What is Private Equity Real Estate & Its Top 3 Categories of Investors
What Is Private Equity Real Estate?
Private equity real estate is an alternative investment class involved in real estate markets. It involves acquiring, financing, and owning properties through investment funds. Because it requires substantial capital and long-term commitment, it's typically seen as an investment for high-net-worth individuals. Private equity real estate differs from publicly-traded equity REITs, whose revenues mainly come from the income of rental properties that are part of a REIT's holdings.
Key Takeaways
Private equity real estate involves investing in real estate through professionally managed funds; it differs from publicly-traded real estate investment trusts (REITs).
These investments are primarily accessible to high-net-worth individuals and institutional investors due to significant capital requirements and limited liquidity.
With annual returns ranging from 6% to 10%, private equity real estate can offer significant rewards but carries higher risk compared to other real estate investment options.
Investors must commit substantial upfront capital, often over $250,000, and be prepared for long lock-up periods, sometimes over a decade.
Private equity real estate can be structured in various legal forms, such as limited partnerships or limited liability companies, offering diverse investment opportunities in different property types.
How Private Equity Real Estate Functions
Private equity real estate funds allow high-net-worth individuals (HWNIs) and institutions such as endowments and pension funds to invest in equity and debt holdings related to real estate assets.
Using an active management strategy, private equity real estate takes a diversified approach to property ownership. General partners (GPs) invest in a variety of property types in different locations, which can range from new development and raw land holdings to complete redevelopment of existing properties, or cash flow injections into struggling properties.
Private equity real estate investments are commonly pooled and can be structured as limited partnerships (LPs), limited liability companies (LLCs), S-corps, C-corps, collective investment trusts, private REITs, separate insurer accounts, or other legal structures.
Key Factors to Consider in Private Equity Real Estate
Investing in private equity real estate requires an investor with a long-term outlook and a significant upfront capital commitment—over $250,000 initially and follow-on investments over time. Little flexibility and liquidity are offered to investors since the capital commitment window typically requires several years.
Lock-up periods for private equity real estate can last over a dozen years. Distributions can be slow since they're often paid from cash flow, not liquidation, and investors can't demand a liquidation. Fund managers often charge a 2-and-20 fee: 2% of invested assets yearly plus 20% of profits.
The following category of investor invests in private equity real estate:
Institutions (pension funds and nonprofit funds) and third parties, such as asset managers investing on behalf of institutions
Private accredited investors
High-net-worth individuals (HWNIs)
Funds for individual investors usually need to be funded when signing the investment agreement, while institutional investors funds require a capital commitment. This capital is drawn down as suitable investments are identified. If no investments occur during the agreed period, nothing can be drawn from the commitment.
Important
Private equity real estate investing is risky, but it can also provide high returns.
Assessing Returns in Private Equity Real Estate Investments
Despite limited flexibility and liquidity, these investments can offer the potential for high income and strong price appreciation. Annual returns in the 6% to 8% range for core strategies and 8% to 10% for core-plus strategies are not uncommon.
Returns for value-added or opportunistic strategies can be much higher. That said, private equity real estate is risky enough that investors can lose their entire investment if a fund underperforms.
Fast Fact
Private equity real estate funds became popular in the 1990s amid falling property prices as a way to scoop up properties as values fell. Previously, most institutional real estate investing adhered to core assets.
Options in Private Equity Real Estate Investments
Office buildings (high-rise, urban, suburban, and garden offices); industrial properties (warehouse, research and development, flexible offices, or industrial space); retail properties, shopping centers (neighborhood, community, and power centers); and multifamily apartments (garden and high-rise) are the most common private equity real estate investments.
There are also niche property investments such as senior or student housing, hotels, self-storage, medical offices, single-family housing to own or rent, undeveloped land, manufacturing space, and more.
The Bottom Line
Private equity real estate is an alternative asset class that offers potentially high returns but comes with greater risk and larger capital investment requirements than other real estate investments. It's best suited for high-net-worth individuals and institutional investors due to the substantial capital commitments and long lock-up periods. While returns can be attractive, investors should be aware of the risks, including the possibility of losing their entire investment if a fund underperforms. In addition, private equity real estate investments have limited flexibility and liquidity compared to other real estate investments.