{"id":158829,"date":"2023-09-25T17:41:15","date_gmt":"2023-09-25T23:41:15","guid":{"rendered":"https:\/\/www.biggerpockets.com\/blog\/?p=158829"},"modified":"2023-09-25T17:41:17","modified_gmt":"2023-09-25T23:41:17","slug":"questions-you-must-ask-a-private-debt-fund-manager","status":"publish","type":"post","link":"https:\/\/www.biggerpockets.com\/blog\/questions-you-must-ask-a-private-debt-fund-manager","title":{"rendered":"Private Debt Funds are Attractive Right Now\u2014But You Must Ask These Questions First"},"content":{"rendered":"\n<p><span data-preserver-spaces=\"true\">Considering investing in a private debt fund?&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">Right now, against the backdrop of market volatility and increased interest rates, private debt funds are attractive to&nbsp;<\/span><a class=\"editor-rtfLink\" href=\"https:\/\/www.biggerpockets.com\/blog\/passive-real-estate-investing\" target=\"_blank\" rel=\"noopener\"><span data-preserver-spaces=\"true\">passive investors<\/span><\/a><span data-preserver-spaces=\"true\">&nbsp;who want to&nbsp;<\/span><a class=\"editor-rtfLink\" href=\"https:\/\/www.biggerpockets.com\/blog\/7-ways-diversify-investment-portfolio\" target=\"_blank\" rel=\"noopener\"><span data-preserver-spaces=\"true\">diversify<\/span><\/a><span data-preserver-spaces=\"true\">&nbsp;their real estate investments while achieving steady returns.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">Unlike syndications, which are inherently riskier because of speculative pro forma, private debt funds can provide more stable and predictable returns, albeit with less upside potential than syndications may offer. For those seeking more consistency in their return profile, private debt funds are an excellent choice that often have shorter lock-up periods and provide cash flow almost immediately, as compared to syndications, which have longer, less predictable return expectations.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">There are several key performance indicators (KPIs) you can use to compare private debt fund offerings, including:<\/span><\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li><span data-preserver-spaces=\"true\">Preferred return<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Targeted return<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Waterfall profit splits\u2014if any<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Lock-up period<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Redemption options<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Total assets under management (AUM)<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Composition of the other limited partners (LPs)<\/span><\/li>\n<\/ul>\n\n\n\n<p><span data-preserver-spaces=\"true\">These are just a few questions that allow a prospective investor to evaluate multiple fund offerings with information that can typically be found on a lender and\/or fund manager\u2019s website.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">However, most public information, as well as specific fund documents such as private placement memorandums (PPMs) or limited partnership agreements (LPAs), only provide broad-stroke commentary on mandate and execution to avoid clauses that can be too confining and subject the manager of the fund to potential risk and litigation. Fund mandate and subscription agreements are often based on boilerplate legal documents from security attorneys, giving the fund manager a fair amount of discretion.<\/span><\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">Basic Questions to Ask<\/span><\/h2>\n\n\n\n<p><span data-preserver-spaces=\"true\">So, how do you get to the real meat and potatoes of what a fund provides in terms of historical performance, risk, and cultural fit? Here are essential topics you should address with a prospective fund manager or management team before deciding.<\/span><\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">Track record<\/span><\/h3>\n\n\n\n<p><span data-preserver-spaces=\"true\">How long has the fund been in service, and how has the fund performed historically? Request details on past investments, returns, and any challenging periods they navigated successfully. This includes past funds and investments made by the management team in the same asset class (real estate).&nbsp;<\/span><\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">Portfolio strategy<\/span><\/h3>\n\n\n\n<p><span data-preserver-spaces=\"true\">What is the fund\u2019s approach to loan underwriting and due diligence? Understand the risk appetite and loan-to-value guidelines, historical principal loss and default rates, diversification strategy, and alignment with your investment goals.<\/span><\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">Risk management<\/span><\/h3>\n\n\n\n<p><span data-preserver-spaces=\"true\">How does the fund manager assess and manage risk? Inquire about their risk assessment process and how they protect investors&#8217; capital during turbulent market conditions. How do they model for future adverse scenarios?