Real estate private equity (REPE) is a type of alternative investment that usually comes with high risks and high returns.
By reading this guide on private equity real estate, you’ll learn the following details a keen investor would want to know:
- What is private equity real estate?
- How does a real estate private equity fund work?
- Real estate private equity acquisitions
- Private equity real estate investments
- Pros and cons of real estate private equity
What is private equity real estate?
Private equity real estate is a private equity investment focusing on property and real estate instead of investing in company stock.
A real estate private equity firm pools capital from such institutional investors as pension funds, hedge funds, and insurance companies and accredited investors such as high-net-worth individuals. They use that pooled capital to purchase, develop, and sell properties.
The key interest of REPE is commercial real estate—office buildings, retail properties, shopping centers, industrial properties, and multifamily units. However, there are cases when real estate private equity funds also invest in residential real estate.
There are two principal differences between real estate private equity funds and real estate investment trusts (REITs), although they may seem very similar. REITs are considered highly liquid, while REPE firms often require contributions for several years. REITs are also strictly regulated regarding the real-estate-related assets they own, while REPE funds are freer with their investment options. Real estate private equity firms are also similar to real estate operating companies (REOCs). However, they don’t face the same restrictions and requirements and don’t come with the same tax benefits.
Note: Find out everything about mergers and acquisitions in healthcare industry in our dedicated article.
How does a real estate private equity fund work?
Just like regular PE firms, private equity real estate funds tend to raise capital from limited partners like private investors—pension funds, insurance companies, asset managers, university endowments, or high-net-worth individual investors.
Below are the typical stages of private equity real estate fund operations:
- Property purchase
A fund manager conducts market research, defines promising properties, and a firm acquires them. The entire investment period might take up to 2 years.
- Property development and renovation
This stage, the “holding period”, is when a REPE firm takes the time to develop properties to increase returns. Sometimes it also includes construction management. It usually takes 3-5 years.
- Property selling
At this final stage, a REPE firm sells the property to get a satisfying investment return. There are no clear time limits for this stage. It all depends on how fast the firm finds a qualified buyer and how quickly it can close the deal.
Sometimes, private equity funds real estate also rent out properties after renovation to get a stable cash flow and increase an investment’s annual returns.
The structure of a real estate private equity firm usually includes a general partner who is a fund sponsor and limited partners who are private investors. REPE fund’s employees often come from real estate brokerage firms or investment banking.
Private equity real estate firms charge management fees of around 2% of the invested assets plus 20% of annual profits.
Usually, after the property is sold, 80% of the return is shared among limited partners. The size of investment returns every limited partner gets depends on their contributions. 20% of returns become carried interest: a general partner gets most of it while the rest is shared among associates, VPs, and partners. Those percentages represent the industry norm and may vary in specific partnership agreements.
Real estate private equity acquisitions
Property acquisitions are a core process in the operations of all private equity real estate funds.
Commonly, the acquisition team is combined with the asset management team inside a REPE fund.
The main responsibilities of an acquisition team include:
- Searching for prospective acquisitions
- Conducting market research
- Analyzing a deal’s potential
- Building financial models
- Negotiating deals
The responsibilities of an asset management team include:
- Executing business plans
- Performing regular asset valuations and tracking their performance
- Conducting due diligence with the acquisition team
- Managing the portfolio
- Selling property
Private equity real estate investments
Private equity real estate investments are considered alternative investments.
Real estate investment banking requires outside investors ready for a significant and long-term financial commitment. Every accredited investor in private equity for real estate is usually expected to invest at least $250,000 (or the equivalent in local currency) as an initial investment, with further investments over time.
Annual returns for private equity real estate investment usually range between 6% and 10%.
Though private equity investment can be lucrative, usually providing high returns, it’s also extremely risky, and investors can lose their entire investment if a firm underperforms.
As a rule, private equity investment in real estate includes the following property types:
- Office buildings: suburban, urban, high-rise
- Shopping centers: community, neighborhood, power centers
- Multifamily apartments: high-rise, garden
- Industrial properties: industrial space, warehouse, research centers, flexible offices
- Niche properties: manufacturing space, undeveloped land, medical offices, and hotels
Pros and cons of real estate private equity
Naturally, as an alternative investment type, private equity in real estate comes with certain advantages and disadvantages.
Pros
- High returns
Real estate private equity investors usually earn high returns after selling a property.
- Diversification possibilities
Investing in different property types enables capital diversification.
- Almost effortless process involvement
Since responsibility for asset management falls on the fund manager, private investors can stay passive during the investment process.
Cons
- High risks
With high returns come high risks. This is especially true when using opportunistic investment strategies.
- Additional management fees
Every real estate private equity fund charges an annual asset management fee of at least 2%.
- Minimum investment contribution required
High-net-worth individuals are the most common REPE investors since the minimum required investment is usually $250,000.
- Long-term commitment
Private equity real estate investors generally need to wait 5-7 years for returns, and during that period, their investment is usually locked up.
Key takeaways
Real estate private equity investment is not for everyone—high risk brings high returns.
Let’s summarise this article’s central points:
- The key interest of private equity real estate investors is commercial real estate—office buildings, multifamily units, industrial properties, shopping centers, and retail properties. However, there are also cases of residential real estate investments.
- Common real estate private equity fund operations include purchasing properties, developing and renovating properties, and selling properties.
- Private investors usually investing in PERE include insurance companies, hedge funds, pension funds, and high-net-worth individuals.
- The structure of a private equity real estate fund includes a general partner (sponsor of a fund) and private investors (limited partners).
