An Introduction to Private Real Estate
If you have a high net worth, a long-term time investment horizon, and extra liquidity, you’ve probably received advice that you should invest in private real estate deals to get exposure to real estate as an asset class.
Navigating the nuances of private real estate investment opportunities can be complex, but we're going to simplify the sub-asset class into two categories:
- Direct real estate ownership and
- Private real estate funds and REITs.
What types of private real estate can I invest in?
There are two main types of direct real estate ownership we’ll be covering:
- Individual ownership, meaning you buy the property and manage it yourself.
- Private deals, where you and a group of partners pool funds together to purchase a property (or multiple).
You’ve probably seen the Twitter threads detailing people flip homes for big gains, or maybe you’ve watched the YouTube channels and home improvement shows dedicated to people buying, flipping, and operating properties.
For most people who have full-time jobs and are not real estate experts, buying an individual property as an investment is not an effective way to gain exposure to the broader asset class. It’s also time-consuming (can often require full-time hours), requires significant expertise, and there’s still no guarantee your returns will be any better than other types of investing. Therefore, it tends to be a riskier form of real estate exposure.
Buying properties as an individual means you also may end up allocating a higher-than-desirable portion of your overall wealth toward just a handful of assets. This scenario creates concentration risk in just a few properties whereas a fund or REIT might invest in hundreds of properties in various locations and of different types.
Direct ownership deals
Direct deals, sometimes called sponsored deals, are other forms of exposure of real estate as an asset class. Here’s how it works. An individual or a company finds a group of investors, like you, to participate in a real estate investment opportunity. This usually involves buying an individual property and, occasionally, deals can expand to encompass multiple properties.
The risk is similar to individual ownership, but there are a few extra benefits:
- If the sponsor is high-quality, then real experts may be operating the properties.
- Sponsored deals often provide for better diversification than individual ownership, often requiring a smaller capital commitment.
Direct deals still require you to be mindful of concentration risk. Therefore, consider them only if you have enough capital to diversify across many of these opportunities.
Private REITs and real estate funds
The last two categories of private real estate investing that we’ll cover are:
- Private REITs
- Private real estate funds
A REIT (Real Estate Investment Trust) is a company that is defined by two features:
- Owns, operates, or finances income-generating real estate
- Is legally-obligated to distribute at least 90% of its taxable returns back to its shareholders
These are important traits that make REITs different from traditional public or private real estate investment opportunities.
A private REIT is a REIT but it’s not listed on the public stock market. Private REITs have different reporting requirements, as they generally are able to take advantage of regulatory exemptions that Public REITs cannot. Those same regulatory exemptions make private REITs less transparent, which can, of course, introduce uncertainty and risk.
Private REITs are generally more diversified than other types of real estate investing and they tend to have better medium-term liquidity when compared to traditional longer-dated investment opportunities, like traditional real estate funds. However, they still have limited liquidity and investors will likely face gates if they submit redemptions requests, meaning you won’t be able to get all your money immediately and it might be spread out over a specific timeframe.
Traditional private real estate funds
Earlier in this piece, we mentioned private real estate deals — sponsored deals in which you and some co-investors pool funds to buy a property. Traditional private real estate funds are sort of like this, but the ones we’re describing below tend to be on a bigger scale.
When you participate in a traditional fund, you’re typically investing in a blind pool (meaning little-to-no identified assets), which will invest across numerous transactions or deals. Due to the complex nature of these funds, investors should understand that they’re considered highly illiquid and they’ll need to have a very long-term time horizon.
How do I invest in private real estate?
You may still be wondering about access — how do you actually get access to these deals and funds?
Of course, your net worth is going to determine what opportunities might be suitable for you and, therefore, what access you might have.
It’s best to work with a financial advisor who has invested heavily in an in-house research team to source, diligence, and execute on opportunities for their clients. It’s really critical to have diligence and oversight on any investment, especially private real estate, which may have conflicts of interest that need to be mitigated or monitored proactively. Here’s how Compound’s in-house Investment Research team has evaluated real estate as an asset class and opportunities in the space.
The bottom line
If you’re an accredited investor or a qualified purchaser, your financial advisor may recommend suitable private placements or private REITs. These can help you achieve broad exposure without having to purchase and manage properties yourself.
There are downsides, of course. Private real estate investments are illiquid, which means you can’t just pull your money out at any time. There can also be a lack of control, conflicts of interest, limited transparency, and limited diversification that can come with investing in private placement real estate deals or private REITs.
Because these types of investments typically involve pooling funds with other investors and relying on a management team to make investment decisions, you have limited control over specific properties and decision-making processes. Private real estate investments will involve layers of fees, too, which is something you’ll want to keep in mind as you evaluate options. Most real estate transactions involve leverage, an important topic we didn’t get to address. Leverage is typically used to increase the return potential but it also introduces interest rate risk. There may also be conflicts and lack of transparency between investors, management team, vendors, partners, and other third parties hired to build or manage properties.
If you’d like to talk with a financial advisor about options and how they fit into your financial picture, you may be interested in talking with a Compound Financial Advisor. We help entrepreneurs, professionals and retirees make smart decisions about their money. Schedule an intro call here.