For some investors, the traditional asset categories of stocks, bonds and cash equivalents aren’t enough to ensure a well-diversified portfolio. In such cases, these individuals may want to consider turning to alternative assets in the private market space.
Common alternative assets include private equity, private debt, private real estate and hedge funds.
Because high-net worth investors are considered to be better equipped to sustain potential losses than average investors, private market funds are generally less regulated when compared to assets in the public market.
In this series of articles, we are taking an in-depth look at each of these alternative assets to help you decide if they are a wise choice for you. Here, we look at private real estate investing.
What is Private Real Estate Investing?
With private real estate investing, money from a group of investors is pooled together into a private real estate fund to buy commercial or residential real estate. This allows investors (primarily high-net-worth individuals) to invest in large real estate deals they wouldn’t be able to participate in on their own. A single fund offers the flexibility to invest in multiple real estate assets instead of just one deal.
Private real estate investing offers a number of tax benefits, including pass-through depreciation. Also, private real estate returns are usually taxed at preferential long-term capital gains rates instead of ordinary income tax rates. These two tax benefits alone can save 20% or more on investment profits earned annually.
Private real estate funds are usually structured as limited partnerships. Investors become Limited Partners by contributing money to a pool that’s used to invest into real estate. General Partners invest in different types of property located in various areas of the country that meet the fund’s investment strategy. These may range from new property development and raw land holdings to redevelopment of existing properties and injections of cash into distressed properties.
Private Real Estate Investment Strategies
There are four main investment strategies for investing in private real estate:
The most conservative strategy, this tends to focus on lower-risk but also lower return properties, or high-quality, high-value properties that require minimal redevelopment or maintenance. Core properties are usually comprised of fully leased, multi-tenant structures offering predictable cash flow.
This strategy is a little riskier than core, but it also offers higher return potential. Core-plus properties usually require modest levels of value-added activity or property enhancements.
3. Value added
This strategy offers medium to high return potential along with a moderate degree of risk. General Partners typically purchase properties, redevelop them and then sell them when market conditions are right. Management changes might also be made and rental rates increased if the market allows.
This is the riskiest strategy, but it also offers the highest return potential. General Partners usually purchase undeveloped land and lightly trafficked properties, as well as properties in underperforming markets.
Potential Limitations of Private Real Estate Investing
It’s important to realize that private real estate investing is a long-term commitment — your capital is illiquid and could be inaccessible for years or even decades. This could limit your ability to take advantage of other potential investment opportunities that may arise. There is also limited regulation of private real estate funds, and it can be difficult to evaluate a fund’s financial performance and the properties in the fund.
Who can Invest in Private Real Estate Funds
Investing in private real estate is generally limited to what are referred to as accredited investors. These are individuals or couples who own at least $1 million in assets (excluding primary residence) and have annual income of at least $200,000 over the past two years ($300,000 for married couples) with a reasonable expectation of the same level of income for the current year.
Private Real Estate Investing vs. REITs
Sometimes private real estate is confused with real estate investment trusts, or REITs. While these are similar — for example, both are pools of capital used to invest in real estate — there are some important differences. For starters, a REIT is a company that owns income-producing real estate, while private real estate uses a fund vehicle to invest in the acquisition, financing, or ownership of investment property.
Also, REITs are often publicly traded which makes them more liquid than private real estate. REITs usually have lower investment minimums than private real estate and a higher correlation to the stock market since they are valued daily like stocks. Private real estate isn’t as impacted by stock market moves as REITs are. Finally, private real estate investors generally expect higher returns than REIT investors in part due to the illiquidity of private real estate funds.
How We Can Help
The team at C.W. O’Conner Wealth Advisors works closely with investors to determine if alternative assets, including private real estate, are appropriate based on goals, time horizon and risk tolerance. Call us directly at 770-368-9919 or email Cliff at email@example.com or Kevin at firstname.lastname@example.org to learn more.