Understanding Private Equity Real Estate

There has never been an easier time to be a real estate investor. With plenty of investing options available, the real estate markets are open to many everyday investors.

Investment opportunity and access was mostly limited to institutional investors, but today the playing field has changed and brought more investment exposure to real estate.

However, that means you as an investor need to determine the best way to grow your capital in real estate assets. There are several options competing for your money in San Diego County, and our post today will show you how private equity gives you exposure to the San Diego real estate market.

What is Private Equity Real Estate?

Private equity real estate is a finance term relating to a specific type of real estate investment. There are four categories under private equity real estate: private equity, private debt, public equity, and public debt.

Essentially, private equity funds utilize debt and equity mechanisms that allow multiple real estate investors to pool their capital together, often for commercial investments.

Investing in real estate was very limited in the past, and focused primarily on core residential real estate investments. Throughout the 1990s, alternative investment tools and strategies emerged due to falling asset prices in the real estate markets.

Private equity real estate introduced new investing opportunities that were traditionally reserved for institutional investors. Now private equity real estate serves as its own asset class and has been widely adopted in recent years.

This makes it important for private investors to understand how private equity applies to real estate, and how to take full advantage of the investing strategies available.

How is Private Equity Different From a REIT?

Previously, we’ve discussed real estate investment trusts and how they differ from private equity syndications.

It’s important to note the differences between the two because when looking at a few of the operating details for each you find they are different types of investments in terms of asset management.

Fees: REITs have a reputation for their higher fee structure, which can include upfront costs of 10-15%. Since the Financial Industry Regulatory Authority (FINRA) started requiring REITs to publicly state these fees, the amount of capital flowing into REITs has dropped significantly.

On the other hand, more capital is making its way into private equity real estate due to a more profitable fee structure. Teams managing a private equity fund can personally serve investors and invest in properties directly, thus eliminating one middleman and their subsequent fees.

Investment: This is the chicken and the egg applied to real estate investing. REITs typically take capital from investors upfront prior to purchasing properties. The benefit for investing in REITs is the diversification of properties. However, the funds don’t necessarily start with a large pool of properties. Instead, fund managers can find themselves with their backs against the wall searching for investment properties to make dividend payments right away, which could lead to riskier investments.

With REITs, the capital commitment comes first followed by the actual investments and property acquisition. Private equity funds take the opposite approach. They call for investors to put up capital once they have an investment property identified and vetted. In other words, the investment opportunity is identified first followed by the call for capital from investors.

Dividends: This is usually the major benefit from investing in REITs; they often have healthy dividends. However, this has also led to an expectation for high dividend payments. REITs can have a lot of pressure to keep dividends steady or increasing, even if market conditions say otherwise. REITs might be forced to use other tactics to make dividend payments and save face -- i.e. borrowing more money or raising more equity.

Private equity funds don’t have the same pressure. Investors don’t want to see declining payments, of course. But private equity funds tend to use other tactics like increasing the property’s cash flow to maintain steady payments.

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Strategies of Private Equity

When it comes to overall investment strategy, private equity real estate funds typically follow one of the following strategies outlined below:

Core: This is a low-risk, low-return strategy with predictable cash flows. It’s considered the safest of the four strategies.

The primary focus is buying and selling stable properties with certain characteristics: good condition, low vacancy rates, desirable locations. This allows for a conservative approach where properties can be easily sold if necessary.

Core-Plus: This strategy follows the same guidelines as core investing, but with the potential for marginally higher returns.

The focus is still on stable properties, but specifically those with opportunity for improvements. This could mean adding amenities to the property like a park area or community center to the real estate development. San Diego County Investors are looking for opportunity where a one-time expense will have a positive impact on rent prices overall in the future.

Value-Added: This strategy brings a bit more risk into the equation, but much more potential for higher returns.

This approach takes core-plus investing to the next level. The focus is finding real estate properties that can generate a significant return if substantial improvements are made. Building renovations and real estate developments can fall under this category. The value-added strategy is a longer-term approach as gains come after improvements are finished.

Opportunistic: This is the high risk, high reward strategy for real estate investing.

The focus for this approach is finding distressed properties in need of major renovation. These properties also typically have high vacancy rates, so often times there is no initial cash flow when the property is purchased. Investing timelines are longest with this strategy due as the whole renovation process takes years or decades to play out.

Things to Consider

When you’re determining which investment strategy is right for your real estate investments, you should account for your risk tolerance and liquidity requirements.

As you move from core investing strategies down to opportunistic investments, the risk increases while your investments become more illiquid. If your risk tolerance is on the lower end, you’re better suited for the core and core-plus strategies. Investors looking to generate higher returns might opt for investments with the value-added or opportunistic approach.

Topics: real estate, investment strategies, private equity