With five years of passive real estate investments under my belt, I’ve invested in a wide variety of projects.
I started with eREITs via platforms like Fundrise and RealtyMogul. I invested in syndicated value-add equity deals from Crowdstreet and Republic Real Estate. Later, I invested in funds from DLP and Origin Investments.
While selecting individual projects gives you more control and a sense of connectedness to the project, connectedness does nothing for your returns, and you have to select quite a few projects to be well diversified.
The eREITs are well-diversified with investments in dozens of projects, but they don’t necessarily offer the highest tax efficiency. Some depreciation is passed through to the investor, some distributions are reported as a return of capital, and REIT dividends can qualify for a 20% deduction via Section 199A, so there certainly are some tax benefits that accompany the REIT structure.
Direct ownership tends to offer the largest tax breaks, and ownership in an LLC that owns real estate projects is the next best thing. Below, I’ll provide an overview of two such funds from Trion Properties and 37th Parallel Properties. The goal of the post is not to declare a winner but to look objectively at what they offer while comparing and contrasting two rather similar funds. Physician on FIRE has a referral relationship with and/or accepts flat fee advertising payments from several of the companies mentioned above and this site may benefit if you choose to work with them.
In reviewing the information below, you’ll find more similarities than differences with both the companies we’re examining and the funds they’re putting together.
Both Trion and 37th Parallel have been in business since shortly before the Great Recession. Each offers a single fund at a time with the option to invest separately in individual projects if you wish. The funds have a similar structure, although 37th Parallel offers two share classes to allow investors to prioritize either cash flow or appreciation potential.
Let’s learn more about Trion Properties Multifamily Investment Fund (Trion Fund IV) and 37th Parallel’s Fund II. Some of the information below was found directly on the companies’ websites. Additional information came from the PPM (Private Placement Memorandum) that’s available upon request and from the helpful representatives from Trion and 37th Parallel.
Trion’s Fund IV projects annual after-fee returns of 12% to 15% to investors.
37th Parallel’s Fund II Class B shares are targeting a 14% to 17% annual return after fees. They also offer Class A shares targeting 9% returns.
“One of the major benefits of income-producing commercial real estate (especially multifamily) is that you can shape your returns between income, equity growth, tax advantages, time-horizon, etc. So, it made sense to provide the ability to more specifically customize the types or return an investor would want.
This is why we launched Fund II with two share classes – Class A and Class B. Note, please review the 37P – Fund II Private Placement Memorandum (PPM) for specific details. Below is just a summary of a few of the relevant terms.
Class A (Current Income) Shares have a 9% annual preferred return, first access to distributable Fund II cash flows, with capped upside. In essence, the portion of the investor’s commitment that’s in Class A shares will receive more income sooner from the fund but will not participate over a 9% annual preferred return. That said, the Class A investor will still get pro-rata flowthrough depreciation, which can help materially defer any taxable income.
Class B (Total Return) Shares have a 7% annual preferred return, second access to distributable Fund II cash flows, with full equity growth participation from the portfolio of multifamily assets in the fund at asset/portfolio sale or recapitalization. In essence, the portion of the investors’ commitment that’s in Class B shares will receive lower current income later in the fund life (although they are still expected to receive income during the fund life), in return they get a higher than normal equity growth and total return potential with all the same tax benefits.
Investors can shape their investment based on their investment goals. While many of our current clients invest in either Class A or Class B, a significant portion allocates a ratio of their Fund II investment across both A and B Shares.”
Trion’s Fund IV is a closed-end fund expected to be complete in approximately 7 to 8 years.
Similarly, 37th Parallel’s Fund II is anticipated to operate for 6 to 8 years.
Both funds are structured as LLCs in which investors have fractional ownership. The LLC will make investments into a number of real estate projects on the investors’ behalf.
One benefit of this structure as opposed to a REIT structure is that the depreciation is truly passed through to the investor. It can be used to offset passive income from this investment and/or other passive income sources the investor may have.
In contrast, taxes on REIT dividends are reduced by depreciation at the fund level, but the investor cannot capture that depreciation to be used against other income sources.
Investing in a private real estate fund works a bit differently than investing in stocks and bonds. You can’t just hand over your cash and be fully invested the next day. Deploying capital on real estate projects takes time.
When you make your commitment to Trion’s Fund IV, their goal is to call 100% of your commitment and put it to work within three months.
