Private Equity Commercial Real Estate: A Guide for Investors

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Key Takeaways

  • Private equity commercial real estate is an asset class that allows individual, often high-net-worth, investors to place capital with a professional team experienced in purchasing and managing commercial real estate assets.
  • Real estate private equity firms are investment firms that specialize in acquiring, managing, and selling real estate assets on behalf of institutional investors or accredited individual investors.
  • Because private equity investments come with varying levels of risk depending on the asset class, holding period, and investment strategy, the U.S. Securities and Exchange Commission (“SEC”) limits the availability of unregistered securities in these private offerings to individuals who are “accredited”.
  • Many investors turn to private equity commercial real estate as an option that is widely viewed as having less price volatility compared to stocks or cryptocurrencies.
  • Investors need to think about their individual financial situation, objectives, and risk tolerance before deciding whether to invest in private equity commercial real estate.

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Private Equity Commercial Real Estate: A Guide for Investors

Investing in commercial real estate (CRE) can be lucrative, but most investors get intimidated by the wide array of options available and the steep price tags associated with many commercial properties. Private equity commercial real estate offers a solution. Private equity firms that specialize in purchasing and managing commercial properties can provide investors with passive income as well as other benefits like tax advantages and diversification.

In this article, we discuss the basics of private equity commercial real estate, how it can benefit investors, and what investors should know before allocating capital. After reading this article, investors will have the information necessary to decide if private equity commercial real estate is the right fit to meet their financial objectives.

At First National Realty Partners, we are a private equity firm who specializes in the purchase and management of grocery store anchored retail centers. If you are an accredited investor, interested in partnering with a private equity firm to allocate capital to a commercial real estate investment, click here.

What is Private Equity Commercial Real Estate?

Private equity commercial real estate is an asset class that allows individual, often high-net-worth, investors to place capital with a professional team experienced in purchasing and managing commercial real estate assets. Private equity CRE firms tend to focus on particular real estate asset classes, such as multifamily properties or office buildings.

Private equity investments are typically reserved for “accredited investors” defined as those meeting certain income or net worth requirements. Many private equity firms require investors to agree to invest for a specified period of time, up to ten years in some cases. For this reason, investors should have the financial means to keep funds tied up with private equity firms for several years without risking a liquidity shortage.

What Do Real Estate Private Equity Firms Do?

Real estate private equity firms are investment firms that specialize in acquiring, managing, and selling real estate assets on behalf of institutional investors or accredited individual investors. These firms typically invest capital on behalf of investors with the goal of generating returns through the appreciation of the real estate assets or through rental income.

Private equity CRE firms take different approaches to investing in real estate assets. Some firms focus on acquiring and managing existing properties, while others may focus on acquiring land and developing it into new properties. Additionally, some may also engage in real estate-related activities such as property management or lending. Many firms choose to focus on a particular asset class like apartment buildings or retail centers.

Examples of Private Equity Commercial Real Estate Investments

Private equity commercial real estate firms often choose to focus on one or more property types, including, but not limited, to the following:

  • Strip Centers & Shopping Centers: As the name suggests, strip centers are smaller shopping centers arranged in a “strip” and typically include tenants like clothing stores, coffee shops, or quick service restaurants. Larger shopping centers, like the ones we purchase and manage, may contain an anchor tenant who is a large, well known tenant who “anchors” the property by attracting shopping traffic and paying a large portion of the rent.
  • Shopping Malls: These are the classic shopping malls found in almost every city, in some shape or form. They contain several anchor department stores and a number of interior stores and restaurants. On the small end, these could be 300,000 or 400,000 SF. On the incredibly large side, they could be 1,000,000 SF or more.
  • Office buildings: Office buildings are places for companies to operate. They can range from general purpose office space, like those used by accounting firms or architects, to highly specialized space like medical office or light manufacturing.
  • Industrial property: Industrial space is used for storage, logistics and manufacturing. It can include light or heavy manufacturing, warehouse space, and flex space to accommodate a variety of commercial applications.
  • Multifamily Housing: Commercial multifamily apartment buildings have two defining characteristics: (1) they are places where renters live; and (2) they have more than four units.
  • Hospitality: Hospitality properties are usually hotels. These can include full service, limited service, or extended stay properties.
  • Mixed-Use: As the name suggests, mixed-use properties are those that combine more than one use. For example, one very common type seen in commercial real estate markets is an apartment building with ground floor retail space.
  • Land: Land is vacant property that has not yet been developed into a specific use. Sometimes the land could be “raw” which means it does not have any infrastructure (power, water, roads, etc) or it may be developed with all of the infrastructure necessary (including zoning) to offer a turnkey property to developers.
  • Special Purpose: Special purpose commercial properties are those that do not generally fall into one of the categories above. They have some sort of unique use or feature that makes them special. For example, airports or amusement parks could fall into the category of special purpose.

