FREQUENTLY ASKED QUESTIONS
Commercial real estate, despite illiquid, poses several advantages as an addition to a well-diversified portfolio as it adds an asset class with lower volatility and diversification to typical securities, and provides a solid hedge against inflation.
Private Equity Funds are among the best suited vehicles to allow a “Direct Investment” in Commercial Real Estate beyond a single investor scale as they allow the investor to diversify its portfolio without taking “personal debt”, while outsourcing the complexity of managing this asset class. Selecting which private equity group to partner with is crucial for a successful long-term investment.
What is a Real Estate Private Equity Fund?
Private Equity Real Estate is an asset class consisting of equity and debt investments in Real Property. Investments typically involve an active management strategy ranging from moderate reposition or releasing of properties to development or extensive redevelopment. Typically a Real Property investment can be easily categorized in 3 stages: (i) Income (stabilized income typically over 90% occupied); (ii) Value Add (partially stabilized with upside potential through enhancements to drive increased occupancy or rental rates); and (iii) Growth (development projects with no current income).
Is the investment liquid?
Generally, a Real Estate private placement is a long-term investment aimed at a mid to long term horizon of 5 years and beyond. Distributions are made only as investments are converted to cash (Refinance, Sale, Net Operating Income distributed as dividends). Private equity fund investments require a long term horizon with capital locked for relative long periods of time. Therefore, Investors profile that fits a real estate private equity fund tend to be best suited for institutional investors or high-net-worth individuals.
What risks are associated to this Asset class?
As any other investment, real estate investments entail risks associated to multiple variables outside of the control of the real estate managers. Such risks include market risk, interest rate risk, general market conditions of the subject assets and liquidity risk.
Once invested, what is the exit strategy for the individual investor?
There are several alternatives. The simplest option is to follow the planned strategy and exit when the asset is refinanced or sold. However, Private equity real estate investors may sell their participation to other investors for opportunistic, liquidity and other reasons. The primary buyers may be the Fund, others investors in the same Fund or new private investors.
Who can invest?
Generally, a private placement is offered only to Accredited Investors. Accredited Investor is defined by the U.S. Securities and Exchange Commission (SEC) as individuals with a net worth in excess of $1 million, or individuals with gross income of at least $200,000 ($300,000 for income with a spouse) for each of the two last years. The definition for accredited investor is contained in Rule 501 of the Security Act of 1933 (Reg 3).
Can I invest through my IRA, LLC, Trust, LP?
Investors can invest through an LLC or trust or self-directed IRAs.
How do I report this type of investment in my tax report?
Deals are structured based on LLC companies. Each LLC is typically structured as a pass-through company for tax purposes. All gains and losses are directly distributed among its partners with a K-1 tax form for the taxable income attributable for each fiscal year.
What are the management Fees?
Fees are generally structured on deal by deal basis. In general, Investors receive a preferred return on their capital invested between 4%-8% annual. Once investor capital is fully recovered including the preferred return, any future profits are split between the fund managers and investors on a predetermined basis. This fee structure typically aligns incentives of the fund managers with those of the investor. Finally, investors may pay a marginal annual management fee on invested capital used for operating expenses.
Why invest in Real Estate Private Equity versus REITs?
A Real Estate Private Equity investment can be a valuable complement for any investment portfolio to achieve long term financial goals. Real Estate Private Equity Funds typically allow access to assets that would otherwise would not be available for individual investors due to lack of expertise, capital or appetite to undertake personal debt.
REITs allow investors to access a more diversified real estate portfolio investing a lower amount of capital providing more liquidity as they are publicly traded. However, they are highly correlated to the stock market fluctuations and trends and the direct investments are less transparent as each asset is not as perfectly identifiable as a specific private equity investment.
How does Inflation and Interest Rates impact Real Estate Assets?
Real estate in a long term portfolio provides diversification, and it has historically acted as an excellent hedge against inflation. Typically this asset class has similar exposure to interest rates as a fixed income asset or Bond. Higher rates render lower face value of the asset while increasing the current income. An improving US economy outweighs any potential temporary negative effects of a hike in interest rates. Rising lending rates may increase the acquisition cost of Real Assets and affect the current asset valuations. However, as an offset, an improving economy typically renders higher economic activity which is typically accompanied with higher occupancy rates and rental rates.