How to Invest in Private Equity Real Estate
June 28, 2022
If you're an accredited investor with a lot of capital to invest, knowing how to invest in private equity real estate can be a great way to diversify your portfolio. But, of course, it's not an option for anyone with low risk tolerance and most non-accredited investors. Still, if you have the capital and can take the risk, private equity real estate can be an excellent addition to your portfolio.
What Is Private Equity Real Estate?
Private equity in real estate is an investment strategy that pools funds from multiple investors to buy and develop commercial real estate properties. Real estate private equity firms typically only offer the investments to accredited investors with a large amount of capital. However, there may be a few rare opportunities for non-accredited investors too.
Private equity real estate funds sound similar to real estate investment trusts, but there are a few key differences, including:
- The requirement to be an accredited investor
- The high amount of capital required (sometimes as much as $250,000)
- The illiquidity of the investment (your money could be tied up for many years)
Finding the Best Private Equity Real Estate Opportunities
Finding the best private equity in real estate opportunities means understanding how the investments work, evaluating the requirements, and determining the risk vs. return to ensure it fits within your investment strategy.
Upfront Capital Needed
Private equity funds' upfront capital investment is often the number one obstacle for non-accredited investors. You might find private equity funds that allow investments as low as $25,000 - $50,000, but most require at least $250,000.
This isn't a small initial investment, even if you're an accredited investor. Tying up many funds in one asset class can be risky, which is why diversifying is always key. Also, ensure the capital you invest isn't all of your liquid funds because you may not be able to access them for many years.
Most funds charge a fee of 2% or more of the capital invested, but it varies by company and fund. Always read the fine print to understand the total fees charged. The fees you'll pay may include management fees, administrative fees, legal fees, and research costs. There typically isn't a limit to the fees, and fund managers can charge more than one fee, so make sure you ask all the necessary questions before investing.
Risk vs. Return
Every investment has a risk, even conservative investments, so it's always important to analyze the risk and compare it to the possible returns. Remember that returns are never guaranteed, but if you know what to expect compared to your risk, you can determine if an investment suits you.
To lower your risk, do your due diligence. Research the fund manager's level of experience, success, and overall investment structure and strategy. Ensure the strategy fits within your risk tolerance and that you agree with how the investment opportunity is managed.
Like we said earlier, returns are never guaranteed, but when private equity funds perform well, the returns have the potential to be high. On average, investors earn 6 - 10% returns, but again, there's no guarantee.
Number of Investments
Diversification is the key to any investment opportunity and its success. Make sure the private equity fund you invest in has a strategy involving purchasing multiple real estate properties. Putting all the money into one property is too high risk and can lead to a total loss even if the real estate market performs well because not all properties succeed.
The best time to invest in private equity real estate is impossible to predict, but choosing a fund manager with experience in the industry who understands the real estate cycles and knows when to invest in different types of properties can help you maximize your investment returns.
Every real estate funds deal is different so vetting can be slightly complicated, but knowing the key metrics helps.
The Internal Rate of Return calculates your return over the investment's term. Of course, a higher IRR is better but always look at the numbers used for the calculation to ensure they are realistic, as some fund managers may inflate specific numbers to make the IRR more attractive.
Equity multiples is another good metric to consider. This measures how much money you'll get back at investment maturity versus how much you invested. Again, this is a good comparison for rental properties because the longer a private equity fund holds onto a property and collects rent, the higher your equity multiples will be (aka your total return).
Private Equity Options
Most private equity options are for accredited investors, but there are a few options for other investors.
Accredited investors usually have the most private equity fund options because they typically have more money to invest. As we said, many private real estate funds require a large minimum down payment, such as $250,000. This is a lot easier for an accredited investor to invest than a non-accredited investor.
The relaxed regulations on crowdfunding have recently made it easier for small-time investors to invest in private equity funds. You aren't investing in the large, multi-million dollar real estate investment companies. But instead, you'll invest in smaller start-up companies that need funding and will accept non-accredited investors.
Private Equity Real Estate Strategies
If you've decided to make private equity investments, you should understand there are multiple options to invest in this type of real estate fund.
Core funds have the lowest risk, meaning the lowest returns, but they have the chance of higher consistency. Most investments in multifamily properties are entirely or mostly leased, giving investors access to regular dividends (rental income).
Core Plus funds are a combination of core and value-added funds. It's a diversified fund with a certain level of conservativeness with core funds plus the excitement and potentially higher returns of value-added funds.
Value-added properties might sell for a discount and need some renovation. The investor buys the property using the private equity fund, renovates the property, and then sells it for a profit, distributing the earnings to investors.
Opportunistic funds, as the name suggests, are the riskiest, but they offer the highest returns when they do well. They invest in more alternative investments like undeveloped land or properties in need of major repairs and renovations.
Real Estate Private Equity Funds
Like any investment, it's good to evaluate the pros and cons of private equity to ensure you understand the risk and reward.
There are many reasons to consider private equity funds, starting with the potential returns. While you shouldn't assume you'll earn high returns, there is potential. As a private equity investor, you will earn a prorated percentage of the investment made, including any rental income.
Most private equity investments are in high-cost commercial real estate that would be out of reach for individual investors. As a result, most fund managers diversify their private equity funds by investing in multiple property types to reduce the risk.
Finally, real estate private equity funds are mostly passive investment opportunities. This means your only job is to invest your capital.
You should consider the downsides of investing in private equity real estate. First, there could be a capital call. This means you pledge a certain amount to invest, but the private real estate fund doesn't use the entire amount at once. If the managers purchase properties or need more capital for renovations, they may do a capital call equal to a percentage of your total pledged investment. You keep your money tied up but possibly not 100% invested.
In addition, the costs can be high since there's little regulation regarding what the private equity funds can charge, and like any investment, there's no guarantee of returns.
How to Get Into Private Equity Real Estate FAQ
What Is the Difference Between Private Equity Real Estate Funds And REITs?
Private equity real estate funds are similar to real estate investment trust funds but have many differences. The largest difference is the liquidity or lack of it. REITs are much more liquid because they trade on the regular stock market during trading hours. On the other hand, private equity funds are tied up for the investment duration, which could be many years. REITs are also much more regulated than private real estate investments.
Who Should Invest in Private Equity Real Estate?
Private equity real estate is best for accredited investors with a lot of capital they can tie up for many years. However, suppose you're looking for a way to diversify a large amount of capital and have all other financing taken care of, including retirement funds and other financial goals. In that case, letting your money grow in private equity real estate can be a good option.
What Return Can You Expect to Receive from Private Equity?
There's never a guarantee of return on any investment, but private equity real estate usually has a return of 6 - 10% depending on the portfolio of properties included.
The Bottom Line
Knowing how to invest in private equity real estate is a good way to diversify your portfolio. After you've maxed out all other investment opportunities that meet your needs (retirement accounts, college savings, etc.), adding commercial real estate investment opportunities to your portfolio can be a great way to increase your earnings and get involved in real estate assets.
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