Pros and cons of private equity real estate partnership

private equity real estate partnership

With private equity real estate partnerships, passive investors can reap several benefits. These include portfolio diversification, multiple asset flexibility, tax efficiency, risk dispersion, and many others. Therefore, passive investors can enjoy asset management and direct commercial real estate ownership.

Let’s discuss the benefits of private equity real estate partnership:

1. Private equity real estate funds enable investing in actual properties

Partnering with private equity real estate funds allows investors to invest in physical properties like multifamily and office buildings. 

Thus, they can receive a stable passive cash flow from these properties in the form of monthly rental payments or unit sales.

Read Lilypads’ article on how to calculate rental property cash flow here.

2. Passive involvement

In private equity real estate partnerships, investors truly stay passive. 

The transaction sponsor or the private equity firm takes care of identifying and acquiring real estate assets. They also perform their analysis and seal the deal in the end. 

Otherwise, the institutional investors must bear all the burden of property acquiring to post-purchase maintenance.

However, private equity real estate investments allow investors to own assets without active management and physical involvement.

2. Partner with expert professionals

Real estate private equity firms consist of experts with a proven track record in every aspect of commercial real estate transactions. 

As a result, when passive investors partner with investing veterans, they are able to leverage the latter’s knowledge, expertise, and industry relationships to unlock the best investment opportunities.

From market analysis and site selection to underwriting, due diligence, and property management, Real estate investment trusts, and private equity real estate funds handle every aspect of the investment on behalf of the investors.

3. Diversification

Since passive investors do not need to commit the entirety of the equity in a given transaction, they are able to invest in various other smaller deals. 

These deals can be diverse in the sense of asset class types, which provides the investors to diversify their commercial real estate portfolio. 

Moreover, the investors can diversify their portfolios based on multiple investments across different asset classes. 

Also, they can expand their portfolios based on geography, business plan, and different sponsors. 

Hence, private equity real estate partnerships pave the way for passive investors to make numerous small investments.

4. Wider access to quality assets

Private equity firms pool investor funds and hence invest in real estate deals and property types.

Under normal circumstances of individual investing, identifying such assets would be difficult for their size, capital constraints, and complexity. 

However, the private equity firms constitute vast networks of brokers and experienced staff. 

And they have a vast network of developer relationships who identify quality assets and properties at investor-friendly rates, that others can’t.

Hence, private equity real estate partnerships enable passive investors to access a large number of quality assets.

5. Tax benefits

Passive investors use commercial real estate private equity investing to gain financial benefits that can be leveraged for tax purposes. 

It is a known fact that even though assets can decline over time it does not affect the market value of the property. 

Hence, the investors can use this depreciation to show a passive loss that will offset their taxable income. 

As a result, this lowers their overall tax burden and increases their yield after taxes.

6. Risk Dispersion

Since a private equity type of investment has multiple equity partners, it disperses the risk of losses. 

As a result, any single investor does not have the bear the entire burden of risk and loss themselves. 

For instance, in a direct ownership scenario, when a property needs additional capital, an individual investor provides the extra funds.

However, in a partnership, the base of investors pool their money to raise the extra capital. 

Hence, this automatically decreases the individual contribution amount. 

Moreover, private equity fund managers evaluate the underlying risks and fundamentals of an investment on behalf of the investor.

As a result, passive investors can select the right deals after proper risk evaluation in a private equity real estate partnership.

Thus, it reduces risks, maximizes growth potential, and offers risk-adjusted returns.

7. High returns on investment

Investing in private equity funds can provide high potential returns on investment through passive income and strong price appreciation

Further, annual returns for core strategies range from 6% to 8% and it ranges from 8% to 10% in the case of core-plus strategies.

Risks of private equity real estate partnership

1. Capital Intensive

Private equity fund managers generally charge huge fees for managing a commercial property. 

So, such investment types become more expensive than the other options. 

Moreover, investing in private equity partnerships requires a long-term outlook and a huge capital commitment of over $250,000 at the initial stages and more follow-up investments over time. 

Further, private equity funds also charge 20% of excess gross profits for the fund as a performance fee. 

2. Barriers to entry

Often private equity real estate partnerships and investments are available to only accredited and high net worth individuals. 

Therefore, a retail investor has to possess sufficient income and net worth.

Also, these investments are also exclusively available to sophisticated investors. 

They must prove that they have enough knowledge to understand the risks of a certain real estate deal.

2. Illiquid

Private equity partnerships are made over the long term. 

This implies that the funds will be locked-in for five years or more years. And, the manager positions the property’s business plans and an exit strategy. 

In some cases, the lock-up periods can stretch for more than a dozen years. 

Hence, if an investor needs to liquidate an investment during that period, it becomes difficult or quite expensive. 

As a result, during that 5-10 years, investment becomes illiquid.  Further, investors have no right to demand instant liquidation during that time, and distributions are paid from cash flow.

The Lilypads Bottomline

Therefore, private equity real estate partnerships are overall more beneficial than risky for passive accredited investors. 

Investors having long-term horizons and higher risk tolerance may benefit tremendously from such partnerships if they are in no need of immediate liquidity.

CRE private equity funds pave the way for portfolio diversification and greater returns on investments for investors without the burdens of property management and direct involvement.  Hence, private equity real estate partnerships prove to be the perfectly suitable and cost-effective alternative to direct investments.

Read Lilya