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Real Estate Funds, Investing & Investee Funds  For purposes of the Investment Company Act of 1940 (1940 Act), an investment company (hedge fund) is one that invests, reinvests, or trades in securities. To avoid classification as a hedge fund, a real estate fund should reply on one or more of the three statutory exclusions and one regulatory exemption that exist. Section 3(c)(1) of the 1940 Act excludes any private investment company has not more than 100 owners, taking into account the owners of all series and classes of its securities, whether debt or equity, voting or non voting in monitoring the 100 owner limit. The 1940 Act has look through rules that apply to an "investing fund" investing in an "investee fund" (i.e., a sub fund).  The owners of the Investing Fund are counted as direct beneficial owners of the Investee Fund if the following both conditions are met:  the investing fund is a Section 3(c)(1) or Section 3(c)(7) fund and the investing fund owns more than 10% of the investee fund's voting securities.  If the investing fund's beneficial owner county pushes the investee fund's beneficial owners over the 100 person limit, the invest fund cannot rely on Section 3(c)(1). Sponsors should understand that limited partnership and limited liability company interest may constitute "voting securities" for purposes of the look-through test.  To avoid registration under the 1940 Act, a real estate fund may have to limit an investing fund to less than 10% of its outstanding interests or count the investing fund's owners as its direct beneficial owners.

Mortgage Loans & Seconds The securities laws explicitly state that any “note” (i.e., debt instrument) is a security. If your fund were to instead make direct commercial mortgage loans to borrowers, it is likely that the such note (i.e. the loan) is not a security.  A fund that has a portfolio of commercial mortgages purchased from a third party loan originator is in fact an investor securities. In that the fund is not an exempt real estate fund and you are subject to state regulation as an investment adviser.

Real Estate Fund Section 3(c)(5) of the 1940 Act excludes a real estate program that is primarily engaged in purchasing or acquiring mortgages and other liens on, and interests in real estate.  The SEC has blessed real estate programs (i.e., exempt from the 1940 Act) when at least 55% of the fund's assets consist of mortgages and other liens on or interests in real estate, and the remaining 45% of its assets consist primarily of real estate related investments. The SEC has agreed that the test that at least 45% of a program's asset consist "primarily of real estate-related investments" means that at least 55% of the 45% must be primarily in real estate related assets and the remaining assets may be investments entirely unrelated to real estate, such as stocks, U.S. government securities, commercial paper, etc. Fund sponsors should note that the test is an asset test and not an income test. The percentage tests relate to obtain SEC "no-action" relief. In many cases, a real estate fund with more than 50% but less than 55% of its assets invested in mortgages or real estate may be able to rely on Section 3(c)(5).  Real estate programs that use financing subsidiaries may also be able to rely on Rule 3a-5 to avoid registration under the 1940 Act.  Contact Us for Assistance

What is Real Estate? Real estate includes a fee interest, a leasehold, a note secured by a mortgage on real estate, and certificates in entire mortgage pools. Being a limited partner is a real estate partnership is not "real estate" for purpose of Section 3(c)(5). However, if you have the power to removed a partnership's general partner with or without case, then your investment is an investment is in real estate.  If your real estate program invests in an entity that owns real estate assets, it must be a majority owned subsidiary to be counted as real estate.  This means that your program owns 50% or more its voting interests.  Generally interests or influence over management can be treated as voting interests.  Even non voting interests can be considered the equivalent to voting interests if the holder has such economic interests so as to have "control" over management.

Qualified Purchasers  Section 3(c)(7) of the 1940 Act excludes your fund as a real estate fund if all of its investors are qualified purchasers.  Generally, that refers to an individual with $5,000,000 in investments, a family-operated company that owns at least $5,000,000 in investments, a trust not formed for the specific purpose of investing in the Section 3(c)(7) fund and of which each trustee who makes investment decisions on behalf of the trust and each contributor is a qualified purchaser, or a person, acting for such person's own account or the account of other qualified person's who owns or invests on a discretionary basis at least $25,000,000 in investments. A qualified purchaser also includes a company not meeting these requirements as long as all the beneficial owners of the company are qualified purchasers.

