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The real estate private equity guide

This guide was written with the objective of giving you the information that you need to invest wisely. Our objective is never to sell you on an investment, but rather to present you with facts so you can exercise your good judgment.

last update Tuesday, November 15, 2022





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Real estate can sometimes be daunting. Add the words private equity and it can become frightening. But fear not, real estate private equity is easier to grasp than it seems. This guide will help you understand the basics of real estate private equity.

This guide was written with the objective of giving you the information that you need to invest wisely. Our objective is never to sell you on an investment, but rather to present you with facts so you can exercise your good judgment.

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What is private equity?

Private equity refers to all forms of equity investments that do not trade in public markets. Private equity investors own shares of companies and partnerships, but these shares do not have a daily quotation, and cannot be bought and sold on a stock exchange. Therefore, private equity investments are less liquid and are privately sourced.

What is the difference between a private REIT, public REIT, and real estate private equity fund?

If you are researching real estate investments, you have probably come up with the concept of a REIT. In this section, we will help differentiate between REITs and other types of investment vehicles, and between private REITs and public REITs.
We will use five perspectives in our comparison:
  • Tax benefits
  • Investment strategies
  • Liquidity and risks
  • Minimum investments
  • Returns
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Tax benefits

Private and public REITs The most important difference between REITs and other forms of real estate equity funds is their tax treatment. REITs avoid corporate taxes for the profits they distribute in the form of dividends (as long as they have been obtained from real estate investments). All REITs are mandated to distribute at least 90% of their taxable income to investors every year in the form of dividends.
Equity funds Real estate private equity funds, on the other hand, do pay corporate income taxes on the profits they generate, but are not mandated to distribute their income every year.
At the investor level, receiving profits every year in the form of dividends or later in the investment horizon can also cause enormous differences in taxes paid. For more information, please contact our real estate investment advisors.

Investment strategies

REITs and funds also differ in their investment strategies. Because REITs have to distribute dividends every year, they need to concentrate on brownfield investments that are already generating cash. Real estate private equity funds have more leeway in choosing their strategies. For example, they can concentrate on greenfield investments that do not generate cash flows in the short term but that promise higher returns in the long term.

Liquidity and risks

At the liquidity level, REITs and other types of funds do not differ that much. Rather, the biggest difference is between public and private investments. Remember, both REITs and other types of funds can be publicly traded or privately held.

Public investments are much more liquid and easier to trade than private investments. They have daily quotations and no mandatory investment horizon. On the other hand, it is much more difficult to purchase and sell a private investment. Private investments usually have a lockup period during which investors cannot claim back their funds, and the investment horizon of a private investor has to be long-term.

Considering other risk sources besides liquidity, REITs and other types of funds do differ. As we mentioned, REITs invest in brownfield projects that are mostly already developed and generating cash, while funds can also invest in more risky greenfield investments. Of course, the risk is project-dependent and each case should be judged separately. A REIT may invest in bad-quality, risky but cash-generating properties, while a fund may invest in non-cash-generating but really sound projects.

Finally, many people are confused by three related concepts: risk, volatility, and correlation with the stock market. Private investments are said to be less volatile and less correlated with the stock market. This is true but only because private investments do not have a daily quotation, and are usually valued using investment models like discounted cash flow. Risk, on the other hand, is the effective possibility of losing money. Risk can be proxied using volatility, but above all, it has to be evaluated on the fundamental soundness of each investment vehicle.

Minimum investments

At the minimum investment level, the difference also lies between private and public investments. Public REITs and public real estate funds (like mutual funds or ETFs) can be traded at the share level, without minimum investment requirements.
On the other hand, private REITs and real estate private equity funds do have minimum investment requirements. To begin with, most of these funds can only be offered to ‘qualified investors’, a category with different definitions but that generally entails a minimum yearly income or minimum net worth. Because private investments require long-term fund commitments, investment managers prefer having fewer investors committing larger portions of capital, in order to keep everybody on the same page. That is, usually, private investments require investors that are knowledgeable, have investment experience, and resources, and are willing to commit for the long term.

Returns

But, if private equity investments are less liquid, why would anyone choose private equity? There are several reasons:

First, private equity investments allow investment managers to have more control over the invested companies’ operations than public investments. Managers of public companies can become too short-term-oriented because they concentrate on stock prices alone. Managers of private investments need only to concentrate on superior long-term value creation.

Second, the investment acquisition process is simpler for private vehicles. This allows managers to find better deals. In the same vein, private equity managers can reach niche pockets of the market not covered by public equities. Sourcing better deals that the rest of the market is ignoring is of paramount importance for generating superior long-term returns.

Finally, private equity funds and companies have lower disclosure requirements and therefore can keep sensitive competitive information to their investors only. While a public company has to inform its strategy and activities to the SEC for everyone to see (including competitors), private vehicles can keep that information to their own investors and regulators alone. That information can be incredibly valuable, especially if the company or vehicle is specializing in an investment niche.

For these reasons, private equity investment vehicles are expected to generate superior returns to their publicly traded counterparts.

How to invest in real estate private equity?

The individual investor can invest directly into private real estate by purchasing and managing his own real estate investments (for example purchasing a property for rent income). However, this method is unadvised because it requires the time and experience that the investor may lack.

The simplest and most widely used method to invest in real estate private equity is through funds and advisors. Advisors like PaperFree specialize in sourcing deals, networking with sponsors, and studying the real estate market. They can then combine that information with the requirements and characteristics of the investor, to offer him the investment opportunities that best fit his goals.

Investing through funds and advisors also provides the investor with more diversification opportunities. While in isolation the private equity investor might be able to source a single deal, he can participate in several deals through a fund.

Advisors, fund managers, and sponsors charge fees for all the work that is needed to source deals, research the markets, and manage and service the investments. These fees vary significantly depending on the specific fund and investment conditions.

Types of real estate private equity investors

Generally, only qualified investors participate in real estate private equity. The reason is that private equity investment has some requirements that not all investors can pass, like long-term horizons, investment acumen, and minimum investments.

One group of private equity investors are institutions, like pension funds, wealth funds, family offices, and all kinds of asset managers. These companies manage significant sums and have experience judging investments.

Another important group is high net-worth individuals (HNWI). Generally, these are accomplished adults that have either direct business or investment experience, and that prefer to do their own due diligence.

Both groups resort to private equity investment in the search for better long-term risk-adjusted returns and diversification.

Top real estate private equity firms

Real estate private equity started to become more ubiquitous during the past three decades after private funds were able to generate superior risk-adjusted returns in the long term. That attracted significant institutional and HNWI attention and capital. Some of the most famous investment names of the present, like Blackrock and Oaktree, have important private equity operations.

We will publish a related article with the top real estate private equity firms soon.

How we can help you

At Paperfree, we specialize in alternative investments backed by real estate. We believe that investments in alternatives are critical building blocks of a smart investment portfolio.

But navigating alternative investments to accurately evaluate the risks and identify high-return potential opportunities is challenging and requires in-depth understanding.

That is why our goal is to provide you with the best real estate investment opportunities available, coupled with the information you need to understand and judge them on their own merits.

We will be more than pleased to answer your inquiries, provide you with further materials, and help you explore the real estate private equity investment universe.

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Our real estate investment advisors

Our real estate investment advisors are licensed professionals that will help you discover investment opportunities in the real estate space. They are perfectly qualified to answer all your inquiries regarding investment characteristics, performance, suitability, estate planning, and tax implications.

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