Private Equity Investor Requirements

Investors interested in private equity need to be aware of the requirements they must meet to be eligible for such an investment.

Because private equity investments come with varying levels of risk depending on the asset class, holding period, and investment strategy, the U.S. Securities and Exchange Commission (“SEC”) limits the availability of unregistered securities in these private offerings to individuals who are “accredited”.

Specifically there are two criteria that applies to most individual investors seeking accreditation:

  1. An investor whose individual net worth, or joint net worth with that person’s spouse (or spousal equivalent), exceeds $1,000,000 (NOTE:  The person’s primary residence is not included in this calculation).
  2. An individual who has an annual income in excess of $200,000 in each of the two most recent years or joint income with that person’s spouse in excess of $300,000 in each of those years and has a reasonable expectation of reaching the same income level in the current year.

In addition to meeting the criteria necessary to be deemed an accredited investor, private equity firms usually have requirements of their own. Many firms seek out investors who have long-term expectations for the investment and a large amount of money to offer for the commitment.

For example, it is common for private equity firms to require a minimum upfront investment of $250,000 or more, followed by other investments over time.

Private equity commercial real estate deals usually have “lock-up” periods where the shares cannot be sold or redeemed. This lock-up period can be as long as a dozen years, depending on the investment terms. Distributions from this investment typically come from the cash flow generated by the underlying real estate assets, offering a slow return over time. In most situations, investors are unable to request liquidation until the lock-up period ends.

How Crowdfunding is Changing the Dynamic of Commercial Real Estate Investing

Many investors do not have the capital required to invest in traditional private equity offerings. In recent years, an alternative has become available for investors looking to invest in real estate assets without having to bring hundreds of thousands or millions of dollars to the table.

This offering is known as “crowdfunding”, and it is a collective approach that allows investors to invest in commercial real estate by pooling their money alongside others. Commercial real estate crowdfunding is a relatively new offering that has grown in popularity since the passage of the JOBS Act in 2012. Crowdfunding offers the opportunity for smaller, non-accredited investors to participate in commercial equity investments they otherwise wouldn’t have access to.

The way commercial real estate crowdfunding works is investors create accounts with one of these websites and search for a deal that meets their investment objectives. One of the benefits of crowdfunding for real estate investing is investors, regardless of net worth, can choose to invest in multiple deals to achieve diversification. They must decide how much to invest into each deal and usually have to meet a small minimum investment requirement.

Similar to investments in other types of real estate vehicles, such as publicly traded REITs, crowdfunding websites usually maintain regular dividend payouts to investors. Over time, investors can also benefit from appreciation in the market value of the rental properties they have invested in.

Prior to the rise in popularity of real estate crowdfunding, there were barriers placing commercial real estate investments out of reach for many individual investors. An investor looking to purchase commercial deals often needed a prohibitively large amount of capital. Often, the minimum amount of capital needed for this type of commercial real estate investing is well into the six figures.

In comparison, crowdfunding allows investors to join with as little as $10 in some cases. Investors have the opportunity to start small and build a sizable investment portfolio of real estate properties over time. This can be a great way to break into real estate investing and learn the ropes while growing a capital base.

