Complete Guide to Investing in Private Equity Real Estate

Investing in private equity real estate (PERE) has gained significant traction over the past few decades. With a blend of high returns, diversification benefits, and tangible assets, PERE offers an appealing option for sophisticated investors looking to enhance their portfolios. This comprehensive guide will explore the fundamentals of private equity real estate investing, including its structure, types of investments, risks, and strategies for success.

What Is Private Equity Real Estate Investing?

Private equity real estate investing is another investment strategy that offers investors a way to grow their wealth and earn passive income from real estate assets. However, instead of identifying and purchasing properties on their own, investors will put capital into a professionally managed fund alongside other investors.

The capital in this fund will then be used to purchase raw land, undervalued properties and other real estate. The fund often will be used to develop land or rehab a property and then sell it for a much higher price.

Private equity real estate funds are usually set up as a limited partnership (LP.) The private equity company that manages the fund is the general partner. They identify properties and projects to invest in, manage the pooled capital in the fund and coordinate any property development projects or liaise with real estate developers.

The group of investors are limited partners. They have little to no say in the operations of the fund but provide capital and earn returns based on the fund's performance. In other words, they are passive investors. Real estate private equity funds can also be structured as limited liability companies (LLCs,) S-corps, C-corps and other structures.

How Does Private Equity Real Estate Investing Work?

Private equity real estate funds are private investment funds. They aren't traded on the public market because of their exclusive nature. These funds will find a handful of high-net-worth investors and pool their capital. Once the fund has the capital it needs, the managers will identify potential real estate properties and projects.

The fund can invest in a variety of real estate opportunities. It could purchase a distressed property, flip it and sell it. Or it could partner with a real estate developer who has plans to develop a piece of land or property and finance their project.

Private equity funds have become an increasingly popular option for real estate developers looking to develop a property, whether that's turning a multiunit property into luxury apartments or building a new shopping center on raw land. These projects are often too big and risky for typical lenders but may not be for a private equity company. The private equity real estate fund will inject capital into these projects and collect their returns, which will in turn grow the fund and be distributed to the investors.

Some funds may focus on certain types of opportunities, while others may invest in a wide variety of opportunities. If the fund purchased a property, it will sell it after it's been rehabbed and the property appreciates. If the fund finances a project, it will wait until the investment time horizon is over and then collect its returns.

Benefits of Investing in Private Equity Real Estate

Private equity real estate funds have become a popular investment option for passive investors looking to grow their wealth through real estate. Here are just a few advantages that make these funds so attractive.

• Leaner and More Efficient: These private funds are limited to a few accredited investors, so they don’t require as big a management team as other public funds. There’s not much overhead, and the fund’s success is often enough to cover the majority of the operational costs. This can lead to fewer front-end fees compared to other investment opportunities. 
• Higher Returns: Private equity real estate investment funds are extremely illiquid, and while this can be seen as a disadvantage, it’s balanced out by an illiquidity premium. Because of the fund’s illiquid nature, investors can demand higher returns to make up for it.
• Passive Investment: An asset manager or team of managers will actively oversee the fund, ensuring the capital is allocated to projects and properties that are likely to produce returns. You’ll earn passive income while the fund managers handle the day-to-day operations.
• Direct Ownership: Unlike other real estate funds, investors in private equity funds will own real properties. You’ll be able to earn returns based on the properties’ profitability, without the hassle of managing it.

Drawbacks of Investing in Private Equity Real Estate

• High Investment Minimums: Private equity real estate funds are an exciting opportunity, but they aren’t feasible for every investor. They aren’t publicly traded, so you’ll need connections to financial professionals who can notify you about private equity opportunities. PERE funds are often exclusive to accredited investors and have steep investment minimums. They can be a great option for high-net-worth individuals but aren’t accessible to most investors.
• Management Fees: Private equity real estate funds typically have steep management fees of around 2% of your investment. This fee can eat into overall returns, so ensure you understand a fund’s fees and how they’re paid before agreeing to invest.
• Capital Calls: When an individual initially invests in a private equity real estate fund, the private equity firm will make them sign an agreement that a certain amount of capital will be paid to the fund when they need it. This is called a capital call and typically happens when the fund is nearing close on a deal and needs more capital. The fund may not provide advanced notice, and investors are required to pay the sum requested. This can make financial planning difficult because investors must keep a certain amount of funds liquid and available if a capital call is made.
• Illiquidity: Because they aren’t traded on the public market, these funds are highly illiquid. For most private equity real estate funds, exiting them before the investment horizon is up is nearly impossible. Before investing, ensure you understand the fund’s investment horizon and exit strategies if there are any. Consult with your adviser to check that your portfolio can handle this type of illiquid investment.

Difference Between Private Equity Real Estate and Other Investment Options

Many real estate investment options are available, and private equity real estate funds are often confused with real estate investment trusts (REITs.) Both PERE funds and REITs involve multiple investors who provide capital that a management team allocates to real estate investment. However, the structure and scale of these investment vehicles are very different.

Equity REITs are often publicly traded and can sell hundreds of shares, so many people are invested in the same REIT. These investors do not have any ownership over the property the REIT invests in, they simply own a share in the portfolio created by the REIT.

Private equity real estate funds are privately traded and only allow a handful of accredited investors to invest. Instead of these investors purchasing shares of the fund, their pooled capital is used to buy and sell real estate projects. These funds are also bigger, allowing them to partake in larger-scale acquisitions such as development projects.

Various Types of Private Equity Real Estate Investment Funds

The four main types of private equity funds are each focused on different real estate opportunities and property types.

• Core: Core private equity funds focus on new, high-quality multiunit or retail properties with a good location and stable tenants, such as multifamily apartments in a desired downtown area or retail properties with trusted tenants. Because these investments are stable, there’s less risk associated. Investors can expect to see lower but stable returns.
• Core Plus: Core plus funds are a good fit for investors who have tolerance for a little more risk for a chance at higher returns. These funds will also incorporate riskier investments, such as older industrial properties, properties that need renovations and real estate in secondary locations.
• Value-added: In a value-added fund, the investor’s capital is used to renovate properties in a good location but needs work. They are bought for a low price, then the fund pays for renovations, which add value to the property so it can be resold for a much higher price.
• Opportunistic Funds: Opportunistic investment funds are the riskiest of these four. They almost solely invest in high-risk, high-return properties. These projects could be ground-up development or a complete renovation of existing buildings. These projects require a lot of capital upfront and take a long time, so investors likely won’t see returns for years after the initial investment. 

When Should You Invest in Private Equity Real Estate?

Private equity investment funds can be a strong addition to some portfolios. But every investor should review their holdings, market conditions and goals before investing. 

Private equity funds are highly illiquid. You’ll want to look at your overall portfolio and ensure you can invest a large amount without needing to touch it for years. Also, consider your financial goals and whether they align with the investment’s time horizon and risk. 

If you’re looking to build generational wealth, a PERE fund may be a good fit. However, if you're saving for a more short-term goal, private equity may not be the best option.

The real estate market can be volatile, so always conduct market research before making a real estate investment. A good economic indicator is interest rates and average rent prices. This can inform whether it’s a good market for sellers and the current supply and demand dynamics. Before investing, you will want to ensure there is demand for the types of properties you’ll be investing in.

Develop Your Portfolio with Private Equity Real Estate

Private equity funds provide investors with direct ownership of a portfolio of properties so that they can earn passive income without the responsibilities of management. However, these investment funds are typically only accessible to high-net-worth accredited investors. Investors who have the risk appetite for a large, illiquid investment may want to explore private equity opportunities further with their trusted financial professional.

Frequently Asked Questions