An Understanding of Private Equity Funds Will Help Smaller Investors Move Beyond Single-Family into Commercial Real Estate
Commercial real estate investments bring immense benefits that an investor is hard-pressed to achieve with a portfolio that is limited to single-family homes. However, individual investors traditionally have shied away from this asset class, thinking, “Commercial real estate investing is out of my reach because I don’t have the capital or the expertise.”
While this misperception held merit for many years, the tides are shifting quickly in favor of the individual real estate investor looking for something more in his or her portfolio. Commercial real estate allows investors to diversify across assets that move in different market cycles. It can pass through outstanding tax benefits. It provides economies of scale and opportunity to add value far beyond what is typically seen with single-family homes.
The significant event that is changing the way people look at real estate investing was the enactment on Sept. 23, 2013, of Title II of the JOBS Act, allowing public solicitation of private equity funds. To explain why this was so momentous, it is important to first understand private equity funds as an investment vehicle.
Private equity funds have been used for decades, primarily by institutional and ultra-high-net-worth investors. The structure is simple: Multiple investors invest significant amounts (often millions of dollars each) into an entity, usually an LLC. The entity is managed by a trusted group of people with expertise in the type of property the fund is set up to purchase. This allows the investors to be purely passive, while the managers handle the day-to-day operations and asset decisions. The fund managers have access to properties, area expertise, industry connections and resources that the investors do not. Essentially, each investor is putting the fund manager to work for him or her when making the investment.
Highly Structured and Regulated
While this might sound similar to a partnership or a REIT (real estate investment trust), it is vastly different. Unlike a traditional partnership, a private equity fund is a highly structured and regulated investment vehicle. These funds are regulated by the Securities and Exchange Commission and the Corporation Commission. Many funds are also audited on an annual basis by a third-party accounting firm. Asset values are often determined by third-party appraisals every year. In other words, more thought, consideration and legal structuring go into a private equity fund than into a partnership or joint venture. Also, a private equity fund investment is a direct investment into real property, rather than a derivative of real estate, or stock based on real estate, as is the case with a REIT.
Return on investment will vary based on the types of properties the fund acquires. Annual returns of 20 percent or higher are not uncommon in commercial real estate. Extremely conservative funds that purchase already-performing property may only produce single-digit cash flow. Value-add and opportunistic funds often reach double-digit returns from cash flow distributed on a quarterly basis.
Thanks to Title II of the JOBS Act, these types of real estate private equity funds are now more accessible than ever before. You don’t have to belong to an “insider” group of ultra-wealthy people. While private equity investments are still not widely known to the public, they are now an option available to those looking to add commercial real estate to their portfolio.
Investment amounts vary depending on the limits determined by the fund manager. Nowadays it is common to see minimum investment amounts set at $50,000 or sometimes as low as $25,000. In other words, you can add large properties like an airport hotel, professional office complex or 200-unit apartment community to your portfolio with a five-figure investment.
Key Points to Consider
This presents an incredible opportunity, but there are key points to consider before investing in a real estate private equity fund.
1. Different asset classes move in different market cycles
We’re currently finding outstanding value-add opportunity in hotels, professional and medical office properties and self-storage facilities.
2. Invest in areas you know
Commercial property is most stable in cities with a diversified economy. Sub-markets should be areas where “normal people” tend to be. For example, a high-end golf resort in a vacation spot will tend to be more volatile during a recession than a major brand hotel next to an international airport.
3. The fund structure is easily as important as the properties the fund buys
A well-structured fund is one where the manager is highly incentivized to make the properties perform at their maximum potential. The fund manager should participate in profits only after meeting specific return benchmarks for you, the investor.
4. Real estate private equity funds come in all shapes and sizes
No two funds are the same. Some are set up to invest in one specific property, while others purchase a variety of properties to provide diversification. Some are designed to produce monthly cash flow, some are designed strictly for long-term capital gains, and others will provide a combination of cash flow and gains. Some funds are designed to keep capital deployed for a single year, while others may have a five- to 10-year outlook. Invest in the fund that fits your parameters.
5. Real estate is a business, and as in any business, your team is your most valuable asset
The team supporting the fund should have expertise and a proven track record with the types of properties the fund purchases. Remember, when you invest, you are putting the fund management team to work on your behalf. That team should operate with full integrity and transparency. I believe the team is the most important factor in any private equity fund’s success.
It is important for every serious real estate investor to understand these types of investments. As you start your research, you’ll quickly find that a whole new world of investment opportunity is now more readily available than ever before. This shift is a significant benefit to investors and the real estate industry indefinitely.
DISCLAIMER: Information is provided for educational purposes only and may not be relied upon in connection with the purchase or sale of any security. All investors should seek professional counsel and fully understand each offering prior to making an investment..
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