Private Real Estate And The High Net Worth Investor
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When I first learned about real estate it was through my radiology partner, who kept extolling the virtues of owning property (he cited tax benefits and positive monthly cash flow he was receiving through his multiple single family home properties).
I still hesitated as I did not want to be a landlord (had some bad experiences with condos I had bought and subsequently lost (happily) in the divorce).
It was only when I was exposed to fractional institutional quality real estate investing that the light bulb went off and I knew I had to incorporate it into my portfolio.
Michael Episcope, co-founder of Origin Investments, was gracious enough to provide the following article for my readers.
[Disclaimer: Origin Investments is a sponsor of this website. I also have personally committed capital to the Origin Income Plus Fund.]
Why Private Real Estate Belongs in Every High Net Worth Investors’ Portfolio.
Byline: Michael Episcope.
Physicians and other high earning professionals have the means not only to buy their office space, but to also prosper with other real estate investments.
Commercial buildings offer the dual attractions of generating income from rents and wealth from property appreciation.
As a result, property can generate a healthy cash flow and high total returns once the asset is sold.
There’s one caveat: busy professionals don’t have the investment resources of foundations and pension funds that regularly turn to real estate investments to build long-term wealth.
Their time, networks and resources are typically limited in comparison, and the deals they latch onto through friends, local brokers or even their investment advisors can fall short of investment grade.
For many years, private equity real estate deals were largely the province of university endowments, insurance companies and other high-asset institutions such as private equity groups that run huge opportunistic real estate funds.
Thanks to their large reserves of capital and connections, they could bid directly for fully leased prime office or multifamily buildings in major cities.
And they were offered other high-return options as well that were traditionally available only to private asset managers.
However, in 2012, federal laws opened private equity real estate to a wider group of investors with the Jumpstart Our Business Startups Act—accredited investors with a net worth beyond their home of $1 million or more.
Qualified Opportunity Zones, a creation of the 2017 Tax Cuts and Jobs Act, can also exponentially increase profits for individual investors because they offer a range of major tax breaks for real estate funds that make long-term bets on up-and-coming areas.
Private real estate now has many options for investors looking for stable, and often more profitable, alternatives to the stock market.
Creating Wealth, Reducing Risk.
There’s a reason that institutions invest in private real estate: investments outside stocks and bonds often offer higher yields in return for the years that they lock up capital.
Committing to an illiquid alternative investment rewards long-range goals, such as money saved for a personal retirement plan.
Yale University, renowned for the performance of its endowment, led the long-lasting trend to diversify institutional portfolios from stocks and bonds, and in particular to use property as a hedge against the volatile public markets.
They were so successful using this strategy that Yale’s investment performance over the past 20 years returned 11.4% while other college and university endowments have generated an annual average investment return of 6.5%.
Today, the Yale endowment typically allocates 9-11% of its investment portfolio to real estate.
Diversification is just as important for smaller portfolios.
Real estate has a relative stability and independence from other business sectors, which is an advantage for publicly traded REITs.
However, publicly traded REITs suffer the same price volatility as other public equities: larger economic forces such as interest rates do have an impact on prices, especially for REITs that invest in mortgage-backed securities.
Even though the prices of the underlying assets move slowly, market trends will affect share prices immediately.
How Private Equity Compares to Other Real Estate Options.
Typically, private equity deals are partnerships or corporations that hold assets for five to 10 years but may recapitalize or extend their holdings for longer periods as market conditions change.
With a substantial holding period, private equity real estate is similar to private REITs–real estate investment trusts that do not trade on public exchanges.
However, the structure of a private equity real estate deal can be more advantageous because private REITs can carry high fees, including commissions built into the front end of the investment.
Instead, private equity managers are often paid only after investors reach a projected rate of return.
Private equity holds tax advantages as well.
Investors can take depreciation on their property, which lower tax liability on their revenue, and the sale proceeds are taxed at lower capital-gains rates.
Real estate funds are also investment vehicles for Qualified Opportunity Zones, which give extremely beneficial tax incentives for a limited time to improve specific geographic areas.
It allows investors who invest using capital gains to get an immediate tax deferral and for the asset itself to appreciate tax free.
The funding of private equity real estate is another distinctive element.
Instead of asking for cash up front, an organizer secures capital commitments–pledges to invest–before moving forward on a deal in the pipeline.
Funding comes from a combination of short-term loans, long-term debt and capital calls to investors to collect commitments.
Many high net worth investors have contemplated buying real estate themselves directly, either alone or with friends, associates, or family.
This is an understandable option, but one that can push an investor’s limits on time and capital.
This option makes it harder to diversify a real estate portfolio: houses, medical offices or small apartment buildings may be within reach, but their earning potential can fall short of prime commercial real estate.
Holding only a few properties leaves the entire portfolio vulnerable to any single setback.
Also, without deep research into the property and its competition, it’s difficult to know if the price is right.
Vacancies, problem tenants or management mistakes exact a high cost for DIY landlords.
Hiring a real estate company can limit the risk in finding or managing property, if they hire and retain the right experts.
My partner David Scherer and I started Origin Investments to buy real estate with our own funds, and grew rapidly as we created private real estate funds that made sense not only for us but also for those without previous access to investment-grade properties.
We are firm believers that private equity real estate is the best way for high net worth investors to meet their personal goals– funding children’s education, starting new business ventures, generating retirement income, giving to charity or leaving a family trust.
Property appreciation is a true wealth builder.
If you are in search of financial help, please consider enlisting the service of any of the sponsors of this blog who I feel are part of the “good guys and gals of finance.”
Even a steadfast DIY’er can sometimes gain benefit from the occasional professional input.
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