In July of 2019, the current economic expansion officially became the longest in United States History1. It began in June of 2009 and, for the last decade, investors of all types have benefited from a truly historic ,economic expansion. Opinions vary widely on when or how it’ll come to an end, but precedent tells us two things are nearly certain: It will end, and when it does, it’ll likely be painful for those who aren’t prepared.
But, how does an investor prepare for an event with an unknown date and unknown consequences? Traditionally, the answer has been to construct a well diversified portfolio of investments that can thrive in all phases of the economic cycle. In many cases, that portfolio may consist of just stocks and bonds, but we believe that there’s a compelling case for private real estate to be included.
What is a Private Equity Real Estate Partnership?
An investor can gain exposure to real estate by investing in publicly traded securities of real estate companies or by entering the private market.
In a private real estate transaction, an investor may purchase physical real estate like a single family rental or small apartment building. Or, they may choose to pool their resources with others to purchase larger, institutional grade assets. In the second scenario, individual investors may form their own partnerships or they could place their capital with an investment manager like a private equity firm.
By definition, a private equity real estate partnership is an investment vehicle where an asset manager (the private equity firm) pools investor funds and deploys them into real estate assets with the expectation of earning a return. The vehicle may be constructed as a “fund” where investors will place capital with the private equity firm for a general purpose and let them decide how to invest it. Or, investors may work with a private equity firm to place their funds in a specific deal or property.
Either way, the private equity firm is staffed with real estate experts who leverage years of experience and vast broker/seller networks to identify and pursue profitable deals on behalf of their investors. In doing so, they’ll employ sound risk management principles to ensure there’s downside protection in the event of an economic contraction.
How Private Equity Partnerships Protect Wealth
Private equity real estate partnerships protect wealth in three ways:
- Portfolio Diversification: Private real estate price movements tend to have a low level of correlation with those of publicly traded assets like REITs or Equities2 which means that they may not fall as far or as fast when the next down leg of the economic cycle occurs. They also tend to be less volatile than
those of publicly traded assets by appreciating slowly over time rather than going up one day and down the next.
- They Own Physical Assets: Private equity real estate partnerships own physical real estate that produces revenue in the form of monthly rental payments or unit sales. These cash flows are the driving force behind lower price volatility and help to stabilize values in downturns while continuing to provide income to investors.
1 National Bureau of Economic Research
2 Based on comparison of the NCREIF National Property index to equity indices such as the Russell 2000
- They’re Tax Efficient: Private real estate partnerships tend to be more tax efficient than their publicly traded counterparts. Through strategies like depreciation and cost segregation, individual investors benefit from paper losses that can be used to offset taxable income, reducing their tax bill and freeing capital to be reinvested into other profitable projects.
While these benefits are impressive, there are a few drawbacks to consider.
Drawback to Private Equity Real Estate Partnerships
Like any investment, there are two sides to the private equity real estate partnership story. Creating and protecting wealth through real estate assets is a time tested and effective strategy, but there are nuances to consider when working with a private equity firm:
- There Are Fees: Using real estate expertise and vast networks of brokers, sellers, and investors, private equity firms identify, select, purchase, and manage assets on behalf of their clients. To fund these activities, private equity firms charge fees. They typically include a small management fee and participation in the profits once certain return milestones are reached. Fees vary by asset manager and may affect an investor’s overall return.
- Performance Varies: Each private equity firm has their own investment ideas and viewpoints. One may prefer the Industrial asset class while another may prefer Multifamily, but time will tell who performs best over the long term. When selecting an asset manager, it’s important to work with firms who have an established track record of delivering consistent returns to their investors and an investment thesis suitable for your risk tolerance and time horizon.
- Fund vs. Deal: Some private equity firms offer the opportunity to invest in a fund, which will pool investor capital and deploy it into a diverse basket of properties. Others solicit investments for a specific property or deal. One isn’t necessarily better than the other, but it speaks to the importance of understanding a firm’s investment strategy and structure before committing to invest.
- Regulatory Requirements: In most cases, private equity investments are only available to investors who are either “accredited” or “sophisticated.” An accredited investor must demonstrate compliance with certain income and net worth hurdles while a sophisticated investor must possess the knowledge
required to sufficiently evaluate the risk of an investment opportunity.
Private equity real estate partnerships can be complex so it’s important to understand the nuances of each opportunity before committing funds to it.
Interested in Learning More?
First National Realty Partners is one of the country’s leading private equity commercial real estate investment firms. With an intentional focus on finding world-class, multi-tenanted assets – including middle market service oriented retail shopping centers – well below intrinsic value, we seek to create superior long-term, risk-adjusted returns for our investors while creating strong economic assets for the communities we invest in. Whether you’re just getting started or searching for ways to diversify your portfolio, we’re here to help. If you’d like to learn more about our middle market retail investment opportunities, contact us at (800) 605-4966 or email@example.com for more information.