37th Parallel takes a different approach with Fund II. They require 10% down and have a goal of calling the remaining 90% in increments over the course of one year.
When interest rates were next to nil, this cash drag on money waiting to be called was a real nuisance. At least in early 2023, you can earn 3% go 4% in high yield savings and money market accounts on the cash that’s yet to be invested in the fund.
Co-Investments by the Company and Its Principals
As an investor, it’s important to see those responsible for the fund willing to invest money of their own into it.
I was happy to see that this was the case with both funds.
37th Parallel will invest more than $1,000,000 in Fund II and the company’s managers and principals plan to invest another $1,000,000 to $2,000,000.
In Trion’s Fund IV, Trion will co-invest at least $2,500,000, and the company’s principals also invest directly in the properties.
Trion Properties is expecting to add a total of 13 to 18 projects to the fund. Each of their last two funds held 18 investments. The target total investment for the fund is $100 Million.
37th Parallel is targeting 6 to 10 assets in the A/B+ class (higher-end properties) for their Fund II. The target fund size is $40 Million to $80 Million.
37th Parallel is planning to invest primarily in Texas, Florida, Georgia, North Carolina, and South Carolina.
Trion’s target range is a bit broader and includes California, Colorado, Florida, Georgia, North Carolina, South Carolina, Oregon, and Texas.
Both funds will invest primarily in value-add multifamily properties.
37th Parallel also includes Core-Plus investments (generally with a lower risk and return profile) in their Fund II, while Trion’s Fund IV may include up to 20% ground-up construction.
The minimum investment in Trion’s Fund IV is $50,000.
The minimum investment in 37th Parallel’s Fund II is $100,000.
The returns from past investments and the projected returns on these funds are reported net of fees, that is, after all fees have been paid. That makes the discussion of fees less relevant, but you should still know what you’re paying and what you’re paying for.
The bulk of these fees are the cost of doing business. Performing due diligence, record keeping, tax filing, investor relations, and marketing all cost money. Fees help cover these necessary functions of a private real estate company. You cannot compare such fees to the expense ratio of a mutual fund, a fee that covers a much narrower range of functions.
Here’s what 37th Parallel reports for fees in Fund II:
Annual Fund Administration Fee: 0.25% on invested capital
Acquisition Fee: up to 2.00% of the purchase price incurred at the deal level.
Asset Management Fee: ~0.4% of net asset value at the deal level
Disposition Fee: up to 1.00% of the sales price paid at the deal level
Bonus: 37th Parallel has agreed to reduce fees by $500 for Physician on FIRE readers.
Trion’s Fund IV will levy the following fees, according to Andrew Lucas, Managing Director of Capital Markets:
The only fund level fee is a 1% Fund level AUM fee on deployed fund capital. Our funds invests in all of our deals, but is not the sole investor in any deals. We typically allocate money from the Fund and raise equity directly into the deal from institutions, family offices, or our HNW investor base. Therefore, the fund will pay its pro rata share of the following deal level fees. We offer our high net worth investor base the ability to invest directly in about half the deals we invest in. On the other half, our fund invests and we raise from an institution or family office for the bulk of the equity. One of the selling points of the fund is it gives high net worth investors access to deals they wouldn’t otherwise be able to invest in.
1% acquisition fee taken at closing.
1% loan origination fee taken at closing.
4% property management fee of effective gross monthly income at each asset (we’re vertically integrated and self-manage our assets.
Construction management fee of 5% of renovation hard costs. Ie. If there is a $1 million renovation the CM fee will be $50,000
Again, these fees are accounted for in the preferred returns and projected returns of these funds. They will not be subtracted from them.
The Distribution Waterfall
The waterfall defines how profits will be distributed. It can be rather complicated, especially when you’ve got two different share classes in the same fund, so I’ll lean again on Dr. Bethel to describe the waterfall for 37th Parallel’s Fund II.
“The detailed waterfall can be found and should be viewed in its entirety in the 37P – Fund II PPM. At a high level Class A shares receive 100% of all cash flows from operations during the hold period each year until they have received their full 9% annual preferred return. In any year where the preferred return is not met, the preferred return will accrue and accumulate until met in future years. Any cash flows over 9% will flow to the Class B investors. Keep in mind, Class A shares are limited to no more than 25% of the total fund equity. As the fund starts disposing of assets in years 7 to 8, Class A investors will receive distribution of sales proceeds until they have received 100% of their invested capital and the full 9% annual preferred return.
