Many affluent investors already have substantial exposure to real estate before deciding how to allocate additional investment capital to the asset class. They may consider their primary residence, a vacation property, apartment building, property owned by their business, and/or commercial investment property. Others invest in syndicated deals or funds. This article will help investors decide the best vehicle, or vehicles, for investing in real estate.
For purposes of this article, investing in real estate has three main approaches: Direct ownership, investing in individual real estate deals run by a sponsor, and investing in a fund run by a manager. There are pros and cons to each approach and one or several approaches may be best for each investor.
Direct ownership provides the greatest control over asset selection, financing, operations and disposition. In exchange, the owner is responsible for sourcing the deal, arranging financing, and overseeing the investment. Direct ownership may require greater concentration of investment capital, increased time dedicated to each project and greater personal financial exposure while avoiding the cost of a sponsor’s fees or promote.
Deal-by-deal LP investing requires the investor to source and select individual deals run by sponsors. This approach can allow for broader diversification across strategies, operators, and geographies while providing flexibility in investment selection, allocation and outsourcing property-level operations. Additionally, the investor must dedicate time to sourcing and evaluating opportunities, relinquish control over major decisions-including the timing of sale or refinancing events, and pay sponsor fees and promote.
Fund investing provides an investment manager with discretion, within the mandate of the governing documents, to build a portfolio of investments. With a single investment, investors can gain exposure to multiple assets, operators, strategies and/or geographies, depending on the fund's mandate and portfolio construction. Like individual deal structures, the tradeoff is the manager retains control over underlying investment decisions while charging fees and promote.
This table expands on many of the features of each of these investment vehicles.
|
Aspect |
Direct Ownership |
Deal-by-deal LP |
Fund |
|
Investor’s time requirement |
Generally High |
Generally Moderate |
Generally Low |
|
Diversification |
Investor/capital dependent |
Investor/capital and deal-flow dependent |
Fund mandate and manager dependent |
|
Ability to decline individual investment |
Yes |
Yes |
Generally not after commitment |
|
Investment sizing flexibility |
Generally Low |
High |
High |
|
Operating Control |
Investor |
Sponsor |
Manager and/or underlying sponsor |
|
Asset Selection |
Investor |
Investor |
Manager |
|
Sourcing Responsibility |
Investor |
Investor |
Manager |
|
Personal Liability |
Ownership and financing structure dependent |
Typically limited to investment |
Typically limited to investment |
|
Manager Fees and Promote |
None |
Sponsor determined |
Manager determined |
|
Disposition Control |
Investor |
Sponsor |
Manager and/or underlying sponsor |
|
Portfolio construction |
Investor |
Investor |
Manager |
|
Capital deployment timing |
Investor |
Investor |
Manager |
|
Asset Leverage |
Investor |
Sponsor |
Manager and/or underlying sponsor |
|
Administrative Burden |
Generally High |
Generally Moderate |
Generally Low |
|
Sponsor/Manager Economic Layers |
None |
Usually 1-Sponsor |
Can be multiple depending on fund structure |
|
Liquidity |
Low |
Low |
Low |
|
Primary Investment Decision |
Property |
Sponsor and Property |
Manager and Mandate |
|
Key Man risk |
Investor |
Sponsor |
Fund Manager |
|
Tax complexity |
Owner’s responsibility |
Potentially one K-1 per investment |
Often consolidated at fund level; structure dependent |
|
Estate Planning Flexibility |
High |
Structure dependent |
Structure dependent |
|
1031 Eligible |
Potentially |
Structurally dependent |
Generally not at LP level |
Many investors hold real estate through multiple vehicles, each with different advantages and tradeoffs. There is no single approach appropriate for every investor or every situation.
In general:
Direct Ownership
Deal-by-deal LP
Investor selects sponsors and deals
Property operations are delegated
Investor constructs the portfolio
Fund
Manager selects investments
Portfolio construction is delegated
Greater diversification potential
Here are some questions to consider when making your next decision:
Do I have the expertise and relationships to source and evaluate opportunities?
How much control do I want over individual investments?
How much time do I want to dedicate to my real estate investments?
How concentrated is my existing real estate exposure?
What level of leverage and risk am I comfortable with?
How much capital can I allocate while maintaining appropriate diversification?
Am I comfortable delegating investment decisions to a sponsor or fund manager?
Do the benefits I receive justify the fees and promote I am paying?
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.