Over the last ten years, we’ve launched and executed three private real estate funds at Origin. Last year we closed Origin Fund III and, since then, many people have asked when we are going to launch Origin Fund IV. The short answer to that question is that the Origin IncomePlus Fund is Origin Fund IV.
The core strategy of the Origin IncomePlus Fund is to acquire core plus and value add apartment complexes in ten fast-growing markets in the U.S., the same strategy that we utilized for Fund III. So why not call the IncomePlus Fund Origin Fund IV? The name IncomePlus more accurately identifies what the Fund is designed to do for investors: generate income and appreciation. The IncomePlus Fund is our flagship investment and the best way for investors to build and preserve wealth with private real estate.
One of our core values at Origin is continuous improvement and this extends to every Fund we bring to the market. Each of our funds has been a better version of the one before it and the IncomePlus Fund is the culmination of ten years of learning. The goal of this Fund is to create the same amount of wealth as our previous funds, but do it with less risk and by managing capital more efficiently.
From Buy, Fix and Sell to Buy, Fix and Hold
We believe that real wealth is built by holding quality real estate assets forever. With the IncomePlus Fund, we’ve shifted from a buy, fix and sell strategy to a buy, fix and hold strategy because this minimizes the frictional costs of selling assets. Selling an asset means risk is taken off the table, but it also creates a taxable event and can cause capital to sit idle for months as it waits to be deployed into the next deal, a concept known as “cash drag.” Both of these events negatively impact the ability to build wealth. The IncomePlus Fund’s buy fix and hold strategy solves these issues and enables investors to realize the full tax benefits of owning private real estate.
Even though the IncomePlus Fund can hold assets forever, we most likely won’t, because forever is quite a long time for physical real estate to last. In the event we do decide to sell a Fund asset, we can defer those taxes by rolling the gains into another asset utilizing a 1031 exchange. And, even though the Fund has no expiration date, investors aren’t locked in forever. Investors can enter the Fund by buying shares and then exit by redeeming those shares if and when they choose. The difference in this model is that you choose when to trigger a taxable event, rather than us deciding it for you.
Tax Efficiency is Paramount to Building Wealth
Tax efficiency is something we considered in our last three funds but only within the constraints of a buy, fix and sell model. One of the greatest benefits of investing in real estate is its tax efficiency. However, our strategy was to sell assets once we completed the business plan. We made sure that our investors received long-term gains versus short-terms gains, we depreciated assets while we owned them, and we returned capital back to investors tax-free when we refinanced. However, all of those tax benefits were largely diminished when we sold an asset because we triggered a taxable event.
The impact of taxes on overall investment returns and building wealth can’t be underestimated. Every taxable investor must consider this on overall portfolio performance because money that goes to the government is money no longer working for you. Whenever a gain is realized on any asset, investors only keep 50% to 70% of the profits after paying state and federal taxes. And, paying 30% of your profits to the government is no different than losing 30% of your money overnight.
Below is a chart that illustrates this point. The dark blue column represents the wealth created on a $10 million investment that earns 10% but generates a tax liability each year at a rate of 30%. The light blue column represents the wealth created in an investment that also earns 10% each year but its tax obligation is deferred.
Growth of $10 Million
After ten years, the tax-efficient investment grows to $26 million, while the tax inefficient investment grows to roughly $20 million, a difference of 30% in wealth. After 20 years, the wealth difference is even more pronounced. The tax-efficient strategy grows to more than $67 million, while the strategy that gets taxed every year grows to around $39 million, a 74% difference in wealth just from minimizing taxes.
How does this apply to the IncomePlus Fund? The goal of the IncomePlus Fund is to deliver a 10% annualized return each year with little to no tax consequences. Income generated from the Fund will be partially or fully shielded from taxes via depreciation, which means there will be almost no taxable income on the 6% annual distribution, once the fund is fully stabilized. The other 3% to 5% in appreciation grows tax free. And, investors can take advantage of compounding returns by simply reinvesting their distributions.
