Among the many ways to invest in real estate, the one you’ve probably heard the least about is direct investing in a private equity real estate fund. That’s unfortunate, because although this approach isn’t right for everyone, it could represent the strategy that best fits many investors’ needs and profiles.
In this post, we’ll compare direct investing in private equity to the other real estate investment strategies that you’re probably more familiar with, so you can assess for yourself whether this approach might be right for you.
Let’s review a couple of the more traditional methods real estate investors have historically used to gain access to this asset class.
This strategy can be attractive to investors who like the idea of digging into the details involved in purchasing, maintaining, and operating a piece of real estate, or who enjoy physically working on a property. Some investors also find it psychologically reassuring to own a rental home or apartment building, because this investment is something physical and tangible that they can visit, see, and touch.
Additionally, if you are willing to put in either additional capital or your own sweat equity, you can find many ways to add value to your investment property, which can both increase the property’s income performance and your eventual profit when you sell it.
But if you don’t have the time and energy to commit to managing a property yourself, and you don’t want to have to be accessible to a property management company that might call you at any time to discuss a problem with the property, purchasing a piece of investment yourself might not be the best real estate strategy for you.
Note: A very similar set of pros and cons applies to investing with a few partners, an approach often mistakenly described as a more passive type of investment. Yes, you and your partners might be dividing the labor and skills you each bring to the investment. Perhaps you bring knowledge of the geographical area to the team, while another partner brings the building and construction skills to help upgrade the property. But make no mistake: This is still a highly active type of investment for all partners involved.
For investors who are impressed by the steady upward trend of real estate values over the decades and want exposure to this asset class—but who don’t want any operational or decision-making responsibility for maintaining a property—purchasing shares in real estate companies might be a more attractive alternative.
Unlike acquiring and maintaining a property directly, buying stock in businesses in the real estate industry—which could include publicly traded development firms, real estate agencies, mortgage companies, etc.—is a passive investment. In fact, if you can find a public real estate company whose shares pay dividends, you can earn passive ongoing income from those dividends.
It is important to keep in mind, however, that buying shares of any company on a stock exchange exposes the investor to the volatilities of the stock market. This means that even shares in a strong real estate company, whose fundamentals and performance are solid, are always at risk of being pulled down by problems affecting the broader equities markets.
Note: Publicly traded REITs, although similar in some ways to other real estate stocks traded on the major exchanges, have their own unique characteristics, benefits, and drawbacks. To learn more about those specific pros and cons, see our article discussing private equity real estate vs. public REITs.
The reason you’ve heard so little about this investment approach is that, until relatively recently, private equity real estate funds were accessible only to financial institutions or to the extremely wealthy.
Historically, such a firm might raise tens or even hundreds of millions of dollars in investment capital from just a few large financial firms and ultra-high-net-worth individuals. The firm’s managers would then use this capital to acquire and control real property—often generating high rates of return for these few lucky investors.
In some ways, a private equity real estate fund takes an investment approach similar to a REIT. Both companies raise capital to invest, both concentrate their investment efforts on real estate (sometimes even a specific category of real estate, or within a limited geographic area), and both distribute regular dividends to investors.
But these organizations also differ in several important ways. To cite just one advantage that a private equity real estate fund has over REITs, consider that SEC regulations demand REITs distribute a certain amount of their income each year as dividends. This means a REIT’s managers might have to liquidate assets, or divert capital planned for investment purposes, to pay out these government-mandates distributions, even if the investors themselves would prefer the money be used to increase the value of the fund.
In other words, government regulations are such that sometimes a REIT is forced by law to act in ways counter to the fund’s own interests.
Because private funds are not regulated by the SEC, by contrast, direct investing in private equity real estate allows the fund’s managers to make more of their decisions based on what is best for the fund and its investors—not what a regulatory body demands.
Through direct investing in private equity, you can gain access to the benefits of each of the types of real estate investing we’ve discussed here.
As an investor in a private equity real estate fund, for example, you will have direct ownership in real property, and you will be able to participate directly in the upside potential of that property over time.
At the same time, however, you can enjoy the benefits of passive investing—because your equity stake in the properties your private equity fund controls will not obligate you to any management or operational responsibilities to those properties. The fund has onsite experts to handle the day-to-day. In this sense, your direct investment in a private equity fund will work similarly to owning a dividend-producing real estate stock—but without exposing you to the volatilities of the broader equities markets.
To more about this form of direct investing, let us introduce you to The Worcester Fund, a private equity real estate fund whose managers have delivered annualized 30% returns for the past decade.
This does not constitute an offer to purchase securities, and that any purchase may be made only through delivery and receipt of a confidential private placement memorandum from the issuer, pursuant to which any potential investor must complete and provide an investor questionnaire, subscription agreement and other things required by the issuer, and are subject to the issuer’s verification of accredited investor status and issuer’s acceptance of the subscription