<\/span><\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">Fund duration<\/span><\/h3>\n\n\n\n<p><span data-preserver-spaces=\"true\">Is the fund open-ended or close-ended? Does the investment horizon of the underlying investments (assets) match the fund\u2019s cash flow and investor flows (liabilities)?<\/span><\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">Fees and expenses<\/span><\/h3>\n\n\n\n<p><span data-preserver-spaces=\"true\">&nbsp;Is the fund manager transparent about all costs involved, including management fees, performance fees, and any other charges? Consider asking them what their expense ratio is historically.&nbsp;<\/span><\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">Fund size<\/span><\/h3>\n\n\n\n<p><span data-preserver-spaces=\"true\">How much capital is currently under management? This gives insight into the fund&#8217;s scalability and the manager&#8217;s ability to deploy capital effectively. Moreover, what is the composition of the other investors in the fund\u2014are they individuals or institutions? Does one investor account for over 25% of the assets under management?<\/span><\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">Lock-up periods and redemption rules<\/span><\/h3>\n\n\n\n<p><span data-preserver-spaces=\"true\">What rules exist around requesting a redemption or a return of your capital? Are there investor-level gates or throttles to safeguard the fund and its investors from liquidity risk?<\/span><\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">Co-investment<\/span><\/h3>\n\n\n\n<p><span data-preserver-spaces=\"true\">Inquire if the fund manager invests their own capital alongside the investors. This indicates their confidence in their own strategies, and they have \u201cskin in the game.\u201d Never trust a chef who doesn\u2019t eat their own cooking.<\/span><\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">Distribution and communication frequency<\/span><\/h3>\n\n\n\n<p><span data-preserver-spaces=\"true\">Are distributions monthly, quarterly, or some other time frame? How often will they provide updates on the fund&#8217;s performance and risk analytics, and what kind of information will be included?<\/span><\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">References<\/span><\/h3>\n\n\n\n<p><span data-preserver-spaces=\"true\">Request references from other investors to get a sense of their experiences and satisfaction with the fund manager.<\/span><\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">Going Beyond the Basic Questions<\/span><\/h2>\n\n\n\n<p><span data-preserver-spaces=\"true\">All these questions are fairly basic to ask when interviewing a fund manager. But to&nbsp;<\/span><em><span data-preserver-spaces=\"true\">really&nbsp;<\/span><\/em><span data-preserver-spaces=\"true\">distinguish between managers with proven success and those who don\u2019t meet your expectations, you should ask these questions as well:<\/span><\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">Is your historical performance verifiable through an external audit or another method?&nbsp;<\/span><\/h3>\n\n\n\n<p><span data-preserver-spaces=\"true\">How often are those conducted? While not all funds have mandatory audits, prospective participants should still be requesting how performance can be proven and validated. Also, be sure to ask about the fund manager\u2019s former experience and successes\u2014is that verifiable?<\/span><\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">Do you use a third-party fund administrator who performs trust accounting and financial reporting, or is this done in-house?&nbsp;<\/span><\/h3>\n\n\n\n<p><span data-preserver-spaces=\"true\">While it\u2019s fine to have accounting facilitated in-house, it\u2019s better to have these services provided by an objective third party who can verify and defend fund performance while applying appropriate generally accepted accounting principles (GAAP) that non-CPAs may not be well versed on, particularly as it relates to private debt funds.&nbsp;<\/span><\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">Does your fund have a catch-up clause in case you are unable to meet the preferred return?&nbsp;<\/span><\/h3>\n\n\n\n<p><span data-preserver-spaces=\"true\">Funds do not always meet their targeted return, meaning that a shortfall is created between the targeted return and the realized return in a given accounting period (monthly, quarterly, and\/or annually). When this occurs, do the investors roll over the shortfall into the next account period and receive a future preferred catch-up return before management gets their next set of fees, or do the managers forget about past shortfalls and participate in all the future upside?<\/span><\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">What strategies do you employ to handle non-performing loans (NPLs) to avoid diminished returns and cash drag?