Often, casual conversation can make it seem like owning and operating rental properties is a risk free, passive endeavor. In reality, an individual owner managing one or more rental properties may find that the required level of effort is far from passive and that the returns are sub-optimal when accounting for time invested. For many, this creates a dilemma, they’d like portfolio exposure to real estate as an asset class, but don’t want the time and hassle associated with managing it.
Fortunately, there’s an alternative. For investors who prefer a passive approach, private equity partnerships offer many of the benefits of real estate ownership, but not the hassle.
What is a Private Equity CRE Partnership?
A private equity firm is an investment management company that takes money from investors and pools it to make an investment. Typically, the investment constitutes the equity contribution in a deal while the remainder is financed with some form of debt. Often, the private equity firm invests alongside their clients, which makes each transaction a true partnership.
Like any partnership, each party has a role to play. In a private equity CRE partnership, the investor supplies the capital and the manager finds, selects, underwrites, closes and manages the asset, typically in return for a fee. Because the asset manager does much of the leg work, these partnerships are often preferred by passive investors.
It’s important to note that private equity partnerships aren’t open to everyone because they’re regulated differently than other types of investments. To place money with a private equity form, an investor may have to demonstrate that their assets and income meet certain requirements or that they’re “sophisticated” in the sense that they have the ability to assess the strengths and weaknesses of a deal.
Why Passive Investors Prefer Private Equity CRE Partnerships
Individuals who meet the financial requirements to partner with a private equity firm frequently specialize in areas other than real estate. They may be doctors, lawyers, accountants, or business owners that have obtained their wealth in other arenas. Time is their greatest asset and it’s best spent continuing to grow their influence and expertise in a specific field. These individuals, along with other businesses and institutions may choose to invest their capital in a private equity real estate partnership for the following reasons:
- Partner with experts: Private equity firms are staffed with experts in all facets of a real estate transaction. From site selection to underwriting, market analysis, due diligence, documentation, and property management, their skills are honed over many years they work on behalf of all investors.
- Outsource the leg work: To hold up their end of the partnership, the private equity firm is responsible for leveraging their expertise and relationships to identify acquisition candidates, perform analysis, and close deals. This is work that would have to be done by investors should they choose to invest on their own. In most cases, private equity firms have superior resources that allow them to do this work better, faster, and more in depth than an individual.
- Access to institutional quality assets: By pooling investor funds, private equity firms are able to invest in deals that aren’t available to the individual investor due to their size and complexity. In addition, they’re able to leverage their vast networks of broker and developer relationships to access deals that others can’t.
- Tax benefits: Typically, private equity investors are high earners and like to use CRE partnerships and the depreciation that comes with them to offset their taxable income, which serves to lower their overall tax burden. Further, private equity CRE investments are usually held in limited liability companies, which are considered a pass-through entity by the IRS. As such, income and expenses are passed to individual investors as part of a tax-advantaged structure.
- Diversification: Prices for privately owned real estate tend appreciate slowly over time so they don’t experience the same level of volatility as their publicly traded counterparts. For this reason, private equity CRE partnerships bring a degree of diversification to the traditional stock/bond portfolio.
While the benefits are impressive, a private equity CRE partnership isn’t perfect.
Drawbacks to Consider
Before committing funds to a private equity CRE partnership, there are three aspects of the investment that should be considered to ensure it’s suitable for your risk tolerance and time horizon:
- Liquidity: Real estate gains are made over the long term. Often, committing to a CRE partnership means that the funds will be tied up for five or more years while the manager positions the property for an exit. If an investment has to be liquidated during that time it may prove to be expensive and/or difficult.
- Fees: Expertise comes at a price. There may be fees associated with a private equity CRE partnership that make it more expensive than other options. However, that expense is often offset by superior risk adjusted returns combined with the tax advantaged treatment.
- Idiosyncratic Risk: Idiosyncratic risk is the risk associated with investing in a single asset or asset class due to the unique characteristics of that asset. Real estate isn’t a risk free asset and changes in economic conditions such as interest rates, job creation, required regulation may adversely impact the
performance of an individual property or portfolio of properties.
The Importance of Partnership
Commercial real estate investing is a team sport and, for individuals wanting portfolio exposure to real estate without the hassle of managing it, private equity partnership can make a lot of sense.
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 info@fnrpusa.com for more information.