Real Estate Fund Managers & Investment Adviser Registration (RIA) Does your fund invest directly in real property (i.e., takes title to real estate). If yes, your fund is not investing in securities and it is a "real estate" fund.  The same is true if your fund (or its delegate) controls and/or actively manages real estate.  However, if your fund is a passive owner, the fund is invests in securities, it is not a real estate fund, and you as the fund manager are subject to investment adviser regulation.  If your fund invests in stock of company that owns real property, then the fund is not a real estate fund and you as the fund manager are subject to investment adviser regulation (unless your fund owns 100% of the stock).  If your fund invests in a limited partnership that owns real estate or invests as an investor in an entity that owns real property, your fund is not a real estate fund and you are subject to state investment adviser regulation.

CALL US FIRST We are experts. Click on any reference below to our leading articles:

Strategic Hedge Fund Planning by Hannah Terhune.  Wilmott Magazine Ltd. (Volume 2013, Issue 63, pages 8-11 January 2013).

Hedge Funds - Limited Partners' Right of Access After Parkcentral Global, L.P., v. Brown Investment Management, L.P. by Jim Brennan.   Cititrust Edge Magazine (4th Quarter 2012).

Strategic Hedge Fund Planning by Hannah Terhune. Canadian Hedge Watch (March 2012).

America the Beautiful Tax Haven. Cititrust Edge Magazine (1st Quarter 2011).

Offshore Hedge Fund Focus:  Master & Feeder.  Cititrust Edge Magazine (4th Quarter 2010).

U.S.--Cross Border Credit Agreements:  Planning for U.S. Withholding Taxes.  Practical International Tax Strategies (November 15, 2010).

Starting an Offshore Fund.  themanager.org (June 2008).

Mixing Investment Adviser and Brokerage Services.  Hedge Fund Monthly by EurekaHedge.com (October 2007).

Offshore Fund Taxation.  Hedge Fund Monthly by EurekaHedge.com (May 2007).

Forex Trader to Forex Manager.  Offshore Business Magazine (November 2006).

Forex Trader to Forex Fund Manager:  The Path to Success.  Hedge Fund Monthly by EurekaHedge.com (October 2006).

Drafting Hedge Fund Performance Allocations.  Hedge Fund Monthly by EurekaHedge.com (August 2006).

Como Crear su Propio Hedge Fund by Hannah M. Terhune, Eva Porras, Argilio Rodriguez and Garrett Fisher (2006).

Offshore Hedge Funds: Focus on Master/Feeders by Hannah M. Terhune (2006).

Temas Sobre Impuestos de Sociedades Colectivas para Hedge Funds en Paraiso Fiscal by Hannah M. Terhune (2006).

Establish a Marketable Track Record with an Incubator Fund by Hannah M. Terhune (2006).

Must I Register as a Commodity Pool Operator? by Hannah M. Terhune (2006).

Do’s and Don’ts for Crafting Hedge Fund Performance Allocations by Roger D. Lorence and Hannah M. Terhune. Derivatives:
Financial Products Report (an RIA publication) (September 2005).

Trading Foreign Index Contracts? Know the Tax Rules Before You Trade by Hannah M. Terhune and Roger D. Lorence. Stocks, Futures and Options (June 2005).

Practical Strategies For Section 475(f) Elections by Roger D. Lorence and Hannah M. Terhune. Derivatives Financial Products Report (WG&L/RIA, a Thompson Company) (March 2005).

Forex Hedge Fund Management by Hannah Terhune and Roger D. Lorence.  Currency Trader (March 2005).

Advising Clients on Internet Server Co-Location Agreements, Practical International Tax Strategies (March 15, 2004).

Structuring and Financing International Operations Using Hybrid Entities and Tax-Efficient Financing Practical U.S./International Tax Strategies (Jan. 15, 2004).

Hedge Fund Compensation Arrangements. Practical U.S./Domestic Tax Strategies at Page 18 (Dec. 2003).

U.S. Inbound Investment – The Portfolio Interest Exemption. Practical U.S./International Tax Strategies (Dec. 15, 2003).

Foreign Futures Planning: The 60/40 Question. Practical U.S./International Tax Strategies at Page 12 (Sept. 30, 2003).

Managing Offshore Hedge Funds - A View from the Beach: Practical U.S./International Tax Strategies at Page 9 (June 15, 2003).

Offshore Hedge Funds - Master/Feeder Compliance Issues: Practical U.S./International Tax Strategies at Page 9 (May 15, 2003).

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