Investors Weigh Differences in Private Equity vs Private Security Real Estate Investments

Investors who want to diversify portfolios and build wealth through commercial real estate property can choose from a variety of options. Having choices is always advantageous as it can help individuals find the best match for their investment strategy. Yet choices also can be confusing.

Two real estate investment vehicles that sound quite similar are private equity investment funds and private security investment funds. The reality is that these are two distinctly different investment structures. Both investment options do offer some of the same benefits of commercial real estate investing, such as access to institutional quality assets and greater stability compared to volatility in the public stock market.

At the same time, there are some notable differences. Private equity investments can be structured as a limited partnership (LP) or limited liability company (LLC). In the case of commercial real estate, real estate investing, or operating companies generally sell shares or unit interests of the LPs or LLCs to investors. These generally refer to private equity real estate funds or private REITs. In the case of commercial real estate, these generally refer to private REITs. Additionally, other notable differences between the two structures relate to investment strategy, taxes, fees, and overall returns.

Laser Focus: One of the attributes that people like about a single asset private equity investment is that it allows them to invest their money into one particular investment with defined investment timeline. By investing alongside the project sponsor, preferred equity investors know exactly when and how their capital is used in the project (an office building in Atlanta or an apartment building in Dallas) and how profits are distributed. To compensate for the lack of diversification, high-quality single asset private equity investment when managed well can generate far superior returns compared to investing in private equity real estate funds.

CanAm Capital Partners (CACP) makes such project-specific capital investments on behalf of its investor clients. For example, CACP recently completed a private equity investment offering that provided financing for a 271-room Kimpton Hotel in Philadelphia. Investors in that transaction knew exactly how, when, and where their money was put to work, and oftentimes, who is investing right alongside them.

Lower Fees: One of the biggest criticisms of private REITs has been their historically high load or fee structure. New regulatory requirements have brought more transparency to the sector that has pushed many REITs to reduce fees and/or shift costs away from front-loaded fees. However, it is important for investors to look closely at all of the different fees within each individual investment that can potentially impact the overall return.

Tax Benefits: One of the biggest advantages of private equity real estate investment is the tax benefits. Income from private equity real estate investments can be offset by depreciation deductions. Additionally, partnerships do not pay corporate income tax, rather they “pass through” income directly to investors.  Both private equity partners and REIT shareholders may be eligible for a new tax deduction of up to 20% on their pass-through income as part of the new Tax Cuts & Jobs Act of 2017.

Wealth building: There is some competitive rivalry among the many different real estate investment alternatives available. Some believe that private equity real estate offers higher absolute returns, because investors do have the potential to benefit from value appreciation and/or cash flows, tax advantages and lower fees. Another theory is that private equity investments with experienced managers are more likely to generate alpha returns versus REIT s that deliver blended returns across larger portfolios.

In fact, there is plenty of research on both sides to make a case that either private real estate performs better, or private securities perform better. What both sides agree on is that real estate has generally outperformed other indexes over time. For example, the National Council of Real Estate Investment Fiduciaries (NCREIF) property index tracks returns of private institutional-grade commercial properties. The 20-average of the NCREIF Index is 9.3% as compared to 6.7% for the S&P 500. To that point, many investors do invest across different private and public real estate investment opportunities.

As with any investment, it is important for investors to conduct careful due diligence and make sure that investment in a private equity real estate fund or offering fits with their risk tolerance and investment goals.

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