Benefits of Investing in Private Equity Real Estate Investing

In the past, commercial real estate investing was only available for institutions. But now private equity opportunities are available for individual private investors looking for passive income tied to commercial real estate. There are many reasons why private equity investing is gaining in popularity among accredited investors seeking exposure to commercial real estate overseen by professional asset management teams.

Diversification

Private equity real estate investments are considered alternative investments because the returns on these assets tend to be uncorrelated to traditional assets like stocks and bonds. This means allocating capital to real estate funds can help to diversify a portfolio and reduce overall risk.

In addition, there are a number of opportunities for diversification within private equity commercial real estate with different property types, locations, and asset classes.

Income Potential

Private equity real estate investments can generate income through rent payments received from tenants. This cash flow is distributed to the investors in the fund and represents passive income to the limited partners. Payout structures vary depending on the way the investment is designed, but it is common for investors to receive distributions monthly, quarterly, or annually. Over time, general partners work to increase the amount of cash flow each property generates, usually through rent hikes as market rents and demand for leased space rise.

Tax Benefits

Under current income tax laws, there are two major tax benefits available to commercial real estate investors who deploy their capital into commercial real estate assets: depreciation and 1031 exchanges.

Real estate is a physical asset, and like any physical asset, the condition degrades over time.  To account for this, tax rules allow a commercial property owner to depreciate the value of the property a little bit each year and list the amount as an expense on the property’s income statement (similar to interest expense or property taxes).  As a result, the property’s taxable income is reduced, which can result in significant tax savings over time. 

Section 1031 of the Internal Revenue Service Tax Code allows an investor to defer taxes on the profitable sale of a property as long as they “exchange” the sale proceeds into another property that is considered to be “like kind.” There is no limit to the number of 1031 Exchanges that can be completed so, in theory, an investor could complete a series of successive exchanges over time, allowing their profits to grow tax deferred indefinitely.

To receive these tax breaks, there are 1031 exchange rules that must be followed.

Professional Management

Private equity real estate companies are managed day-to-day by experienced professionals who have track records sourcing, underwriting, and managing commercial properties. Management teams are typically responsible for key decisions that influence the returns investors ultimately receive. Important management functions are often related to managing renovations, leasing, and maintenance. Investing in private equity funds run by top-notch managers can be especially beneficial for investors who don’t have the time or expertise to manage real estate investments on their own.

Property Value Appreciation

Real estate investments have the potential to appreciate in value over time as the properties are improved, leased up at higher rates, and benefit from price increases in the local real estate market. Appreciation provides investors with an additional way to earn a decent rate of return on their investment besides relying exclusively on cash flow. Sophisticated management teams often look to complete opportunistic sales of appreciated properties using tax advantaged strategies, such as 1031 exchanges, when the market allows for it.

Downsides of Private Equity Investing

Like any investment, there are downsides to investing in commercial real estate through a private equity vehicle. Investors should always take the time to complete adequate due diligence before making an investment.

High Minimum Investment

Most private equity firms maintain minimum investment requirements investors must meet in order to become limited partners. Minimum investment requirements in the private equity space usually start around $25,000 and can rise to $100,000 or higher in some cases. These high minimum investments put private equity investments out of reach for many individual investors.

Illiquidity

Liquidity describes how easy it is to convert an asset to cash. Private equity commercial real estate is generally considered to be an illiquid investment vehicle.  Private equity investors cannot convert their holdings to cash very easily, or sometimes at all, due to the required lock-up period. This means it may be difficult or impossible to sell a private equity investment before this period ends. Lock-up periods generally last three to five years but can be longer in some cases.

Risk of Loss

Like with any investment, there is no guarantee of returns when investing in private equity real estate. Unforeseen factors such as downturns in the real estate market, tenant turnover, and property maintenance costs can all negatively impact the performance of a real estate investment.

Fees

In order for commercial real estate investment sponsors to fund the effort required to identify and acquire suitable investment properties, it is normal and customary for them to charge fees to the limited partners. Typical fees include acquisition fees, disposition fees, asset management fees, and debt placement fees. 