Class B shares receive 100% of all cash flows from operations after the Class A Shares have been paid up to the full Class A preferred return each year. Keep in mind that the number of Class A shares are limited. So it is expected that Class B shares will receive cash flow from operations sometime in years 2-4 and ongoing until the end of the fund. With regards to distributions from capital events (sales/refi/recap), Class B investors will receive their 7% accumulated annual preferred return including any and all accrued and unpaid preferred return, their original capital, and then 80% of all remaining profits up to a 15% total annual average return. Distributions above this level will be 60% to the Class B investor and 40% to the manager. Earlier investors get additional bonus profit splits. Again, please request and review the offering materials for more information.”
For Trion’s Fund IV, first, investor capital is returned.
Next, a preferred return goes to the investor. This is 10% for “seed” investors who contribute the first 20,000,000 of capital and 8% for ordinary members who commit their capital after the first $20,000,000.
After that, a manager catch-up applies to a percentage of profits, after which profits are split with approximately 74% to 80% going to the investor, depending on the amount of capital committed.
In both instances, the specifics can be found in the Private Placement Memorandum.
Will Investors Need to File Multiple State Tax Returns?
One of the advantages of REIT structure is that the fund can file an aggregate return and individual investors do not have to file state income tax returns in such instances.
However, with the LLC format that these two funds use, investors may be required to file multiple state tax returns. Note that some states only require a return to be filed if your taxable income attributable to that state meets a certain threshold.
Obviously, you won’t have to file in states that have no state income tax. In these funds, that includes Florida and Texas.
If you’re investing in a self-directed IRA or 401(k), you will not have to file state tax returns.
Investors investing outside of any tax-advantaged retirement account whose income from a state meets that state’s threshold should file tax returns in the individual states. Anecdotally, I’ll say that it seems there’s some inconsistency in how people approach this, and I’ll leave it at that.
How Much Leverage is Used?
The amount of leverage in each fund will vary a bit within the fund from one project to another, but it’s good to know how much leverage can be expected to be utilized, on average, within the funds.
As you might expect, the two funds have similar plans for the use of leverage.
37th Parallel’s Fund II anticipates acquiring assets in the 60% o 75% loan-to-value range.
Trion’s Fund IV can be expected to use leverage of a more narrow range of 65% to 70% loan-to-cost.
You may notice that they are using two different metrics. Loan-to-cost (LTC) compares the debt to the cost to purchase and improve the property, whereas loan-to-value (LTV) compares the debt to the expected value of the completed project.
When comparing apples to apples, LTC should be a higher percentage than LTV, as the future value should be higher than the total cost of the project if actual value is being added via forced appreciation, a.k.a. property improvements.
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How Long Has the Company Been in Business?
Trion Properties was founded in 2005.
37th Parallel Properties was founded in 2008.
Both obviously survived the meltdown in residential and commercial real estate in the late 2000s and undoubtedly learned lessons that will help them navigate current and future challenges in the real estate market.
What are the Companies’ Track Records?
As of January 2023, Trion Properties reports an average realized IRR of over 30% for investors on all completed deals.
37th Parallel has now transacted on over 10,000 units with a collective value of over $1 Billion with 100% profitable track record for its investors. They have not published a specific IRR for all completed deals, but 2022 dispositions gave investors a gross annual profit of 32% according to Fox 5 San Diego.
You can view individual closed properties here.
Must One Be an Accredited Investor to Invest?
For both of the funds in question, the answer is yes. Non-accredited investors are usually eligible to invest in diversified funds organized into eREITs, such as those from Fundrise (minimum investment $10) and RealtyMogul (minimum investment $5,000).
Most attending physicians qualify as accredited investors. You must have either a sufficient income (two years of $200,000 as an individual or $300,000 as a couple) or a million dollars in assets not counting your primary home.
Where Can I Get More Information?
Visit Trion Properties to learn more about Fund IV and download the PPM.
Visit 37th Parallel Properties to learn more about Fund II and download the PPM.
Additionally, I’ll be joined by 37th Parallel’s managing partner Chad Doty for an educational webinar on Monday, February 13th at 8 p.m. Eastern / 5 p.m. Pacific time. The focus will not be on their specific fund or investment offerings, but rather on the topic of Using Multifamily Investing to Accelerate Wealth. If you can’t make it live, a recording will be sent to you as long as you’ve registered beforehand. Register here.
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