Private real estate within private equity funds can be a lucrative investment opportunity … for the right kind of investor.
This segment of the real estate market isn’t accessible to everyone. In fact, it’s only accessible to a small subset of people. But if you have the money to invest in a private equity real estate fund—and you don’t need that money for the next several years—your returns could be substantial.
In addition to potentially high returns, these investments may have some tax advantages, they are naturally diversified, they’re typically uncorrelated to the stock market, and they can work as a hedge against inflation.
That’s why I’m never surprised to see a high amount of interest in this type of alternative investment.
If you’re trying to determine whether investing in private real estate via private equity funds is right for you, I’ll help by answering a lot of common questions about the space. For instance, who qualifies to invest in private equity real estate? (Hint: You might not.) What should you look for in a real estate fund? What are the different types of private equity real estate funds? And how are they different from real estate investment trusts (REITs)?
Let’s go ahead and tackle these questions. And if you decide this is the right route for you, I can also point you toward ways to get started.
What Is Private Real Estate?
Private real estate is any real estate you can’t invest in via public exchanges, such as the New York Stock Exchange (NYSE) or Nasdaq.
The most common type of public real estate, for contrast, are publicly traded real estate investment trusts (REITs). REITs are special business structures that own and often operate dozens if not hundreds of properties, and virtually anyone with a brokerage account or individual retirement account (IRA) can invest in these via the NYSE, Nasdaq, and other major stock exchange in the U.S. and worldwide.
Private real estate tends to be pricier to invest in and is less liquid (your money is locked up for longer), but they tend to have little correlation with publicly traded stocks and have the potential to deliver significantly higher returns. Publicly traded REITs, on the other hand, usually cost less than $100 per share and can be traded virtually anytime, though they can also be weighed down by poor broader stock-market performance.
What Is a Private Equity Real Estate Fund?
Private equity real estate funds pool capital from high-net-worth individuals and institutions and invest it in a diversified portfolio of privately held real estate assets. These assets are often commercial real estate (CRE)—properties such as warehouses, shopping centers, and office buildings—but can include residential real estate such as apartment buildings.
These funds are usually formed using an entity such as a limited partnership (LP) or limited liability company (LLC). All gains or losses are attributed directly to the members of the entity. Typically, these funds are actively managed by a sponsor, who might also invest some of their own money.
Through private equity real estate funds, individual investors can access large commercial real estate investments they might not have been able to participate in on their own.
Are You an Accredited Investor?
Only accredited investors can partake in private equity real estate funds. SEC Rule 501 of Regulation D states to be considered an accredited investor, you must meet at least one of the following criteria:
- Have an annual income over $200,000 (or $300,000 joint income with your spouse) for the last two years with the expectation of earning at least that much in the current year.
- Have a net worth of more than $1 million, either individually or jointly with your spouse.
- Be a general partner, director, or executive officer for the business that is issuing the unregistered securities.
- Hold a Series 7, 65, or 82 license.
- A Series 7 license is the General Securities Registered Representative license, and it lets you sell a broad range of securities.
- A Series 65 license is the Uniform Investment Advisor Law Examination and allows you to provide clients with investing and financial advice.
- A Series 82 license lets you transact private placement securities as part of private offerings. You get this license by taking the Private Securities Offerings Representative Exam.
In the past, only very high-net-worth individuals could afford the necessary capital investment. But the asset class is now more accessible thanks to lower minimum investment requirements.
Non-accredited investors who want to invest in commercial real estate should look into equity crowdfunding platforms.
How to Find the Private Real Estate Fund That’s Best for You
One downside to most private investments, including private real estate funds, is the relative lack of information for investors. Publicly traded companies are required to regularly report a wide variety of their financials. Reporters regularly cover their comings and goings. And thanks to a large volume of available information, numerous analysts are able to provide further insight into these companies.
Private equity real estate funds, however, are not registered with the SEC and don’t have to regularly disclose their finances to the public. Information tends to be much more sparse as a result. So when you’re evaluating a private real estate fund, you might not have much to go on. Below, we’ll talk about some considerations, including fund manager, overall costs, investment structure, expected returns, and more.
1. Scrutinize Fund Management
One of the most important factors in a real estate fund’s performance is management.
How experienced is the manager—have they been managing this or other funds for a year, five years, 20 years? How has the manager performed? Yes, past performance is not a guarantee of future returns, but it’s one of the few tools you have for judging a fund manager’s ability. And how were those returns generated? Did the manager benefit from one blowout performance over a relatively short time period, or has she generated high returns for years while managing a diversified portfolio composed of dozens of properties?
Also look into any co-managers or other core personnel that might somehow influence the returns of the fund.
Commitment and transparency are essential from a fund manager, so make sure the fund manager is honest and open about potential risks.
A quality fund manager should be able to answer all of your questions about the investment strategy, including why they chose the residential or commercial real estate that they did. Do they provide projected rates of return—what are those projections, and are they explained well?
