Marking Assets to Market in SBRE Funds

By Matt Burk, Founder and CEO Fairway America, LLC, and, CrowdFundBeat Guest Editor,

One of the challenges in an open-ended Net Asset Value (“NAV”) pooled SBRE fund is determining what value to ascribe to any given individual asset in the portfolio at any given point in time. In fact, this is one of the most frequently misunderstood and mishandled issues we see in our deep and myriad involvement with SBRE funds which includes advisory, creation, administration and investing. Many managers simply do not understand the issue and how to apply it to their fund. Many more refuse to acknowledge when assets have been impaired or have declined in valued or, conversely and far less often, to understand and act when it makes perfect sense to mark them up in value. Yet this issue goes to the heart of fair and accurate treatment for investors who are subscribing and redeeming units at various points in time in the life of such an open-ended fund.

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Different asset types may be treated differently on multiple fronts depending on their nature. First and foremost, there is the treatment of the asset according to Generally Accepted Accounting Principles (“GAAP”) which drives much of how things should actually be done. A performing loan is different than an impaired loan which is different than a non-performing loan purchased at a discount which is different than a property taken back through foreclosure which is different than a property purchased directly. There may also be differences between the book value on the financial statements and what the manager chooses to use for NAV purposes, which may in fact not be one and the same. It is a very technical and complicated component of running a fund, and yet incredibly important in terms of how investors get treated, and it can easily be handled incorrectly. My experience is that most managers do not understand GAAP treatment for different asset types as they are real estate entrepreneurs and not accounting experts. Even accounting people who are not regularly involved in this arena may not get it right. Frequently the fund manager does not have the accounting expertise on staff who not only understands how to apply GAAP correctly but who will also stand up to the fund manager on the matter when they insist upon something different. More often, the manager will just treat any issues in this area however it makes sense to them, whether it is correct or not.

The reason this is all important is that it goes to the very heart of the share price calculation for an open-ended fund. In such a fund, the share price may function similar to a mutual fund whose assets consisted of publicly traded stocks. That is, it may go up or down. The difference, of course, is that the valuation being ascribed to any given fund asset at any given time is considerably more subjective than in a mutual fund of publicly traded stocks. In the latter case, the price of a share is automatically determined at any given moment by the market because each asset is publicly listed and a price is posted on the exchange on which it is traded at all times. In the former, the fund manager is determining the valuation that it will assign to each asset at any given time (typically at the end of a specified reporting period, e.g. a month or quarter). In real estate, that value is not always perfectly clear and is rather a matter of opinion, and different people, of course, will have different opinions (as well as motivations). Ideally, the manager will have a written policy it follows (and updates as needed) and which it makes available to the fund’s investors so they understand the methodology the manager is using to determine the value of assets. Nevertheless, the value of a real estate based asset is ALWAYS subjective, some assets more than others, until it sells or pays off. Waiting until the point of disposition and only recognizing the value as realized income (or loss), however, may not be the best way to create as much fairness as possible in an open ended fund. Because managers do not understand these intricacies well, they may or may not be determining a share price that accurately reflects the true condition of the underlying assets in the portfolio.

There are generally two basic types of assets in most SBRE funds – either a financial instrument (a note secured by a deed of trust, contract, or other form of real estate secured debt) or direct ownership of real property. In the case of a financial instrument, the valuation of a performing loan is most often simply the unpaid principal balance of the loan plus any accrued by unpaid interest. This is true unless and until the asset is “impaired”, which determination can be very subjective (and managers can be very reluctant to admit and recognize that an asset is impaired). In the buying and selling of sub-performing, non-performing, and distressed notes, the treatment is more complex and well beyond the scope of this blog (as well as the understanding of the typical manager and in fact many CPAs who may not have any other clients with such assets). The valuation of a property that has been acquired through foreclosure of the financial instrument carries another set of rules. The valuation of real property acquired directly carries yet another, and how it is valued on the books may not necessarily be how it is valued for determination of NAV. Why? As an example, some direct investments in real property will, during the hold period, be worth more in reality than the cost basis due to any number of factors such as increased NOI, lowered expenses, market appreciation, higher occupancy, and/or other value having been added to the asset after acquisition, rehab and stabilization. In such cases, a diligent fund manager will want to be able to allocate that increased value to the then existing shareholders who have taken the risk of owning that asset during that period.  This will require them to “mark to market” any such asset and will have the effect of increasing the share price of the fund so that new investors (and any existing investors exercising a redemption which they accept) will pay (or receive) a higher price for those shares to reflect that increase in value. Conversely, if an asset underperforms and loses value, the manager may choose to mark that asset down at the end of a given period for the same reason, which would lower the Fund’s unit price.

Of course, I am not a CPA or an attorney, and I am not trying to give anyone professional advice about these issues.  I raise these issues just so that readers who are managers know what they need to discuss with their CPAs and that readers who are investors have a better idea of what questions they should be asking their fund managers. The dynamics and workings of what I have discussed here would (or should) be disclosed extensively in the fund’s offering documents. However, my experience is that most managers as well as investors do not really understand precisely how all of this works or why. Done correctly, the price of a unit in an open-ended fund will not always be exactly $1 (or $100 or $1,000 or whatever the base unit price is) and it may be higher or lower as the fund morphs. If the manager does their job well and chooses assets wisely, the share price should go up more frequently than down. But if and when markets gyrate, there may be times where it drops in a given period. This will not necessarily be cause for alarm. It may, or it may not. In fact, a manager’s willingness to recognize any perceived decreases in asset value in real time is, in my opinion, much more than most managers will ever do for fundamental reasons of human nature and may instead be a good sign. A good manager’s objective should be to simply peg each asset at what they believe to be its most reasonable and probable market value (without trying to be too aggressive or too conservative) at any given point in time in order to maximize fairness to both existing and incoming investors.


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Matt Burk is founder and CEO of Fairway America, LLC,, and Chief Investment Officer of Fairway’s two proprietary nationwide small balance real estate (SBRE) asset based pooled investment funds, Fairway America Fund VI, LLC, and Fairway America Fund VII LP. Fairway is the nation’s premier consulting, advisory, and investment firm in the SBRE private pooled investment fund space, providing a full spectrum of practical, real world products and services (including capital) needed for true success for SBRE entrepreneurs all over the U.S. Matt is a highly regarded adviser, consultant, and mentor to dozens of SBRE fund managers and author of a widely read blog followed by serious SBRE entrepreneurs and investors. For over 20 years, Matt has led Fairway’s deal underwriting as well as capital raising efforts in Fairway’s seven proprietary funds and individual trust deed investments, resulting in more than $250,000,000 in capital raised from accredited investors through more than 1,000 SBRE deals. He is currently working on multiple SBRE fund consulting engagements nationwide, authoring a book on how to raise capital for and effectively manage pooled investment funds, and dedicating his efforts to create greater awareness and drive more capital to the many high caliber and deserving SBRE entrepreneurs around the U.S.

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