Private real estate investing continues to attract plenty of interest. In recent years, more investors of sufficient means are turning to private equity real estate and real estate funds to diversify their portfolios with an asset class that offers both ongoing revenue and ownership of a tangible asset.
While private real estate investing can be lucrative, there are many important considerations to make before jumping in. This guide will explore some of the pros and cons of private real estate investing.
What Is Private Real Estate Investing?
Private real estate investing involves the direct ownership of property or contribution to a private real estate fund or partnership. It can be a more active form of investing than traditional avenues, as stakeholders are often directly responsible for maintaining the properties they own.
Private real estate investing is considered an alternative financial vehicle. Unlike public real estate investment trusts (REITs), private real estate isn’t traded on financial markets. It also demands a more managerial outlook than other typical items in a portfolio.
Residential properties are probably the most popular vehicles for private real estate equity due to their availability, ease of management, and potential for predictable ongoing revenue. Commercial properties, specialized buildings, and undeveloped or semi-developed land are also favorites of the private real estate investment community.
Profits in private real estate investing are realized via regular income like rents and value appreciation over time. Investors can also take advantage of tax deductions on property depreciation.
More than $160 billion was raised globally for private real estate investments in 2022. Like any investment vehicle, the private real estate market endures ups and downs, especially in times of inflation and recession. Even so, the industry is positioned to grow as real estate markets expand.
Is private real estate investing worth the risk? Here’s a look at some of its advantages, drawbacks, and potential opportunities.
➕ Pros of Private Real Estate Investing
Private real estate equity is especially attractive to high-value investors and funds. Here are some of the reasons why.
High Potential Returns
There are many avenues for finding success in private real estate investing.
Rental income and lease payments are common for residential and commercial properties. Undeveloped land with valuable resources like oil or minerals can also earn investors extraction royalties. Depending on the property, private equity holders can even earn ancillary income from sources like parking space rentals or licensing fees.
Appreciation is another appealing prospect to private investors.
Properties tend to increase in value when held for several years. This is especially true in areas going through rapid development or economic growth. Private investors earn money through appreciation by selling the property at a higher value or leveraging their equity for refinancing or other investments.
Diversification is a key concept for all investment strategies, including real estate. The idea is to distribute one’s money across a wide variety of commodities and assets.
An investor’s portfolio may include holdings in stocks, bonds, cash, or even cryptocurrency. They may also have holdings in multiple industries, such as positions in real estate, tech, consumer goods, and utilities commodities.
The biggest benefit of diversification is risk mitigation. When you hold positions in several different areas, the investments that perform well can balance out the ones that are underperforming.
For example, if a boom in the real estate market drives up the value of your property holdings, it can make up for times when your tech stocks suffer from industry-wide slowdowns.
By contrast, concentrating all your investment capital in just one or two specific areas exposes you to risk. If your portfolio holds nothing but communications, for instance, you’re tied to the ups and downs of that industry alone. When the communication sector goes through a downturn, your portfolio’s value can take a disastrous hit.
Diversification addresses this issue, protecting shareholders from market volatility and changing economic cycles. By adding private real estate interests into your portfolio and holding a diverse array of properties, you can effectively manage and mitigate your overall risk.
Control and Decision-Making
Private real estate investing is a more active form of investing than stocks or ETFs. For example, owning a residential property for rental income necessitates property maintenance, improvement costs, regulation awareness, and so forth.
While active management takes more work, it gives the investor more control over their assets. They make decisions and take actions that directly affect their holdings in hopes of generating income. More passive investors may not often have a meaningful say in the day-to-day maintenance of their holdings.
Being more involved in decision-making gives investors a sense of control over their assets. It also reinforces the investor’s connection and dedication to their properties, which can be great incentives for active management.
Large-scale investments are often vehicles for holders’ tax strategies. Several real estate investing strategies help limit annual taxable income, offering the opportunity for deductions.
For example, an investor in low-income housing may receive tax credits for making improvements, complying with energy efficiency regulations, or depreciation. A commercial real estate investor can get breaks on property taxes, interest expenses, or qualified income.
