How Private Equity Real Estate Investing Works for Normal People

[ad_1]

Heard the term “private equity real estate investing” thrown around, but not sure how it works?

Don’t sweat it — private equity might sound intimidating, but it’s actually pretty simple. In fact, it’s a lot easier to invest in real estate private equity than it is to buy a rental property.

You might just find yourself humblebragging about your own private equity real estate investments at the next cocktail party.

What Is Private Equity in General?

Private equity simply refers to an equity interest — an ownership interest — in a private company. In other words, owning part of a company that isn’t publicly traded as a stock.

In the case of real estate private equity, the company is typically a single-asset LLC that owns an investment property and nothing else. You hold fractional ownership in a property by holding ownership in the company that owns it.

Private equity in real estate investments is a niche, of course. Most private equity is in operating businesses. The classic example of a private equity investment goes like this: a private equity firm buys a small business and grows it quickly by infusing money into marketing campaigns and bringing in experienced leadership. They turn around and sell the company after it has grown, thereby earning a tidy profit.

Other forms of private equity include hedge funds and venture capital that buys and grows startups. Hedge funds invest in private equity companies as high-risk, high-return investments, and hedge against some of that risk through strategies such as short-selling stocks or trading options and futures.

Which is fascinating if you’re a big ol’ investing nerd, but that’s outside our focus on real estate investing.

What Is Private Equity Real Estate Investing?

In the world of real estate investing, private equity comes in two broad forms: real estate syndications and real estate funds.

Real Estate Syndications

“Thanks Brian, that explanation gives me more terms I don’t know. So what is a real estate syndication?”

A real estate syndication is a private equity investment in a single property or small portfolio of properties. The syndicator — a professional real estate investor also known as the sponsor or general partner (GP) — finds a commercial property and raises money from outside investors like you and me to help fund it. In exchange, we passive investors (known as limited partners or LPs) get an ownership interest in the returns.

In other words, you buy fractional ownership in a property (or in a few properties as a package deal).

Real estate syndications have a fixed start and end: the sponsor buys the property, often renovates it to force equity, then sells it. Upon sale, everyone (hopefully) gets a nice paycheck, and the deal is over.

You can think of it like a glorified flip, with the sponsor flipping an apartment complex rather than a single-family home.

Real estate syndications aren’t limited to multifamily properties, but they’re the most common type of property. Syndications could feature any type of real estate, however, from office buildings to retail space, self-storage facilities to mobile home parks, or industrial properties and beyond. Beyond different property types, these investment opportunities could be existing buildings or new construction real estate development.

Some real estate syndications only allow accredited investors to participate. These fall under regulation 506(c), with looser rules for sponsors to advertise and raise money. Sponsors can alternatively structure the deal as a 506(b) syndication, which allows up to 35 non-accredited investors to buy in, but they can’t market the syndication to the general public.

Real Estate Funds

Rather than buying into a specific property, you could buy into a real estate fund that owns many properties.

Or will in the future — often you buy into funds blindly, without knowing exactly what assets they’ll buy.

In some cases, real estate investment funds have a set period for raising money, then they close. The fund manager might plan on selling all the funds’ assets after a certain length of time, and then the fund ceases to exist. Once you buy in, you often can’t sell shares until the fund liquidates.

Alternatively, some private equity real estate funds are open-ended, with no fixed end date. They buy properties, hold them for a few years, then sell them and buy more. Individual investors can buy and sell shares at any time, or more often after a minimum holding period.

Most real estate private equity funds only allow accredited investors to participate.

Returns on Real Estate Private Equity

As with every other type of investment, returns vary. Still, the reason wealthy investors like real estate syndications and other private equity real estate is the high historical returns.

Annualized returns typically range between 15–30%, and often higher. One general partner who we’ve invested with several times in our real estate investment club, Rise48, has delivered average annual returns of 70.5% across the properties it’s sold.

These returns break down into income and profits upon sale, as with most long-term real estate investments. Broadly speaking, investors often earn 4–8% annual yields for income while owning a private equity real estate investment, plus another 8–20% annualized returns in profits upon sale.

But these deals come with slightly more complex profit sharing arrangements than just owning a fixed percentage of the pie. Often sponsors offer a “preferred return” to attract passive investors — a percentage return that LPs get first priority in receiving, before the GP starts collecting their returns. Common preferred returns range from 6–8%.

The sponsor takes on all the labor and liability, however, and they want compensation for their trouble. So above the preferred return, they typically get a separate portion of the profits (called the “promote”). For example, above an annual 7% preferred return, profits might be split 80/20, with 20% going directly to the sponsor and the remaining 80% divvied up proportionately among passive investors.

That sometimes gets further complicated when there’s a “waterfall.” In that case, the profit sharing changes depending on the profit. Continuing the example above, the profit split might be 80/20 for returns between 8–12%, then drop to 70/30 for profits between 12–20%, then 50/50 for profits above a 20% annualized return.

[ad_2]

Source link

Leave a Comment

Your email address will not be published. Required fields are marked *