Key Takeaways

  • A private equity real estate partnership is a specialized type of investment structure that invests in the non-publicly traded securities of a company that owns real estate.
  • Given that the securities offered in a private equity real estate partnership are non-publicly traded, access to them is restricted to investors who are either “accredited” or “sophisticated” as defined under SEC rules.
  • There are a number of benefits to investing in a private equity real estate transaction including:  income, capital appreciation, tax deferral, portfolio diversification, and preferred returns.
  • For qualifying investors interested in a private equity real estate investment, it is important to evaluate each potential firm based on their investment philosophy, legal structure, preferred return options, and the market(s) they operate in.

For individuals interested in commercial real estate investing, there are a number of vehicles through which capital can be deployed.  For example, an investor could purchase a property directly, which entitles them to 100% of the property’s cash flow and appreciation, but it also requires a significant time commitment to manage the property and exposes them to 100% of the risk associated with the investment.  For this reason, some investors prefer a private equity commercial real estate partnership.

What is a Private Equity Real Estate Partnership?

To define private equity real estate partnerships, it is helpful to break the term into two parts.  First, a “private equity” firm is a specialized type of investment manager that provides financial backing or invests in the non-publicly traded securities of startups or operating companies.  These investments can span all industries, including real estate.  Second, a “real estate partnership” is a legal investment structure that combines the liability protection of a corporation and the tax benefits of a partnership.  

Putting the two together, a private equity real estate partnership is a specialized type of investment structure that invests in the non-publicly traded securities of a company that owns real estate.  In many cases, the private equity firm will find a commercial property and create a limited liability corporation (LLC) through which to purchase it.  To fund the acquisition, they rely on a combination of debt and equity.  Typically, the debt makes up 60% – 80% of the property’s purchase price and comes from a real estate lender while the remaining 20% – 40% comes from equity investors.  To raise the equity, the private equity firm will contribute a portion of their own funds, usually 10% – 20% of the total equity needed, and sell securities to real estate investors to raise the rest.  

To facilitate this transaction structure, private equity firms rely on an exemption that allows them to sell the company’s securities to investors without having to register the offering with the Securities and Exchange Commission (SEC).  However, this same exemption limits who can purchase the securities.

Who Can Invest in a Private Equity Real Estate Offering?

SEC exemption rules limit access to private equity investment opportunities to individuals who are deemed to be either “accredited” or “sophisticated.”

Under SEC Regulation D, an accredited investor must meet one of two requirements:  

  1. Net Worth:  Individual net worth, or joint net worth with an individual’s spouse in excess of $1,000,000.
  2. Income:  Individual income in excess of $200,000 in each of the two most recent years or joint income with an individual’s spouse in excess of $300,000 in each of those years with the reasonable expectation of reaching the same income level in the current year

If an investor does not qualify as accredited, they may still be able to invest in a private equity securities offering if they can prove that they are “sophisticated.”  Under SEC Regulation D, a sophisticated investor is one who  “has sufficient knowledge and experience in financial and business matters to make them capable of evaluating the merits and risks of the prospective investment”.

In both cases, the intent of the rules is to limit investors to those who have the financial capacity and/or the knowledge necessary to understand the risks and benefits of investing in non-publicly traded securities and it is up to the investment manager to perform the necessary due diligence to make sure they meet the legal threshold for investment. 

Benefits and Risks of Investing in a Private Equity Commercial Real Estate Partnership

For investors seeking the benefits of real estate ownership without the hassle of managing it, a private equity commercial real estate partnership comes with a number of benefits:

  • Leverage:  By partnering with a private equity firm, an individual investor can leverage the firm’s network, tools, technology, and expertise, all of which are used in service of finding the most profitable investment opportunities.
  • Quality:  Because a private equity firm pools investor funds to facilitate the purchase of an asset, it gives each individual fractional ownership of an institutional quality asset that they likely could not afford on their own.
  • Income:  By definition, the real estate assets owned in a “commercial” real estate partnership are rented to other businesses to generate income for investors.  By virtue of their investment, individuals are entitled to a portion of the income and profits produced by the underlying asset, resulting in a steady stream of dividend income.
  • Diversification:  Real estate price movements tend to have a low level of correlation with publicly traded debt and equity securities.  As such, private real estate partnerships add a layer of diversification to the traditional stock/bond portfolio.  An additional layer of diversification can be obtained through investing in different types of commercial real estate like multifamily or office buildings.
  • Incentive Alignment:  In most cases, the return structure in a private equity commercial real estate partnership is designed to align the financial incentives of the manager with those of the investor.  Usually, this takes the form of a “preferred return” for investors, which means that the manager’s access to property income is limited until the investors have received a certain return on their money.
  • Time:  By investing with a private equity firm, investors outsource the task of property identification, acquisition, leasing, and management to a third party (the private equity firm), freeing up their time to pursue other interests. 

While the benefits are impressive, a private equity commercial real estate investment is not risk free.  Like other assets, real estate is vulnerable to changes in economic conditions and returns can suffer as a result.  In addition, the investment may have limited liquidity during the 5-10 years that it takes to implement the property’s business plan and management fees charged by the private equity firm may erode overall returns.

Even with the known risks, private equity commercial real estate partnerships can be a suitable option for accredited and/or sophisticated investors looking for access to institutional quality commercial real estate assets.

How To Invest in a Private Equity Commercial Real Estate Partnership

For accredited or sophisticated individuals sold on the idea of a private equity real estate investment, there are many firms who offer this type of investment opportunity.  As such, it is necessary to filter through them to find one that matches an individual’s risk tolerance, time horizon, and return requirements.  There are several factors to consider:

  • Investment Strategy:  Every private equity firm pursues their own investment strategy.  Some could prefer short term deals while others prefer longer term value add plays.  Some may specialize in a specific type of asset class like multifamily or retail while others may prefer a more broadly diversified investment portfolio.  Individual investors should find a firm whose strategy and investment philosophy match their own.
  • Legal Structure:  The legal structure of the investment is an important distinction.  Some private equity firms may offer more of a mutual fund type structure where investment capital is deposited into a large fund and the manager deploys it as they see fit.  Others may offer an opportunity to invest in a syndication as a limited partner.  It is important that individual investors understand the differences and ensure that they work with a firm whose structure matches their preference.
  • Preferred Return:  As an incentive to invest with them, some private equity firms may offer a preferred return to investors, which guarantees they will receive a certain return before the firm receives any money in the deal.
  • Real Estate Market:  While many firms operate across the United States, others concentrate on a specific market.  For example, many firms like high growth markets like Florida, Texas, and Arizona while others like the stability of established markets like New York and California.

Once a firm has been found, the rest of the process is fairly simple.  The firm will have an investor onboarding process that includes verification of accreditation requirements.  Once these checks are passed, funds are transferred and the investment is finalized.

Interested in Learning More?

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 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.

To learn more about our investment opportunities, contact us at (800) 605-4966 or info@fnrpusa.com for more information.

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