Private equity real estate is best defined as a type of asset that pools together public and private real estate investments. These funds are typically costlier and often times riskier than other forms of investments in real estate, but they allow high-net-worth individuals and institutions invest in real estate related equity and debt holdings.
First, there are several different structures within this fund. Some are listed and described here below:
· Private REITs: A type of real estate fund that is exempt from registering with the SEC. These shares do not trade on national stock exchanges and are typically sold only to institutional investors.
· Closed-End Structure: A very common real estate fund structure and is usually set to last for five to six years. Investors in this type of structure are typically not allowed to make additional contributions or withdraw capital during this time period.
· Domestic Real Estate Fund Structure: Typically made up of the following types of entities:
o Limited Partnership Structure (LPs): Exists when two or more partners go into business together and invest together, but the limited partners are only liable for the amount of their investment. An LP has limited partners as well as a general partner who has unlimited liability.
o Limited Liability Companies (LLCs): Where the owners of a business are not personally liable for debts or liabilities incurred by the company.
· Offshore Fund Structure: Avoid direct US tax liability. Generally, funds seeking to avoid tax liabilities will be set up in a “tax-neutral” region of the world like the Cayman Islands. However, with real estate, the leveraged domestic blocker must be used to achieve this goal.
o A leveraged domestic blocker strategy utilizes an American company that is comprised of loans and equity. Its purpose is to shield offshore investors from United States tax filing obligations.
The type of structure of a private equity real estate fund depends on several tax and financial considerations.
There are also different types of private equity real estate funds altogether:
· Core: Lowest risks and lowest rewards
· Core-Plus: High quality assets in secondary markets or slightly risky assets in primary markets. Higher net equity than a core fund
· Value-Add: The assets in these types of funds are improved by re-leasing, redevelopment, or operational efficiencies. They offer higher net equity than the previous two funds.
· Opportunity: High risks but also higher returns. This involves redeveloping poor or outdated buildings/properties. Higher net equity.
· Distressed debt: These funds buy older loans or nonrated commercial mortgage-backed securities and offer net equity comparable to that of a core-plus fund.
Additionally, certain entities that have plans like IRAs, 401(k)s, college endowments, and pension plans are tax-exempt but are subject to the unrelated business income tax (UBTI). This can be avoided through what is known as the fractions rule. For more information regarding this, please visit the following site: https://www.eisneramper.com/fractions-rule-real-estate-private-equity-1018/.
Finally, when setting up a fund, several considerations should be made. For example, how much equity capital should be raised? In other words, how large should the fund size be? Furthermore, are all sponsors and investors clear on time and energy commitments required to set up a fund? Lastly, what strategy and structure (as previously discussed) will be used? Prospective investors should also be aware of the large upfront capital commitment that is required, as well as potentially long-lasting lock-up periods which prevent the investor from liquidating their shares. Most importantly, these types of investments are highly risky, so much so that an investor could lose their entire fund if it underperforms.
Given the large costs and risks associated with private equity real estate funds, what are the benefits? These funds can provide high levels of income along with significant price appreciation.