By Dan Miller, WCI Contributor
Investing in real estate offers a multitude of opportunities, each with its own set of advantages and disadvantages. However, for those seeking a more passive investment journey, private real estate funds may be the perfect solution. Let's explore what private real estate funds are and determine if they are the right choice for you.
What Are Private Real Estate Funds?
Private real estate funds provide a passive way to invest in real estate. Essentially, these funds bring together a group of individuals who pool their money to acquire, finance, and own specific properties. By investing in a private real estate fund, you gain the ability to participate in much larger projects than you could on your own.
Accredited Investor vs. Qualified Client vs. Qualified Purchaser
It's important to note that some private real estate funds are exclusive to high net-worth individuals. Here are the three main investor categories:
- Accredited Investor: Individuals with an income of $200,000 for each of the last two years or $300,000 for couples, or investable assets of $1 million or more.
- Qualified Client: Those with $2.2 million investable assets, $1.1 million invested with an advisor, considered a "qualified purchaser," or involved in investment activities.
- Qualified Purchaser: Individuals with $5 million or more in investments or entities with at least $25 million in investments.
For a more detailed comparison, check out our article on accredited investors vs. qualified clients vs. qualified purchasers.
How Do Private Equity Real Estate Funds Work?
Private equity real estate funds operate by pooling money from multiple individuals to purchase real estate assets. While a simple example may involve several people contributing to buy an apartment building, most private real estate funds are more complex. These funds typically have a manager or controlling partner who oversees the fund's day-to-day operations and property management.
Choosing the Right Fund Manager
When considering investing in a private real estate investment fund, selecting a reliable and capable fund manager is crucial. A skilled manager can turn a potentially bad deal into a success and can ensure the fund avoids unfavorable investments. To find the right fund manager, consider these five factors:
- Philosophy: Ensure that the manager's investing philosophy aligns with your own.
- Communication: Look for a manager who maintains open and transparent communication.
- Trustworthiness: Integrity is non-negotiable; choose a manager with unquestionable honesty.
- Competence: Opt for an experienced and competent manager who excels at their job.
- Discipline: Select a manager who knows when to invest and when to avoid a bad deal.
Conducting due diligence on the fund manager is essential. Start by reviewing their company website and Private Practice Memorandum (PPM). You can also seek information from current and former investors, trusted sources, and due-diligence sites like CrowdDD.com. For significant investments, it may be prudent to run a background check on the principals.
What Returns Can You Expect from Private Real Estate Funds?
Unlike index funds, calculating the returns from private real estate funds is more complex. Generally, there isn't a fixed percentage or amount that a fund returns. Instead, it depends on various factors. Here's an example of how a typical private real estate fund may distribute returns to investors:
- The operator usually receives a 1% fee per year.
- The limited partners receive their principal back.
- The limited partners enjoy a preferred return, such as 6%, 8%, or 10% per year.
- Any returns exceeding the preferred return are divided between limited and general partners, often in an 80/20 split.
It's essential to understand the fee and payout structures of the fund before investing your money.
Caption: Private Real Estate Investment Funds
REIT vs. Private Equity Real Estate Fund
While a Real Estate Investment Trust (REIT) shares similarities with a private equity real estate fund, there are significant differences, especially regarding taxation. REITs are eligible for the 199A deduction, issue only a 1099 tax form, and usually don't require filing in multiple states. On the other hand, private funds pass through depreciation via K-1 forms, may necessitate filing in multiple states, and allow you to use depreciation against income from other investments. Additionally, REITs often provide higher liquidity and have lower minimum investment requirements compared to private funds.
Choosing the Best Private Real Estate Fund for You
Determining the "best" private real estate fund is subjective, as it depends on your investing style and philosophy. At The White Coat Investor, we have a list of recommended real estate investing company partners to help you in your due diligence. This list can serve as a starting point as you search for the ideal private real estate investment fund that aligns with your specific needs.
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