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The “democratization” of private equity investing has been increasingly prevalent over the past several years, enabling high net worth individuals to readily participate in an industry traditionally reserved for institutional investors. However, private equity real estate remains a relatively esoteric asset class, partially due to the belief that commercial real estate as a whole is driven by the current challenges facing office properties throughout the United States.
Commercial real estate, in reality, is an extremely bifurcated sector. Offices in key regions may grab the negative headlines, but there are multiple assets that are thriving, including data centers, student housing and multi-family housing. These subsectors are seeing increasing growth and are expected to continue for a variety of reasons including heightened demand and limited supply.
The benefits of select private equity real estate
RIAs and their clients should take advantage of these outsized opportunities and participate in this area of commercial real estate due to the numerous long-term benefits available:
Diversification
Targeted investments in private equity real estate offer investors an opportunity to broaden their portfolio beyond traditional public equity and fixed income portfolios.
Low correlation
The exposure to select private equity real estate may also provide a low-correlation return profile relative to public securities, further enhancing portfolio diversification for investors.
Exclusivity
Private equity real estate offerings are typically unique with limited availability. As a result of their scarcity, RIAs are often drawn to them as a unique – if not exclusive – investment offering that is not available elsewhere. This ultimately assists RIAs in differentiating their practice from other RIAs.
Inflation hedge
Select real estate assets have revenue streams that increase on a recurring – often annual – basis to keep up with inflation. Such assets are often particularly desirable for investors looking for true wealth preservation strategies.
Hands-on management
Real estate investing is a contact sport. All-in, hands-on management is an essential ingredient to maximizing the probability of success. As investors in private equity real estate, high net worth individuals often have not only clear reporting expectations but direct access to the management – or sponsorship – team. This level of access and accountability is unique.
Tangibility
Private equity can seem difficult to understand for the average investor. After all, can you actually touch something like “distressed credit”? With real estate, investors can literally see their investment, understand the asset, and better understand its merits.
Overcoming hurdles to investment allocation
While the advantages of select real estate investments are numerous, there are nonetheless several fundamental shortcomings that have needed to be addressed to make RIAs and their clients more comfortable with the asset class.
Increasing access
The first major challenge has been simply providing access to these investments. Historical thresholds, including minimum investment amounts as well as illiquid fund structures, have proven to be especially high hurdles for adoption among RIAs and clients. In order to address these issues, many private equity firms, including T2, have rolled out funds that break from historical norms.
With minimum investment amounts commonly at $1.0 million or more, many private equity real estate funds have lowered the threshold in order to open their funds up to a broader investment base. T2’s minimum investment amount currently stands at $100,000 and others have gone lower. While still somewhat restrictive, it is far less so than conventional private equity funds from just a decade ago.
The illiquidity of private equity funds is a key – if not the major – impediment toward investing. In stark contrast to publicly traded stocks and bonds, private equity is a non-traded investment vehicle, rendering it illiquid. While palatable for some investors, the illiquidity can be problematic for others. In order to combat the illiquidity and accommodate prospective investors that would prefer not to tie their money up for several years, T2 and others have provided the ability for investors to redeem all, or part, of their investment on a recurring – often quarterly – basis. While the liquidity is still subject to the availability of cash within the underlying fund, this structure has proven to be a breakthrough for many high-net-worth investors.
Moreover, there is a significant advantage for RIAs to work directly with investment firms rather than leverage aggregators. Rather than having to go through (and pay!) an intermediary, direct access to an investor provides a number of advantages, including: greater transparency into the details of a deal itself, including better opportunities to “kick the tires”; lower fees, especially as some firms charge up to eight percent just for the opportunity to invest in a fund; and lines of communication to dealmakers themselves.
RIA education
In addition to addressing challenges in accessing private equity real estate, education is necessary to help RIAs understand the advantages of the sector. It’s a steep learning curve for RIAs that are used to traditional stocks and bonds.
It’s an ongoing effort, but as an independent firm with deep relationships with RIAs, T2 is able to directly connect for hands-on education sessions, while also offering broader educational resources to a wide range of advisors. Education incorporates a number of components, including educational webinars, roundtables and one-on-one Q&A sessions about the industry and particular deals, and on-site visits where T2 brings RIAs to see first-hand the potential of deal project sites. I encourage RIAs to reach out to T2 or firms like it when considering private equity real estate investments.
Client understanding
Beyond having a strong understanding of the value of select real estate investments, RIAs must also be adept at explaining the asset class’s advantages and disadvantages to their clients. I have found that holding meetings between T2, RIAs and their clients goes a long way in explaining the value of the transaction and alleviating any potential concerns. These meetings are also a valuable way of distinguishing the deal from the classic real estate infomercial of ensuring an “easy and painless way to 10X your money!” Instead, it reinforces T2’s role and the RIAs role as a steward of capital, not an influencer promising that a few multifamily investments will easily make their dreams come true.
Taxation
As with all investments, taxes are a key consideration when determining the viability of an asset class. Not only do private equity investments require forms many RIAs may not be accustomed to, but they are often delivered after April 15th, requiring tax preparers to file amended returns. That is why T2 strives to deliver K1s ahead of the filing deadline, so that they may be easily incorporated into a client’s broader return. I also work closely with our RIA partners to educate them on the specific filing requirements needed for private equity real estate investments.
Introducing a new asset class to RIAs is an intensive process, but one I believe is paramount to provide them with the solutions needed to address client goals. Private equity real estate is an increasingly important addition to any portfolio that can now be easily accessed and readily understood.
Jeff Brown is the founder and CEO of T2 Capital Management, a private equity real estate investment firm.
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