Limiting one’s taxable income can result in a more favorable tax return at the end of the year. This, in turn, can free up cash flow and other income strategies like compound growth.
Be sure to consult a tax professional before adopting any tax mitigation strategy!
Access to Unique Opportunities
Private real estate investors have access to prospects that other investors don’t. For instance, they can invest directly in residential or commercial properties. They can also make profits via natural resources like oil or gas.
Certain strategies are unique to private real estate investors.
Besides owning properties themselves, they can become part of a “syndicate”, pooling their funds with those of other investors. They can serve as lenders for development projects, earning interest on debt or mortgage payments, or invest in one-off opportunities in niche markets like senior housing or healthcare businesses that need more specialized attention.
These properties and strategies generally aren’t available to everyday investors, as they often require greater capital or are limited to accredited investors. The exclusivity of these assets makes them more appealing to those who can afford them.
➖ Cons of Private Real Estate Investments
Despite its potential benefits, the private real estate investment market comes with some real disadvantages that investors have to consider carefully.
Investing in real estate is a complex process involving very large assets. Converting investments into cash can be difficult and may take a considerable amount of time. This illiquidity can prove a detriment to some investors.
Since they’re more exclusive, private real estate investments have much smaller pools of potential buyers. The process of investing may further be subject to regulation compliance, zoning disputes, and many other administrative requirements that can slow down transactions and make it more difficult to liquidate an investment.
Risk and Volatility
The scale and substance of private real estate investments make them inherently risky. Real estate is susceptible to economic downturns and recessions, especially during certain market cycles. And since they’re highly illiquid, investors may have a harder time unloading the assets to get out of risky circumstances.
External factors also contribute to the real estate market’s volatility. Interest rate changes, inflation, consumer confidence, and other trends can all negatively affect values.
Higher Capital Requirements
Private real estate investments are more exclusive simply because they require more capital funding. The minimum amount needed for the initial buy-in is often impossible for smaller-scale investors to meet. Many real estate investments are limited to accredited investors because managing them requires specialized experience.
Publicly traded assets like stocks are subject to regulation and reporting requirements. Though stockholders don’t have access to every single minute aspect of public company management, they get quite a bit of detailed information about company operations and earnings.
That’s not the case with private real estate opportunities. Such investments aren’t held to the same level of public disclosure as public commodities. Because of this, fund managers might restrict the information they give to the general investment pool, which can be frustrating for those who want to know more.
Longer Investment Horizon
The complex, large-scale nature of private real estate investing requires a not-inconsiderable time commitment. Returns on investment may not actualize for years after raising initial capital. As such, private real estate investing isn’t generally a suitable avenue for those focused on short-term growth or immediate gains.
Private Real Estate Funds
Rather than buying and managing a specific property, many investors put their resources into private real estate funds. Similar to mutual funds and ETFs, these financial instruments pool money from multiple investors. That capital is then used to provide capital for a range of real estate projects.
A real estate fund can instantly diversify one’s portfolio, spreading investments across different types of real estate properties across various locations.
These funds are typically run by experienced managers who are upfront about the characteristics and strategies of certain funds. Depending on how managers permit or limit exit strategies, they may offer slightly more liquid investments as well.
Open Up Your Private Real Estate Investment Playbook
Opportunities for private real estate investment cover a wide spectrum. Considering which ones to follow comes down to the investor’s general financial goals and risk tolerance.
Residential properties are popular, as they can provide rental income, steady appreciation (if they are in desirable locations), and less complicated lease terms.
Commercial properties, meanwhile, offer more sizable returns on investment, with a wealthier potential tenant base and more complex, longer-term lease agreements. Industrial properties represent the “biggest” private real estate investments. They frequently come with corporate tenants and decades-long lease terms.
Each type of private real estate investment has potential benefits and drawbacks. For this reason, due diligence is crucial in evaluating which ones to pursue. Research on location, income potential, market demand, property condition, financing options, and legal compliance will go a long way toward helping you make the right option.
When faced with such prospects, consulting with financial professionals with experience in private real estate investing can be highly beneficial.
Their guidance comes from years of working on large-scale investments. If you’re just beginning your private real estate investment adventure, make it a point to have a trusted financial expert in your support circle.