Owners keep asking to invest with me. Working out whether a $25M fund pays for itself

I'm early on all of this so mostly a question. When you say blind pool money, does that mean the four owners would be committing before they know what you're buying? I think I'd struggle with that even from someone I trusted, and I'd want to know what happens if you don't find anything for a year.

Your fee base is doing the damage. 1.5 percent on invested capital means you carry the whole cost of sourcing before you earn anything on it, and sourcing is the expensive part.

Build the called capital curve properly rather than assuming an average. Quarter by quarter, with realistic closing timelines, and put a two quarter slip in it because the first fund always closes slower than the model. Then look at cumulative fee income against cumulative overhead. My guess is your hole is bigger than $600k once you include the quarters where you've hired but haven't closed.

Fee on committed during the investment period fixes most of it, and it's normal for institutional funds. Your four owners may push back hard because they're used to deal-level economics. A middle version is a fee on committed at a lower rate, say 1 percent, stepping to 1.5 on invested after the investment period ends.

The thing I'd want to understand as someone learning how this capital actually moves: your LPs are also your management clients. If the fund buys a building and your PM company manages it, the LPs are paying you a management fee at the fund level, a PM fee at the property level, and they're also your customers on their own separate buildings. That's a lot of overlapping relationships to keep clean.

What happens the first time the fund and one of those owners want the same building?

Deployment speed is the reason so many new funds are being launched on the debt side right now. A bridge loan closes in weeks, not months, so you get to an invested balance fast and the fee starts earning. Current pay distributions are also easier to raise against than a five year equity hold with no cash for two years.

But you'd be underwriting credit, not operations, and nothing in 1,400 units of management experience says you can size a loan against a sponsor's business plan. I wouldn't chase that just because the ramp is friendlier.

Naive question, sorry. Does the money you already make managing those 1,400 units count for anything when you ask people to commit to a fund, or do they only care about the two deals you own?

I re-ran your fee line and I get worse than you do. Three year investment period, $25M, and if the average invested balance across years one to four is 55 to 60 percent of the fund, average annual fee is roughly $210k to $225k. Cumulative fee income over four years lands near $850k. Cumulative overhead at $450k a year is $1.8M. That's a million dollar gap before formation legal.

Two things you left out. Organizational costs are usually reimbursed by the fund up to a cap, so the $150k legal may not be all yours, and you should find out what cap your LPs will accept. And you have no line for fund-level insurance or the cost of your own time, which is the largest input in the whole model.

@trellis what's your GP commitment? At $25M a 2 percent commit is $500k of your own cash and I don't see where that comes from either.

Taking the other side of the table. I'm the guy you'd be pitching, and here's what would stop me on a first fund at 1.5 and 20 with no realized exits: I can't tell whether the returns come from your operating skill or from the entry basis, because nothing has been sold yet.

What would get me past that is the PM data. You have five years of actual expense lines, turn costs, and rent achievement across 1,400 units in the exact submarkets you want to buy in. That's a real underwriting edge and it's rarer than a track record of exits. Show me your realized renovation premiums by unit type with the actual spend, not a proforma, and I'd look seriously at a small fund.

I'd still want the fee on called capital, though.

Your problem is that you're running one model where there should be two. The fund has its own P&L and the management company has its own P&L, and right now you're deciding whether to launch based on a blended number that hides which entity is insolvent.

At the fund level, $25M at 1.5 percent on invested is never paying for a two person acquisitions and asset management team. @ledger's $850k over four years against $1.8M of cost is the real picture. So the fund does not support that team, full stop, and the answer isn't to raise a slightly bigger fund.

At the management company level, $70M of fund-owned assets is maybe 700 units at your average, which is a 50 percent increase in your managed door count with no new business development cost and no client who can fire you. At a typical PM fee that's real revenue with a real margin, and it arrives on the same schedule as the acquisitions, which is exactly when the fund fee is thin. That income is how this works, and it's the reason PM operators can run funds that pure capital allocators can't.

Which means the whole thing turns on your answer to your own last question. Affiliate PM income on fund assets is defensible if it's disclosed in the PPM at a stated rate, benchmarked against third-party quotes in the same submarket, and approved by whoever your documents say approves affiliate contracts. It's indefensible if it's above market, or if it's the undisclosed reason the fund's fee looks LP-friendly. Get your own market rate survey done by someone who doesn't work for you, put the rate in the documents, and let the LPs see the full stack in one table.

On the three paths: don't hire before you have committed capital. Do one or two more one-off deals with these same four owners with a written statement that you intend to raise a fund, use those deals to build the affiliate PM precedent and the exit record, and keep the acquisitions work on your own desk until the fee base can pay a salary. The co-GP route teaches you fund operations for free but you'll be doing the work and someone else's name will be on the track record.

Have a securities attorney tell you what disclosure and consent the affiliate contracts actually require, because that part varies with your structure and your state.

Two submarkets you already manage in is also a concentration problem. Diversification is one of the two things a fund sells over a single deal, and if all $70M sits inside two submarkets you're selling the pooled structure without the pooled risk. Your LPs may not care. An institution later will.

How long does raising $25M actually take from the day the documents are done? I've read six months and I've read two years.

The capex piece worries me more than the fees. Value-add across six or eight buildings at once means simultaneous scopes, and someone has to walk them. Who's checking the unit turns when you've got three properties in renovation in different quarters and your acquisitions person is out chasing the next one?

Whether your PM company needs a license to manage fund-owned property, and whether managing property an affiliate owns changes that, varies by state. Some states exempt an owner managing its own property and get fussy about whether a fund entity counts as the same owner. Worth confirming with your state regulator in writing before the documents get drafted, because it can change which entity signs the PM agreement.

Separate accounts. Four owners who already trust you, one vehicle each, each one knows what it bought. No blind pool, no fund admin, no audit, no formation legal. You give up the carry economics and the durable fee stream, which is exactly what you said you wanted, so maybe that's not an answer for you. It's what I'd want as the investor.

@trellis reading this the interesting job to me isn't the GP seat, it's the operations seat. Somebody has to do the capital calls, the K-1 coordination, the LP reporting. If you outsource that at $75k a year, what is the administrator actually doing and what stays on your desk?

@flint I don't agree that $25M can't work. It can't work with two hires. Outsource the admin, keep acquisitions on your own desk for fund one, and pay one analyst. Then your overhead is $150k, not $450k, and @ledger's fee number roughly covers it. You'll be exhausted and fund one will be slower than the model, and that's the trade for building the record that makes fund two fundable at a size that pays properly.

Scope creep on one renovation is a bad quarter. Scope creep on six at once, funded out of the same reserve line, is how a fund misses its pref in year two. Whatever contingency you're carrying per deal, look at what happens if two of the eight go 30 percent over at the same time, because they will, and the money comes out of the same pot with the same LPs watching.