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.
Real estate investments? Awesome. Being a landlord? Less fun.
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Advantages of Private Equity Real Estate
Why do people like me invest in real estate private equity?
Let me count the reasons.
High Returns
We just talked about these so I won’t bludgeon the point to death, but high returns are the primary reason investors like private equity real estate investments.
I mentioned one sponsor who’s delivered an average return of 70.5%. While that’s certainly not the norm, many sponsors do deliver 15–30% returns on average.
For example, we’ve invested with MAG Capital Partners, who has averaged a 20.0% return on investment. We’ve also invested with Bronson Equity (average return: 28.6%) and Wolfe Investments (average return: 67.7%).
That’s why people opt into private equity investments.
Full Tax Advantages
Real estate comes with a slew of tax benefits. If you’ve ever owned a rental property, you know all about landlord tax deductions, which go on a separate schedule on your tax return (Schedule E).
All those same deductions come off your taxable income, on the K1 you receive from the sponsor.
You also get real estate depreciation on steroids. Not only does the standard building depreciation come off your taxable income, but most sponsors conduct a cost segregation study when they buy a property. That lets them reclassify as much of the building as possible to other tax categories that offer faster depreciation.
The upside: you get to show losses on your tax return, even as you collect real passive income from your private equity investment.
In short, you get even better tax advantages on real estate syndications than you get from owning rental properties.
No Property Management Headaches
Managing properties is a huge pain in the rear. And even when you hire a property management company, you then have to manage the property manager.
Private equity real estate syndications are completely passive investments. All you do is sit back and collect passive streams of income from your real estate investments, and then celebrate the big payday when the property sells.
The sponsor worries about property repairs, maintenance, and hiring and managing property managers. They worry about tenant phone calls at 2am, filling vacant units, screening renters, and signing lease agreements.
Good riddance.
We’re all busy. I don’t know about you, but I don’t need another side hustle. I just want a diversified investment portfolio that includes lots of different real estate properties in addition to stocks.
Diversification
In our real estate investment club, each member can invest as little as $5,000 in real estate syndication projects. We feature a new private equity real estate deal each month, and participation is purely optional.
While $5,000 might sound like a lot, it’s far less than the $50,000 or $100,000 typically needed for private equity real estate. Or, for that matter, the similar amount needed for a down payment on a rental property, closing costs, initial repairs, and a cash reserve.
Think of it this way: $50,000 could either get you one rental property down payment, one real estate syndication by yourself, or ten real estate syndications when you split the investment with a club. And each one of those ten properties could be in different real estate markets.
Finally, consider that private equity real estate assets have almost no correlation with stock markets. Compare that to the very real correlation between stock markets and real estate investment trusts (REITs). Which means they offer little diversification benefit, despite investment funds calling REITs “alternative investments.”
No Legal Liability
Limited partners take on zero legal liability. They can’t be named as defendants in a lawsuit. Period.
The same can’t be said when you own rental properties as a landlord. I’ve been sued by tenants, by neighbors, by contractors — you name it. It sucks.
No Loan Liability
Likewise, you don’t sign as a personal guarantor for loans against private equity real estate syndications.
The general partner does typically have to sign a personal guarantee. Which is one of the many reasons why they’re entitled to a separate share of the profits.
Drawbacks of Private Equity Real Estate
No investment is perfect, or else everyone and their mother would invest in it, and then the returns would plummet.
So why does the average person not invest in real estate private equity?
High Minimum Investment
The minimum investment for most private equity real estate deals is between $50–100K. Most of us don’t have that just lying around.
Unless you invest through a real estate investment club like ours, you have to come up with the entire amount by yourself. Yikes.
Some Restrict Access to Accredited Investors
You know how people complain that the rich have access to better investments than the rest of us?
That particular complaint is true, thanks to Uncle Sam’s paternalism. The SEC restricts who can access private equity real estate investments.
In fact, most private equity isn’t available to non-accredited investors. It took a lot of networking on our part to find a solid pool of sponsors who allow non-accredited investors, not just institutional investors and high-net-worth individuals.
No Liquidity, Long-Term Commitment
Once you invest in private equity, your money is locked in. You can’t pull it out in an emergency — you’re at the mercy of the general partner to return your capital to you.
Among real estate syndications, the typical time frame ranges from two to seven years.
No Control
When you own an individual property by yourself, you sit in the driver’s seat. You can renovate the property or not, choose which renters you like, sell when you feel like selling.
For that matter, you can use it as a short-term vacation rental instead of a long-term rental (assuming your city lets you). You could even vacation there yourself.
Not so with real estate private equity investments. The asset manager (the sponsor) makes these decisions — you’re just along for the ride.
Risk of Capital Calls
If the sponsor gets hit with unexpected expenses and they run out of capital reserves, guess who they call? Certainly not the Ghostbusters.
They call you, palm out and pockets empty. Many sponsors and limited partners consider this the worst case scenario: a capital call demanding more money from passive private equity investors.
Fortunately it doesn’t happen often, and has never happened in our real estate investment club. But it’s a real risk, and I have no doubt that if we invest in enough deals (which we plan to), it’ll happen sooner or later.
Should You Invest in Real Estate Private Equity?
Personally, I love real estate syndications. I consider them the best of all worlds: all the advantages of direct real estate investments with none of the responsibilities or headaches.
It’s also a lot cheaper to invest in them, at least if you invest through a real estate investment club like ours that pools money to meet the minimum investment. That means you can spread your money across many more deals and build a truly diversified portfolio.
But you need a separate emergency fund when you park money in long-term investments like private equity real estate. If you live hand-to-mouth, with little cash cushion for life’s hiccups, you aren’t a good fit (yet) for private equity investments.
Still, if you’re reading this article, I have no doubt that you’ll get there. And when you do, reach out to us to see if we can help.♦
What has held you back from these types of investments in the past? How do you see real estate private equity fitting into your broader real estate investment strategy?
More Real Estate Investing Reads:
About the Author
G. Brian Davis is a real estate investor and cofounder of SparkRental who spends 10 months of the year in South America. His mission: to help 5,000 people reach financial independence with passive income from real estate. If you want to be one of them, join Brian and Deni for a free class on How to Earn 15-30% on Fractional Real Estate Investments.
Reach out through the void!
It’s exciting to know that real estate investments still offer attractive profits compared to traditional assets. Thank you for the update.
Absolutely Mika!
I’m definitely new to private equity real estate investing. Thanks for the simple explanation.
Glad it was useful Fei Wang!
The big investment required for private equity is a challenge. We’re looking into creative ways to invest with less, such as your investment club. Hoping to do our first investment soon, will keep you posted.
Glad to hear it Miko!
As a private equity real estate investor, I can benefit from the fund manager’s expertise and decisions, even though I don’t have direct control over the properties or projects. This allows me to maximize returns and avoid operational responsibilities.
Agreed David!
I find the flexibility in investment and liquidity offered by real estate funds quite appealing. I enjoy actively managing my holdings and making timely decisions based on market conditions and my own preferences.
Agreed Stanton!