Some offerings may only provide a simple term sheet, while others provide a private placement memorandum (PPM). A PPM more thoroughly outlines objectives, terms of the investment, risks, and more.
2. Consider Costs and Investment Structure
You’ll also want to know the fund’s costs and how the fund is structured.
You’ll frequently hear “2 and 20” ascribed to hedge funds, private equity, venture capital, and other private investment types. That means the fund is charging a management fee of 2% of all assets under management, as well as 20% performance fee that comes out of profits (sometimes from all profits, sometimes from profits past a predetermined threshold).
These fees generally go to the sponsor to pay for management, research, marketing, legal services, and much more—and, of course, some of it is tucked away as profits for the sponsor itself.
But many private funds have different fees and fee structures, so it’s just important to know how much you’re paying. That’s because these costs ultimately cut into your returns. Indeed, even a decently performing private real estate fund could be a bad deal for you if its fees are prohibitively high.
Funds may have an open-end or closed-end structure.
- With an open-end structure, investors join and exit the fund at regular intervals.
- Funds with a closed-end structure have all investors join at the same time. For obvious reasons, these are more difficult to participate in. But occasionally, closed-end funds offer ways for investors to participate in the fund on an investment-by-investment basis.
Often times, a private fund with limited partners will do “capital calls.” Rather than pay the entire amount pledged for an investment all at once, a fund might ask for partial payments several times over the course of a few months—usually because they can’t put all of the pledged money to work at the same time. A capital call is when a fund’s general partner makes a request for part of the investment.
Any investor who fails to meet the capital call could forfeit their entire ownership share, leaving it open to other investors to purchase.
3. Evaluate Investment Strategy
You’ll also want to know the fund’s investment strategy—in the case of a real estate fund, that mostly boils down to the types of property it will target and how long it plans on investing. Some funds are very targeted, while others are flexible.
For example, a fund might focus only on commercial real estate (retail, offices, storage, etc.) or multifamily apartment buildings. It might be willing to hold different real estate classes. It might insist on holding various property types, but only within one geographical area.
Also, how diversified is the fund—is it a tight portfolio of just two or three properties? A dozen? A broad set of 50 or 60 holdings? The more diversified the fund, in theory, the lower the risk—but that could also tamp down a single explosive growth investment’s ability to pull the fund with it.
Do your goals align with the investment strategy’s likely production? If you’re looking for predictable cash flow, for instance, make sure that’s part of the fund manager’s plan.
Real estate investments, regardless of industry, are typically broken down into four categories by their risk-reward proposition:
Core is considered the safest real estate investment—few risks, but low (albeit dependable) returns. Core properties typically boast a combination of several or all of the following traits:
- High value
- High-quality tenants
- Long-term leases
- Requires very little maintenance
- Low volatility
Core properties are real estate investments for investors who want passive income. Growth potential is typically low—returns are often between 6% and 10% annually—but they’re able to produce substantial and consistent income.
Another common feature of core properties is low leverage. Leverage is debt taken out to finance an investment; the higher the leverage, the more amplified the returns—great when an investment appreciates, but problematic if it goes south.
Core plus properties
Core plus properties are a step higher in both risk and reward potential.
While they typically feature more avenues for growth—returns are typically between 8% and 10%—they can still produce some income. However, the predictability of that income might not be as great as core investments.
That’s because core plus properties can also be riskier than core holdings. They might need redevelopment, have weaker tenant quality, have somewhat shorter lease terms, etc. They also tend to be more levered than core investments.
Value-added properties feature moderate to high risk, but also medium to high return potential.
Growth is the primary aim with these properties, with expected annual returns of between 11% and 15%. But that’s not to say they can’t generate income. Typically, these properties will require a lot of capital up front—over time, however, they might actually generate respectable or even high cash flow.
The risk, however, is these properties aren’t A+ as is. Portfolio managers typically buy these properties knowing that they’ll have to make heavy renovations, improve occupancy, change out management, or tackle other issues to unlock the property’s value. Higher leverage also tends to be standard for investments in these properties, making them more volatile.
At the end of the spectrum are opportunistic properties—if you’re willing to accept very high risk, you could enjoy very high returns.
Opportunistic investments are just an exaggerated version of value-added. Fund managers buy extremely problematic properties with the hopes of, in time, drastically turning them around—greatly boosting the assets’ value (annual return expectations are 15%-plus) while also making them capable of producing meaningful cash flow. But you’ll have to be patient, as opportunistic real estate can take years to even start generating any positive returns.
You might assume leverage is also highest with opportunistic real estate, and it can be, but it’s not necessarily always the case. That’s largely because banks also view opportunistic real estate as highly risky, and thus debt might not always be readily available for these investments.
4. Understand How Long You Need to Stay Invested
As I mentioned earlier, private equity real estate funds tend to be highly illiquid; it’s likely your money will be locked up for many years. Why?
- Real estate assets might need substantial development to unlock value
- Market conditions might necessitate waiting to sell even high-quality properties to maximize returns
- Even when a property sale is made, it could take months for the transaction to close.