&nbsp;<\/span><\/h3>\n\n\n\n<p><span data-preserver-spaces=\"true\">Understand how loans in default affect the performance of the fund\u2014both positively and negatively. For instance, if a loan is in default but has a large equity buffer, the fund would benefit from high default interest rates while the loan is being worked out or foreclosed on. The downside to this situation is that it can take months or years to achieve these rates of return, depending on the state\u2019s foreclosure process and timelines.&nbsp;<\/span><\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">Does your fund employ leverage?&nbsp;<\/span><\/h3>\n\n\n\n<p><span data-preserver-spaces=\"true\">Particularly in an uncertain economy like the one we\u2019re in today, the use of leverage amplifies risk much more than it amplifies returns. Leverage, which is the use of debt, or typically bank debt collateralized by fund assets to make additional investments greater than the actual assets under management invested into the fund, has slowed down or shuttered lenders unable to pay down increasingly expensive costs of capital in adverse market conditions.<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">This last question is arguably the most important question to ask because if a fund is leveraged, participants unknowingly assume a junior position to the credit facility that provides the leverage, as there is a creditor (bank debt) ahead of the equity (investors). Borrowers seeking conventional loans are scrutinized by their debt-to-income ratio, and rightfully so\u2014why shouldn\u2019t private debt funds?<\/span><\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">The Bottom Line<\/span><\/h2>\n\n\n\n<p><span data-preserver-spaces=\"true\">Remember, due diligence is key when considering any investment opportunity. Make sure you feel confident and informed before committing your capital to anyone or any investment vehicle.<\/span><\/p>\n\n\n\n<div id=\"hero-block_62ee867235a1c\" class=\"first:mt-0 hero-block py-4    has-background has-slate-300-background-color has-text-color has-slate-800-color\">\n    <div\n        class=\"gap-10 lg:gap-20 flex flex-wrap lg:flex-nowrap max-w-screen-xl mx-auto px-4 relative lg:items-center \">\n\n        <div class=\"relative z-30 lg:w-2\/3 \">\n            <main class=\"py-4\">\n                \n\n<p class=\"has-theme-slate-color has-text-color has-large-font-size\" style=\"font-style:normal;font-weight:800\">All the cash flow, none of the hassle<\/p>\n\n\n\n<p class=\"my-3 md:my-5 lg:my-8 has-theme-slate-color has-text-color\" style=\"font-size:16px\">Learn how to create financial freedom and passive income in real estate as a private money lender.\u00a0<em>Lend to Live<\/em>\u00a0makes passive income through private lending achievable for anyone. <\/p>\n\n\n\n<div id=button-custom-event-block_64138705d4d27 class='button-custom-event'>\n      <a\n    href=\"https:\/\/store.biggerpockets.com\/products\/lend-to-live?utm_source=blog&#038;utm_medium=marketing_block\"\n        x-on:click=\"window.analytics.track('Blog Block | Publishing: Lend to Live Book', {\n      referrer: 'https:\/\/www.biggerpockets.com\/blog\/questions-you-must-ask-a-private-debt-fund-manager',\n    });\"\n    class=\" btn-shape inline-block no-underline has-background has-theme-blue-background-color has-text-color has-white-color\" target=\"_blank\">Get Yours Now<\/a>\n  <\/div>\n\n\n\n<div id=button-custom-event-block_641384b1eb1d8 class='button-custom-event'>\n  <\/div>\n\n            <\/main>\n        <\/div>\n\n                <div class=\"lg:w-1\/3 first:mt-0 relative h-full lg:flex lg:items-center\">\n            <img decoding=\"async\" class=\"object-cover w-full relative z-20 my-0  rounded-md hidden lg:block\" src=\"https:\/\/www.biggerpockets.com\/blog\/wp-content\/uploads\/2022\/07\/lendtolive-cover-scaled.jpeg\" alt=\"lend to live cover\" title=\"\">\n        <\/div>\n            <\/div>\n<\/div>\n\n\n<p><\/p>\n","protected":false},"excerpt":{"rendered":"<p>Private debt funds can be a great way to diversify, reduce risk, and earn passive income, but it&#8217;s critical that you ask these essential questions first.<\/p>\n","protected":false},"author":613616,"featured_media":158831,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[7363],"tags":[],"class_list":["post-158829","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-reits-passive-investing"],"acf":[],"comment_count":0,"_links":{"self":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/posts\/158829","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/users\/613616"}],"replies":[{"embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/comments?post=158829"}],"version-history":[{"count":0,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/posts\/158829\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/media\/158831"}],"wp:attachment":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/media?parent=158829"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/categories?post=158829"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/tags?post=158829"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}