Navigating the world of investments can sometimes feel overwhelming, especially when you're exploring options outside the traditional stock market. If you're an investor seeking more diversification or aiming to increase your portfolio's potential returns, private real estate might have crossed your radar. It's an intriguing opportunity with unique risks, benefits, and considerations, but where do you start?

This post breaks down the essential elements of private real estate investing, provides an overview of the options available, and helps you understand what every investor needs to know before dipping their toes into this dynamic market. 

What Exactly Is Private Real Estate? 

Private real estate broadly refers to investment opportunities that involve owning or financing properties outside the public markets. Unlike publicly traded Real Estate Investment Trusts (REITs) you may find on the stock exchange, private real estate requires participation in direct property ownership, private funds, or private REITs. 

It allows investors to diversify their portfolios, gain exposure to the real estate market, and potentially reap long-term rewards without the day-to-day volatility of stock investments. However, these opportunities also come with unique risks and complexities. 

Nerd Note: Real estate investments historically experience lower correlation with stock markets. This can make them an effective hedge against market downturns—but it’s important to weigh risks independently before jumping in.

The Two Paths of Private Real Estate 

When it comes to private real estate investing, there are two main paths you can take: 

1. Direct Real Estate Investment 

This category includes owning property outright or entering into direct deals (also known as sponsored deals). 

Individual Ownership 

One popular but high-effort method is buying a property yourself. It might sound glamorous to own a rental property or flip homes for profit (thanks, TV shows), but it’s not without its challenges.

• Time Intensive: Managing properties is essentially a second job. From maintenance and tenant concerns to finding buyers, responsibilities can pile up. To the extent you outsource some headache to a property manager, you will pay 10-20% while still retaining all of the risk.
• Expertise Required: Without market knowledge, investors may face costly mistakes.
• Concentration Risk: Owning one or two properties ties up a big chunk of your portfolio in specific locations, which could be risky if local markets decline.

Sponsored Deals 

A slightly more hands-off approach involves pooling your resources with other investors to purchase properties. Known as sponsored deals, this model offers a few unique perks:

• Professionally Managed Properties: Experienced sponsors oversee the properties.
• Potential for Diversification: These deals may involve multiple properties or asset classes, reducing some risks.

Still, concentration risk remains a consideration for smaller investors who can't participate in multiple sponsorships.

2. Private Real Estate Funds and REITs 

For those looking for less direct involvement, private REITs and real estate funds might be ideal. 

Private REITs

A REIT, or Real Estate Investment Trust, is a company that owns and operates real estate assets while sharing profits with its investors. A private REIT works similarly to a public one, but it isn’t traded on the stock exchange. This structure offers a unique set of features and limitations.

• Pros:
  • Diversification across many assets.
  • Moderate liquidity compared to traditional private investments, though still more limited than public REITs.
• Cons:
  • Transparency is lower due to fewer reporting requirements.
  • Access can sometimes be restricted to high-net-worth or accredited investors.

Traditional Private Real Estate Funds 

This model involves a pool of investments that targets multiple properties or projects. Often managed by professional teams, these funds provide a hands-off approach for investors. However, they typically require long-term commitments with limited liquidity until the fund matures, meaning you could lock up your money for years. 

Nerd Note: Private REITs are obligated to distribute at least 90% of taxable income to shareholders, which makes them attractive for generating passive income. However, remember that they might carry higher fees than public options!

Key Considerations Before Investing 

1. Manager Experience

A primary consideration of any private investment should be the experience of fund managers within the specific space you are investing. A proven track record will help ensure that the expenses you pay are justified, and skill supports future performance, not the economic environment. 

2. Illiquidity 

Private real estate investments are often illiquid, which means you can’t cash out quickly. Make sure that locking in funds long-term aligns with your financial goals, and understand what your options are if you want to divest sooner than anticipated. For example, many funds have a certain percentage of the fund that can be redeemed in any given quarter, which may protect the value of the fund from needing to fire-sale off properties, but have you sitting on your hands.  

3. Transparency Challenges 

Unlike public investments, private real estate opportunities often come with less stringent reporting standards. This can make it more difficult to know exactly how your money is being managed. 

4. Investment Required

Certain investments are structured based on a commitment amount that will be “called” over time when investments arise, rather than invested all up front. Here it is important to understand when the funds are targeted to be deployed. 

5. Fees and Costs 

Between sponsor fees, property management fees, and other administrative costs, you’ll want to carefully evaluate how much of your potential return is being eaten up. Some managers charge their fee on the full commitment amount, not what is invested, making this expense much higher when little is working in the markets for you. 

6. Risk Factors 

From market downturns and tenant defaults to interest rate fluctuations, real estate investments carry risks. Leverage, borrowing money to buy properties, might amplify returns, but also heighten exposure to financial stress during interest rate hikes. 

Nerd Note: The 2022 real estate markets saw unprecedented fluctuations due to interest rate changes, deflating values and increasing the cost to borrow for future investment, highlighting the need for careful attention to economic trends when investing in the space.

Is Private Real Estate Right for You? 

Whether private real estate belongs in your portfolio depends on your financial goals, time horizon, as well as your ability and stomach to take on risk. These types of investments can be rewarding, but they aren't suitable for everyone. 

Questions to ask yourself include:

• Do I have a long-term investment horizon?
• Can I handle the added risks and potential illiquidity of private real estate?
• Am I working with a trusted financial advisor to evaluate opportunities?

For many investors, diversifying through private REITs or real estate funds offers a less hands-on path to growth while still accessing the benefits of one of the world's oldest asset classes. For others, the excitement of direct ownership might be worth the added challenges. 

Take the First Step Toward Better Investing 

Exploring private real estate opportunities can open up a world of potential for your investment portfolio. But the key to success lies in careful research, diversification, and partnering with experienced advisors to guide your decisions. 

Want to learn how private real estate investments can support your financial goals? Speak to a professional who can help you weigh your options and ensure they align with your broader strategy. It’s time to turn possibilities into smart choices.