A Better Way to Call Capital
One of the other common challenges we’ve addressed with this new fund is the capital call process. In a private equity capital call model, managing your capital commitment while you are waiting for the fund to invest it can be a hassle for many. We surveyed our investors and found that 60% kept capital earmarked for Origin Fund III in short-term securities earning little to no money. While this might be a safe place for money, it’s not the most optimal way to build wealth because that money isn’t working to the fullest extent possible.
With the IncomePlus Fund, we now call 100% of your capital at once which means all your money goes to work on day one. The way the capital call process works is that anyone who signs a subscription agreement is essentially in a queue or line and their capital gets called when we find a deal. If the queue is $50 million deep and we find an asset that requires $20 million in capital, then we call $20 million in capital from the front of the queue and the rest of the capital moves towards the front of the line. We still don’t take money until we have an asset to purchase, but this alleviates the two to four years of managing a capital commitment, and investors can avoid the logistical challenge of funding 15-20 capital calls over the life of an investment.
A Better Fee Structure
Our fees are lower in this Fund, which means that for every dollar the property makes, more goes into your pocket. The reason is simple: Real estate will only generate so much profit and our goal is to make sure that profit is split up in way that works for both Origin and the investor.
In a traditional private equity structure, an investor typically pays the manager a committed fee, an asset management fee and a performance fee. The committed fee is used to pay the team while they are looking for opportunities and assembling the portfolio. The asset management fee is used to pay the team while they are managing the assets and building value. The performance fee aligns the interest of the manger with the investor and rewards the manager for outperforming.
With the Income Plus Fund, we’ve eliminated the committed fee altogether. Instead, we take an acquisition fee of 50 basis points on each deal we close. This essentially transfers the risk to us from the investor because we only get paid this fee when we acquire an asset. While this may seem like an incentive to acquire assets, this is a one-time fee on an asset we may own forever and is a small piece of our overall revenue. We are still heavily aligned with investors through a principal co-investment of more than $10 million and a performance-based fee structure.
Our annual asset management fee in the IncomePlus Fund is 1.25% and is charged based on the equity value of the investor’s account. For example, if your account value is $100,000, you will pay $1,250 in an annual asset management fee. Managing real estate is an incredibly labor intensive process and this should not be mistakenly viewed in the same way an asset management fee is paid to a financial advisor. We may use the same word, but it takes five to ten times the number of people to manage private real estate as it does public securities. This fee was 1.5% in our previous funds, but we now charge based on the true value of the assets instead of the initial invested capital. For example, if in the example above, the account grew to $200,000, the fee would be $2,500 per year. In an open-ended and evergreen fund, this is standard practice and incentivizes us to focus on increasing shareholder value.
Lastly, we charge a performance fee of 10%, subject to a preferred return of 6% which means our fee is only earned when you make more than a 6% annualized return. For example, if your account grows from $100,000 to $110,000 in one year, we would be entitled to a $1,000 performance fee bonus. This fee incentivizes us to outperform and further aligns interests. The performance fee in this Fund has been reduced by 50% as compared to what we charged in our previous funds.
We’re excited about all these improvements we’ve designed for the IncomePlus Fund. If you’d like to learn more about this Fund, please download all the Fund’s due diligence materials here.
The information provided does not take into account the specific tax or financial situation of any specific person. You should consider the suitability of any type of investment for your circumstances and, if necessary, seek professional advice. This material was produced by, and the opinions expressed are those of, Origin Investments as of the date of this publication, and are subject to change based on regulatory changes and market and other conditions. The information and/ or analysis contained in this material has been compiled or arrived at from sources believed to be reliable, but Origin Investments does not make any representation as to the accuracy, correctness, usefulness, or completeness. The information in this material may contain projections or other forward-looking statements, or other expectations, and is only as current as of the date indicated. The information in this document, including statements concerning taxation and tax rates, are based on current federal tax regulations, which may be superseded by subsequent regulations or for other reasons.