The type and amount of fees can vary widely by deal, property type, and asset class, so it is important that passive investors understand the fee structure to be able to make an accurate comparison between opportunities. To determine the type and amount of fees, investors should read the offering documents provided by the management team.

Investment Opportunities After the COVID-19 Pandemic

The COVID-19 pandemic changed the way people shop for necessities, including groceries. The shift in shopping habits has changed the retail landscape over the past couple of years. Generally, national grocery retailers have seen increases in foot traffic and sales during this time. This has led private equity firms, hedge funds, pension funds, real estate investment trusts, and real estate mutual funds to view grocery chains as strong commercial property tenants. These tenants are generally considered to have strong credit profiles and low risk.

Commercial properties leasing space to these retailers have benefited in various ways, all centered around the trend toward more frequent, unplanned visits to grocery stores. The rise in e-commerce and pick-up grocery orders has forced most grocers to revise their business plans to accommodate logistical changes and additional traffic. Specifically, many national grocery retailers have sought to lease additional space directly adjacent to existing stores to handle inventory tied to e-commerce, pickup, and delivery.

As a result of new grocery shopping habits, investors in grocery-anchored retail centers have seen some of the biggest tailwinds of any asset class owners across the real estate industry in recent years.

How Investors Can Avoid the Volatility of Public Equities

All public equity investors know they take on an elevated level of risk due to the possibility of large and abrupt short-term fluctuations in prices. Understandably, this makes some investors nervous about allocating significant capital to public equities. Many investors turn to private equity commercial real estate as an option that is widely viewed as having less price volatility compared to stocks or cryptocurrencies.

Investing in commercial real estate can help investors avoid the volatility of public equities because the performance of real estate assets are usually uncorrelated to the performance of stocks and bonds. This means real estate values may not move in the same direction or as severely as the stock market. For this reason, commercial real estate assets can provide a degree of diversification and reduced volatility for an investor.

Is Private Equity Commercial Real Estate Investing Right For You?

Every investor’s situation is unique, which is why investors shouldn’t jump to conclusions too quickly. Not only do you need to consider your financial situation, but you also need to evaluate the investment opportunities that are available as well.

It’s important for every investor to carefully consider his or her investment objectives and risk tolerance before making any investment decisions. It’s also a good idea to seek the advice of a financial professional before making any investment decisions.

How to Getting Started with Private Equity Real Estate

Every real estate investor is different and every property investment is purchased with different objectives in mind. It is important for beginning investors to decide what their goals are in commercial real estate investing. Once new investors have settled on their goals for investing in commercial real estate, they should map out a long-term plan to ensure they stick to their goals. Commercial real estate investing presents many opportunities, not all of them good ones. Having a long-term plan in place will help investors filter out deals that don’t meet their criteria.

Investors all need to think about whether they want to be involved in the day-to-day management of the properties they own. In other words, investors must decide if they want to pursue an active or passive strategy.

A passive investment strategy provides all of the benefits of real estate ownership without the hassle of actually managing it.  The day-to-day work of finding and managing real estate deals is done by professional firms who have the experience and expertise needed to do it well.

An active investment strategy means that one or more real estate investors come together to purchase a property directly.  The primary benefit of this approach is control because the investor controls the property identification, selection, financing, due diligence, and property management processes.  While this can certainly yield favorable results, active investing can also be incredibly time consuming, and it requires experience and expertise.

The Takeaway: Should You Invest in Private Equity Commercial Real Estate?

Private equity commercial real estate is one type of investment in the real estate industry among many. It certainly has its advantages, as we described above. But, it is not right for everyone. Investors need to think about their individual financial situation, objectives, and risk tolerance before deciding whether to invest in private equity commercial real estate.

Because each investor faces a different situation and a unique set of opportunities, it is always a good idea for real estate investors to consult with a financial professional, qualified real estate attorney and/or CPA before deciding whether to allocate capital to a private equity vehicle.

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.

If you are an Accredited Real Estate Investor and want to learn more about our investment opportunities, contact us at (800) 605-4966 or info@fnrpusa.com for more information.

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