As a passive real estate investor, where is the best place to park capital, in publicly traded REITs or in private equity vehicles? It’s a question I often hear, and while there certainly is no concrete answer, I am going to briefly tell you why I think private equity is a superior structure.
First of all, a real estate investment trust and private equity fund (or private syndicated real estate deal) can both follow and adhere to an identical or similar strategy. For example, you can find a value add office REIT and a private equity sponsor who specializes in value add office assets.
So why is private equity superior? Very simply, the structure. Typically, private equity sponsors have much more to gain from the successful outcome of a fund or deal. Once investors get their capital back, private equity sponsors share in a piece of the upside. This is known as carried interest.
In other words, when enough VALUE is created for the investors, the sponsor is typically rewarded handsomely. This alignment of interest and a potential windfall for PE firms is what draws some of the best operators to the private equity business. You do not find this tremendous incentive in public companies.
I am not saying the management teams of REITs do not have the incentive to increase shareholder value, but the direct upside and potential for large gains are what forces sponsors to be laser-focused on creating value. This focus on creating value is what makes private equity operators some of the most successful investors across all industries.
When the team running an investment is heavily incentivized to succeed, you get a better outcome. It really is that simple.
Public companies tend to be more bloated and beauracratic. Private equity is much more nimble.
For example, when we are making offers on properties, we can make a decision to go after an asset within a day, public companies cannot move that fast. We can approve a lease or hire or fire a vendor very quickly.
We like to focus on syndicated individual deals, which I feel is the purest form of private equity. If we perform, we are compensated tremendously for our efforts. If we don’t, we are penalized and do not participate in the carried interest. This alignment is what makes the private equity model so beautiful in my opinion.
I like to look at the management teams running REITs as corporate or portfolio “managers,” not maverick deal men who are obsessed with finding great investment opportunities and creating value for their partners.
In closing, if you want exposure to real estate and need liquidity, a REIT might do the trick, if you are patient and looking for outsized risk-adjusted returns, there are many very successful private equity sponsors you can work with.