discuss this and more in the online training I am creating.
The reals question will be, are you going to fall under SEC (Securities And Exchange Commission) regulation, or will your offering be exempt from direct SEC oversight?
Although technically, you could have what I am calling a “fund” and you be, in essence, a syndication, for this article, I am going to assume you are selling a security when you sell membership shares into your fund.
I have gotten to the table twice on creating a fund, and both times, I decided not to pull the trigger. So, I will share with you the process I went through.
I will say that I have seen people try to enter the self storage business by attempting to create a “fund.”
I strongly advise against this approach. Also, I have never seen it be successful.
Start with partners, syndications, or joint ventures first. Get a track record and history. Then if you really want to expand exponentially, explore creating a fund.
Both times I came close to creating a “fund.” I thought a fund would give me access to larger amounts of capital and allow me to grow faster.
I was going to focus on having money managers and family offices (a family office is a money manager who invests the wealth of a single family who has created generational wealth…that is their single job…to invest a portion of that family’s wealth).
So, I hired a consultant at five times the monthly rate I charge coaching clients to help me.
I was informed I had to find a Broker Dealer, and my coach helped me locate this person.
A Broker Dealer is a securities broker with whom all my shares in the fund will be sold through because, at this level, I am selling securities, not just membership shares, into a single asset LLC that will own a facility.
They technically sell my offering to the investors.
Next, because I am dealing with money managers and other funds, they will have to do “due diligence” on me, my past history in the world of self storage, and the track record of the syndications I had completed at that time.
Money managers usually carry out their due diligence requirements by purchasing a report from a company who does the due diligence. I was informed there are basically two main companies that do this work in the world of real estate today, and with my consultant, we decided on one.
I had to outline and write like a white paper on every syndication I had completed up unit then, highlighting the amount raised, returns created, where we were in the life of that investment, etc. I had to demonstrate I had a history of taking other people’s money and turning a profit.
They looked deeply into where the potential risks are for future investors. Areas such as:
- Accounting procedures.
- Operational procedures.
- Employment practices.
- Selection of vendors.
- How other people’s money was managed during the life of previous syndication.
- Marketing practices.
- Prior legal issues of any company or member involved in the “fund.”
- Anything else they felt relevant to their due diligence.
It was a long and tedious process for us.
I had been involved in several syndications previous to this, and often, different LLCs had different sponsor members, different investors, different practices, different reporting methods and platforms, and different operational structures.
It took a lot to get through, but we did.
We also had to create a very specific type of business plan for the fund.
Again, I hired a specialist to help us create the plan. I gave him our overall structure, acquisition criteria, strategy, and so forth, and he created the plan.
It went through many revisions and was an integral part of the due diligence process as the due diligence company vetted us.
Next, we had to hire a national legal firm that specialized in these types of fund formations. It had to be a firm recognized by the institutional investment world and the company completing the due diligence on us as sponsors.
The estimated cost for the legal work from start to finish was approximately $100,000.
The first time we went through this process, we had a very unique strategy.
Our consultant saw that we were small fish trying to swim in a big ocean with sharks and whales.
His suggestion was to first create a fund to solve a big problem that money managers were having at the time. Then after becoming a known quantity in the institutional world, we could form another fund and grow from there.
The problem he saw at the time (and is still relevant) is that the majority of 1031s were not being completed because of the lack of replacement properties.
Money managers had clients selling their real estate because processes were so high. However, they could not find in time the property to replace the sold properties, thereby deferring their capital gains under section 1031 of the IRS code.
We were going to help solve that issue by creating a “DST find.”
A DST is a Delaware Statutorily Trust, an ownership formation that essentially allows individual investors to put their 1031 money into this fund and defer their capital gains.
DSTs evolved out of the 2008 recession when TIFs ran into some issues.
It was a good strategy.
It is also a heavily regulated corner of the fundraising and investment world.
I ultimately decided I didn’t want to be a fund manager.
I have a morning routine, and I will sit and meditate. When I am taking on something new and expanding my world (something I love to do), I will usually visualize my future as part of my morning routine. What does my life look like in the future? What is a real win in the new and expanded world look like? What does this new world feel like?
As the time grew closer to pulling the trigger, I realized that I just didn’t like the future I was creating. It didn’t feel right to me.
I was dealing with people and investors who, for the most part, I would not know well manage their money.
Also, I often say the quality of your life is a function of the quality of problems you create for yourself. But I also know that every problem I have today, was the solution to another problem I had at an earlier date.
I saw I was creating a problem called “I have $25 million I have to invest in self storage over the next year.”
I thought that was the “right” problem for me to create, a problem I really wanted to create. The next stage in my evolution as a self storage person.
But as I did my morning work, living in the future I was creating, I saw I could have some real issues.
Given my experience in creating value and where my expertise lay in the self storage world, I was going to have a really hard time finding and creating $100 million of projects in the next 12 months ($25 million raised was to be the down payments in a 75% LTV projects).
I have seen fund managers use Proforma techniques whereby rents go up at 5% per year, or 5.5% or 6% Cap rates for future valuations, or other adjustments to hit the numbers needed to make a project fit into the stated acquisition criteria.
I saw myself doing this to deploy that amount of money in such a short amount of time. I just had a hard time with that.
Not that fund managers are wrong or that they may not hit their numbers. I just felt I had a big chance of not hitting the projections I needed to show in order to raise $25 million for the first fund.
Later, I went through the process again for a regular self storage fund (as opposed to a DST first fund) but pulled the plug soon after starting the process for the same reason.
My reasons were purely personal and should not deter you if this is the corner of the self storage world you want to play in.
Perhaps if I had started younger in my self storage journey or had different goals, I would be there now.
Do not let me deter you from exploring this world. It is just not a piece of the investment world I choose to play in.
But funds are a big corner of the fundraising world.
One can also do smaller blind pool syndications under Regulation D scenarios that look and feel more like what I call syndications. I have also done this.
So, no matter where you may want to explore syndications, joint ventures, or funds, get a good attorney and move forward.
This world of self storage still has a bright future and is still a fantastic business for the small investor.