- The fund might simply require your money to be held for a long period of time to enable both investment and reinvestment
Always ask fund management how long your money will be tied up in a real estate fund.
Also ask about early exit fees. In some cases, you might be allowed to withdraw your money from the fund if you’re willing to pay an exit fee—typically between 1% to 3%, though fees might also vary depending on how early you’re withdrawing.
5. Check the Sponsor’s Incentives
You’ll also want to see how the sponsor is being incentivized.
Typically, real estate sponsors invest some of their own capital into deals with other equity investors. Find out whether your sponsor is committing capital invested alongside fund investors to share the risks and rewards.
Often, the sponsor earns the same returns as other equity investors until the “preferred return” is reached. Then, excess profits (if any) are divided unevenly, with more going to the sponsor. Excess profits paid to a sponsor are referred to as the “promote.”
This system makes sense as the sponsor isn’t only contributing capital, but also doing all of the legwork. Sponsors might work harder to earn excess returns knowing that their share is larger.
Some real estate investing platforms use a special purpose vehicle model to list their offerings. These platforms might take their own share of the profits.
Sponsor incentives can be difficult to evaluate. There’s a clear benefit to the sponsor having a lot of skin in the game. But incentives effectively come out of your pocket—meaning that excessive incentives can have a chilling effect on your returns.
6. Determine Whether Institutional Investors Participate
Institutional investors include hedge funds, mutual funds, pension funds, endowments, banks, and insurance companies. And depending on the vehicle you’re investing in, they might be investing right alongside you.
Indeed, the above are still the most dominant investors in private equity real estate, and they’ve upped their allocations slightly over the past few years.
Institutional investors have nearly bottomless wallets and appreciate the hands-off approach to real estate investing that private equity funds provide. Asset managers can typically invest in private equity real estate on behalf of the institutions previously mentioned.
Why does this matter? I consider this a signal of confidence to individual accredited investors. If you’re investing alongside firms with infinite amounts of investigative and due diligence capital, that should give you a strong sense of assurance you’re investing in the right things.
How to Invest in Private Real Estate Through a Private Equity Fund
So, where exactly can you find private real estate investments?
Well, one of my top examples is a top WealthUp CRE pick: First National Realty Partners. Here’s a quick breakdown of the platform:
First National Realty Partners (Grocery-Anchored Commercial Real Estate)
First National Realty Partners (FNRP) is one of the fastest-growing vertically integrated CRE investment firms in the United States. It’s also focused on a very particular niche: grocery-anchored commercial real estate.
FNRP’s team leverages relationships with top-tier national-brand tenants—including Kroger, Walmart, and Whole Foods—to provide investors with access to institutional-quality CRE deals both on- and off-market. Unlike many of the other sites on this list, which are equity crowdfunding platforms, FNRP offers private placements that only an accredited investor can access.
FNRP also progresses from an entire investment lifecycle, from acquisition through disposition, 100% in-house. A large team of professionals filters through thousands of deals to choose a handful they believe will outperform their peers. Unlike a traditional real estate investment trust (REIT) or fund, you have the ability to pick the deals that best align with your investment needs, so you can use FNRP’s various offerings to build your own portfolio.
This relative exclusivity does, however, come with a high minimum investment of $50,000. Sign up to learn more about the opportunity and determine whether it makes sense for your investment goals.
Read more in our First National Realty Partners review.
Private Real Estate Investing: FAQs
Is investing in private equity real estate a good idea?
Like any honest answer to a broad investing question, it depends.
The answer lies in you—specifically, does private equity real estate check the right boxes as to how much you’re looking to invest, your time horizon, objectives, diversification, and risk tolerance.
Investing in private equity real estate can be lucrative. It can produce capital appreciation, and it can also deliver a steady income through distribution payments. Additionally, investors may have the tax benefit of property depreciation, which shelters much of the cash flow from taxation.
Diversified private equity real estate can also minimize your risk. And because these investments aren’t closely correlated to the stock market like public real estate, private equity funds make for excellent alternative investments.
But private equity real estate investments can require a lot of capital, are difficult to access (typically impossible if you’re not an accredited investor), and are quite illiquid.
How do private equity real estate funds compare with a real estate investment trust (REIT)?
A real estate investment trust (REIT) is a company that owns and sometimes operates real estate, whereas a private equity real estate fund is a fund (and thus a different structure) that also owns real estate.
REITs can be public or private—most investors are more familiar with public REITs, which trade just like stocks on public exchanges. Private real estate is, as the name suggests, not traded on public exchanges, and as a result is much more difficult to access.
Public REITs are highly liquid, able to be bought and sold in seconds; private equity real estate is more illiquid, often taking years before your money is unlocked. Public REITs are also much more regulated than private real estate, and thanks to SEC requirements, information on public REITs is much easier to come by. REITs are more affordable, easier to hold (you just need a standard brokerage or retirement account), and typically require much less money for an initial investment—just the cost of a share (or less if your brokerage has fractional shares).