What is commercial real estate private equity?
Imagine you and a group of friends from your hometown always talked about how great an idea it would be to build a multifamily apartment complex where an old, dilapidated building always stood. As you all got older and became more successful, you decide to pool your capital and make that dream into a reality. This type of real estate investment would be a form of direct deal private equity, which we’ll dive into later.
More commonly, private equity investing is handled by private equity firms that can connect the participant directly to a single project. Think of the above example, except instead of investing with your friends, private equity firms take your money and pool it with capital from other investors you don’t know to participate in a single project.
Both end outcomes are the same: a big ROI. But all the legwork of finding a property, buying it, developing it, then selling it is handled by the development firm creating the project. Because they manage everything from acquisition to day-to-day operations, the development group gets paid through the project in terms of development fees, construction fees and management fees. Returns can easily reach 10% or higher depending on the strategy.
Benefits of Commercial Real Estate Private Equity Investing
As mentioned above, the real benefit of private equity real estate investing is the excellent returns. Nonetheless, there are several other reasons to consider commercial real estate funds when building your portfolio.
1. Property Ownership
The great thing about real estate investing is that you own part of a tangible asset. Unlike some investments that can lose value overnight, the property will always retain some value because it’s a physical asset. Real estate values can fluctuate depending on the market, but you’ll never lose all your invested capital.
2. Depreciation Write-Offs
Another advantage of private equity real estate is that investors can further increase their net ROI by writing off the depreciation costs of their investment properties. The IRS allows investors to depreciate the building itself, as well as any additional capital investments. To learn more about real estate depreciation, check out this helpful guide from Nolo.
3. Dividends Through Profit
Many deals are structured to pay dividends derived from the accumulated profit of the property’s business activity. Dividends of this nature are more stable than the dividends paid out by REITs (Real Estate Investment Trusts). REIT dividends are often distributed from investor capital or debt — which can become depleted over time.
Private equity dividends can be paid out annually, quarterly or monthly. Dividends provide additional returns in the form of cash and are an excellent incentive for investors to “stick out” their real estate investments in times when market values may decline.
4. Less Regulation Means More Flexibility
Because private equity invests in private CRE properties, it doesn’t face the same strict regulations as REITs or funds. This freedom allows private equity fund managers to greatly diversify their portfolios and provide more risk-averse or risk-tolerant strategies, depending on the investor’s goals.
5. Well-Structured Deals
Unlike other forms of commercial real estate deals like joint venture equity, private equity investing has more of an investor-first structure. Private equity firms have a huge stake in your success. It is important that the firm you work with has a system to vet the developers they work with and the opportunities presented by their projects. Successful partnerships lead to more opportunities for the private equity group, the developer, and the participants!
What Are the Investor Requirements for CRE Private Equity?
Commercial real estate private equity deals involve vast amounts of capital spread across multiple investments, so there are some barriers to entry to becoming an investor. There are three primary requirements for becoming an investor in private equity.
1. Establish Yourself as an Accredited Investor
The first requirement to invest in private equity is to establish yourself as an “accredited investor.” There are several ways a person can become an accredited investor. The below list are the most common ways people become accredited investors; however, the SEC amended its previous definition of an accredited investor in a 2020 update to include more.
Have a net worth exceeding $1M either alone or jointly with their spouse (not including the value of your primary residence).
Have a gross income of at least $200,000 or $300,000 for partners filing jointly.
If investing as an entity (corporation, limited partnership or charitable organization), the entity must have assets that exceed $5M. Or, if the entity consists of equity owners that are already accredited, they must have investors.
2. Have the Capital
Private equity investors are required to have a high net worth because the investing requirements are immense. Most private equity firms require a minimum investment of $50,000, and they can range upward of $5M or higher.
3. Have the Patience
As mentioned above, most private equity deals involve a long-term strategy to see the promised high ROI. Investors should be prepared to have their capital “locked up” for several years before being able to recall their investment. The period varies depending on the strategy, but an average of 3 years is common.
Direct Private Equity Deals
For a seasoned private equity investor or those confident they are working with a reliable firm, direct private equity deals are an option. These types of deals usually involve one asset. The benefit of direct private equity deals is that the investor gets to learn about the property inside and out. They research their financial statements, business plans, demographic data, local zoning ordinances, and everything else they need to make an informed decision.
In these types of investments, investors essentially research and build their own portfolios. Investors can do all this work themselves, but often they will turn to reputable sponsors to broker deals. Direct private equity deals are also only available to accredited investors.
Making Private Equity Less Private
To some, CRE private equity investing may seem a little exclusionary due to the requirement put in place by the SEC to become an accredited investor. Nevertheless, these requirements are put in place to protect investors and asset managers.
If you’re willing to give it some time, CRE private equity is an excellent investment option that provides high returns, built-in loss mitigation, and several different investing avenues. Unless you’re a seasoned investor, it’s always a good idea to turn to a reliable firm with a proven track record to manage your portfolio.
