Investors can choose among various options to own real estate. One common choice is direct investment, which involves buying and managing property. Some investors prefer this approach as a means to pursue both income and potential appreciation. However, direct investing does have limits, particularly resource limits. One option for investors who prefer to pursue larger properties is to participate in a private real estate fund. Private real estate funds raise capital from investors, identify, acquire, finance, manage investments, and share income.
A private real estate fund has some similarities to (and differences from) a Delaware Statutory Trust (DST) or Real Estate Investment Trust (REIT), which are other examples of how to invest in commercial property as part of a group. All of these structures allow passive investing, in which the participant can earn a share of potential profits without being actively involved in the ongoing operations of the property.
A REIT is typically a publicly traded highly liquid security (although there are private REIT offerings as well) which allows entry by investors at a lower commitment level. While a DST is a private offering, one significant difference between the DST and a private equity fund is that DSTs may not spend investor capital to buy distressed property for the purpose of upgrading and selling the property. In contrast, a private real estate fund can seek to take that approach.
How does a private real estate fund operate?
A private real estate fund may be created for a limited period or for an indeterminate time. The closed-end fund is more likely to invest in properties that need improvements and upgrades and can then be sold for profit. An indeterminate fund, in contrast, might be formed for longer-term operations and the pursuit of income from rent. Private equity real estate funds often have a planned lifespan of approximately ten years but can be shorter or longer.
Do private real estate investors need to be accredited?
Often, real estate investment funds require participants to be accredited due to the lack of publicly available information and the generally higher risk associated with the investment. The accreditation designation is not universal but typically can be achieved by reaching certain income and asset levels. DSTs also require investors to be accredited, but publicly traded REITs are available to unaccredited participants. Private real estate funds are not considered liquid, while REITs typically can be bought and sold when preferred.
What structures can private real estate funds use?
Often, a general partner creates the fund, raises capital by attracting investors, and acquires and manages the properties. These funds are usually structured as limited partnerships but can be C-corps, S-corps, LLCs, or others.
Are there drawbacks to private real estate investments?
While potential returns and possible tax benefits are among the significant attractions of private real estate investments, there are also potential disadvantages to consider. For example, private real estate funds are not regulated and can charge management fees at the sponsor’s discretion. In addition, cost overruns may sometimes result in demands for additional capital contributions. This risk may be more pronounced in funds that focus on remodeling distressed assets, but any real estate fund is subject to the overall exposure that commercial real estate involves. Private real estate funds are illiquid investments. Investors should not invest funds they expect to need before the fund’s anticipated termination date.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.
Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
All real estate investments have the potential to lose value during the life of the investment. All financed real estate investments have the potential for foreclosure.
The income stream and depreciation schedule for any investment property may affect the property owner’s income bracket and/or tax status. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities.
No public market currently exists, and one may never exist. DST programs are speculative and suitable only for Accredited Investors who do not anticipate a need for liquidity or can afford to lose their entire investment. A REIT is a security that sells like a stock on the major exchanges and invests in real estate directly, either through properties or mortgages.
REITs receive special tax considerations and typically offer investors high yields, as well as a highly liquid method of investing in real estate.
There are risks associated with these types of investments and include but are not limited to the following:
- Typically, no secondary market exists for the security listed above.
- Potential difficulty discerning between routine interest payments and principal repayment.
- Redemption price of a REIT may be worth more or less than the original price paid.
- Value of the shares in the trust will fluctuate with the portfolio of underlying real estate.
- There is no guarantee you will receive any income.
- Involves risks such as refinancing in the real estate industry, interest rates, availability of mortgage funds, operating expenses, cost of insurance, lease terminations, potential economic and regulatory changes.
This is neither an offer to sell nor a solicitation or an offer to buy the securities described herein. The offering is made only by the Prospectus.
