10 Reasons Why You Should (And Should Not) Invest In Private Real Estate Funds

Investing in private Real Estate Funds is a great way to introduce diversification to an investor’s portfolio, but there are pros and cons to these investments which are not always stated on the front of every offering memorandum. Here are some of the benefits and risks of why real estate funds may or may not be appropriate for you.

Why You Should Invest In Private Real Estate Funds

1. Diversification

Just as a prudent investor diversifies across multiple equities, real estate investors benefit from spreading their capital across different geographies, operators, hold periods, and investment strategies. A fund allows investors to gain exposure to a portfolio of properties through a single investment by providing the upside of diversification while spreading the risk across multiple properties, markets, and operators. This helps investors mitigate localized downturns and benefit from broader rental demand trends.

     2. Pass-through tax benefits

Unlike publicly traded REITs or other 1099 real estate funds, private real estate funds are pooled investment vehicles which pass through all the tax benefits of owning property to their members. This allows for depreciation and long-term tax benefits to flow through directly to the members on a K-1. These tax advantages can offset income and enhance after-tax returns.

     3. Professional management

A fund manager’s true purpose is to effectively allocate capital in line with the fund’s investment objective for the benefit of the members. The manager will source deals and place capital after rigorous due diligence of the property, operator, submarket, and various macro trends. Fund managers may negotiate terms that are difficult for individual investors to access due to the Fund’s larger investment in each property.

     4. Niche investment strategies

Large private and public REITs are the elephants of the investment world-- They invest in large deals and move slowly. Smaller funds are able to move quickly and strategically place capital in small and mid-size deals, allowing investors to participate in the inefficiencies of the market which are too small for massive investment funds.

     5. Incentive structure aligns the manager’s objectives with the investor's

Private Funds usually compensate the manager in two ways. An asset management fee, which is a fixed percentage based on fund commitments, and a performance fee. The asset management fee often is just enough to cover the fund’s overhead of staff, services, and office space. No fund manager goes to work every day to work for the asset management fee.

An investor-friendly fund structures its distributions so the investor receives their initial investment, then the investor receives a preferred rate of return; only then does the manager participate in the profits of the investments.

In other words, the manager is paid last, and he or she only starts making money long after the investor has received their principal back and a preferred rate of return.

Why Private Real Estate Funds May Not Be Right for Everyone

1. You need liquidity

These investments are some of the most illiquid vehicles in the investing world. Although this illiquidity in this asset class is what also generates alpha, it does not allow for investors to “hit the sell” button and exit the entire position prior to the end of the harvest period.

     2. Only having the available capital for a single fund investment

Although minimums on funds can be as low as $25,000, investors are better off spreading their investments into multiple real estate funds and alternatives in general, across various strategies and managers. This diversification helps smooth expected returns while capturing upside of real estate or alternatives.

     3. Looking for consistent distributions

While multifamily properties can generate steady rental income, distributions may fluctuate due to vacancies, renovations, or market shifts. Investors should expect variability of distributions and returns and not view these investments as a replacement for fixed income products.

Private placements are not FDIC insured. There is no guarantee the manager will deliver on their claims of consistent distributions for the hold period. Investors should not conflate a stated preferred rate of return with a government-backed savings account.

     4. Multifamily investments should complement, not replace, core holdings

Alternative investments, like real estate and venture capital, can offer attractive returns and provide a hedge against inflation. Careful allocation and a balanced portfolio should be the first priority for investors as single alternative investments can be more risky than a well-constructed portfolio of publicly traded securities.

     5. Chasing returns

Alternatives, much like in the stock market, yesterday’s “boom” is today’s “bust”. Every pitch deck contains the phrase “Past performance does not guarantee future results”. Much like this concept is true in the stock market, it is true in the alternative space. Investing in a capable manager is often more important than the investment thesis or market.

Important Information 

This article is provided solely for educational and informational purposes. The views expressed reflect general observations regarding investment analysis, private markets, real estate investing, valuation methodologies, underwriting practices, due diligence considerations, and fund structures.

The information presented is not intended as investment advice or a recommendation regarding any specific investment, manager, property, fund, security, or strategy. Readers should conduct their own independent due diligence and consult their professional advisors before making investment decisions.

Investments in private funds and alternative investments involve substantial risks and are not suitable for all investors. Such investments are generally illiquid, may involve leverage, may have limited transparency, may be difficult to value, and may result in the partial or complete loss of invested capital.

Certain statements contained herein may constitute forward-looking statements. These statements reflect current assumptions and expectations regarding future events and market conditions.

Actual results may differ materially from those expressed or implied due to changes in economic conditions, capital markets, interest rates, tenant demand, property performance, financing availability, governmental actions, and other factors beyond the control of Valoran Capital Management.