Private equity real estate: Why (not) to invest, types of investments, top funds

Even though private equity real estate investment usually comes with high risks, it also brings high returns — often over 20%. That’s why, despite economic uncertainty and geopolitical tensions, it continues to be active in 2024. 

What is real estate private equity? How does real estate private equity work? What are the advantages and disadvantages of investing in real estate? What are the best real estate private equity funds? Find out in the article.

What is private equity real estate?

Private equity real estate refers to investing in real estate properties through private equity firms or funds, which are considered alternative investment vehicles, like mutual funds or hedge funds.

Private equity firms and outside investors find each other through real estate investment banking services. Within a real estate private equity fund, there are two main parties:

• Limited partners (LPs)

These are accredited individuals or institutional investors who contribute equity capital to the fund. They entrust their capital to the fund manager and typically don’t participate in the day-to-day decision-making or operational aspects.

• General partners (GPs)

These are the fund managers responsible for making strategic investment decisions on behalf of the fund. The GP’s asset management team selects and manages real estate properties that offer the potential for high real estate private equity returns and ensures that the properties perform well throughout the holding period.

The collaboration between LPs and GPs is crucial to the success of a private equity real estate investment. Limited partners provide the capital and rely on the expertise of GPs to manage the investments. General partners, leveraging their real estate industry knowledge and operational expertise, identify promising investment opportunities and execute value-enhancing strategies.

This partnership is governed by the fund’s limited partnership agreement, which outlines the rights and responsibilities of each party, including the distribution of returns and fee structures.

The investment horizon is often medium to long-term, with typical lock-up periods ranging from 5–10 years.

What do private equity real estate investment firms do?

Real estate private equity firms specialize in acquiring, managing, and enhancing real estate properties to generate high returns for their investors. These firms pool capital from investors to purchase various types of real estate, such as:

• Commercial buildings
• Residential complexes
• Industrial properties

The primary goal is to increase the value of these properties through active management, property appreciation, rental income, and strategic value-added initiatives, ultimately selling them at a profit.

Here’s a typical workflow of a real estate equity investment firm:

1. Raising capital
   Private equity firms raise capital from external investors, which include accredited individuals and institutional or private investors.
2. Identifying assets
   Conducting market research, property analysis, and due diligence to find potential real estate assets that align with the investment strategy.
3. Property investment
   The money is then invested in commercial or residential real estate properties. This involves acquiring existing properties, financing development projects, or participating in joint ventures.
4. Property development and improvement
   The private equity firm engages in effective property management, employing strategies aimed at maximizing the property values under their control. This includes property renovations, operational improvements, or repositioning efforts to maximize equity returns.
5. Property sale
   After a period of holding and value creation, the properties are sold. The objective is to sell properties for a profit, generating substantial returns.
6. Distribution of capital
   Once the properties are sold, the private equity firm distributes the profits to the real estate investors. This can be in the form of capital distributions or dividends, providing the investors with their share of the returns.

Employees of real estate private equity funds often come from real estate brokerage firms or investment banks.

Real estate private equity firms typically charge management fees of about 2% of the invested assets plus 20% of the annual profits. When a property is sold, the returns are generally distributed, with 80% going to the limited partners. The share each limited partner receives depends on their initial investment contributions.

The remaining 20% of the returns, known as carried interest, is primarily allocated to the general partner. A portion of the carried interest is also distributed among associates, vice presidents, and partners within the firm. While these percentages are standard in the industry, specific partnership agreements may have different terms.

Types of private equity real estate investments

Generally, there are five types of private real estate investments:

1. Core investments
2. Core-plus investments
3. Value-added investments
4. Opportunistic investments
5. Debt investments

1. Core investments

Core investments usually refer to the high-value commercial real estate property with the following attributes:

• High-quality tenants
  Such buildings have responsible tenants generating stable income over long-term leases.
• Profitable locations
  Core property is situated in densely populated, in-demand urban areas.
• Predictable income
  Such property has a stable, predictable occupancy rate and generates a consistent net income.
• Minimal ongoing capital spending
  These are new assets that require little to no renovation.

Core strategies involve minimal risk. However, they produce the lowest returns, from 6% to 9% at best, and have long holding periods, sometimes dozens of years. These properties include office buildings, shopping centers, student housing blocks, retail properties, and modern multifamily apartments.

2. Core-plus investments

Core-plus means income growth and refers to real estate that increases in value while adding minimal value. These types of properties commonly possess the following features:

• More renovation opportunities
  Core-plus buildings are still in good condition but require minimal renovation.
• Good locations
  Such property may be located further from downtown but still has reliable, high-traffic transportation hubs.
• Good tenants
  Most tenants pay consistent, long-term rents. Yet, some of them may have expiring leases.

Core-plus strategies are known to offer higher real estate private equity returns compared to core investments, typically ranging from 8% to 12% returns. However, they still involve a moderate level of risk due to the potential for needed renovations and lease renewals.

3. Value-added investments

Value-added investments may need several improvements to produce better cash flow. These types of properties are often characterized by the following features:

• Capital-intensive upgrades
  Value-add property requires costly and labor-intensive renovations to attract higher-quality tenants.
• Below-market occupancy
  There is a high tenant turnover, and renters tend to avoid such properties due to poor conditions, bad location, and other issues.
• Management issues
  These buildings may have failed inspections, lease problems, utility debts, etc.

Subsequently, value-add funds tend to develop properties to see profits. The value-add asset class can generate returns of up to 13% as it offers higher value and generates better cash flows post-renovation. However, such property involves higher risk as anticipated profit may not beat renovation expenses due to hidden issues.

4. Opportunistic investments

Opportunistic funds primarily target industrial properties in poor condition, distressed or withered buildings in suburban areas, and other properties that may initially appear low in value. The following characteristics are common for such property types:

• Major repair requirements
  Opportunistic properties typically require significant structural repairs or a complete renovation to bring them up to code, meet acceptable standards, and make them marketable.
• Repositioning requirements
  Opportunistic buildings often require repurposing or repositioning to align with current real estate market demands. This could involve converting an industrial property into a mixed-use development or repurposing an obsolete building for a new use.
• Undeveloped land
  There may be no access road, parking, water, gas, electricity, and other infrastructure nearby.

Opportunistic investments involve real estate development and are the riskiest — investors can lose their entire investment if a fund underperforms. However, they may offer over 20% returns in the long run. 

5. Debt investments

Debt investments in private equity and real estate involve various types of loans and securities:

• Senior loans
  Debt funds may purchase senior loans, which have the highest priority of repayment, i.e., properties in default or facing liquidation.
• Bridge loans
  Bridge loans are short-term loans provided by debt funds to bridge the gap between the purchase of a property and long-term financing.
• Mezzanine loans
  These loans are subordinate to senior loans but rank ahead of equity in the capital structure. Mezzanine loans carry higher interest rates to compensate for increased risk.
• Non-rated CMBS tranches
  Debt funds may invest in non-rated tranches of commercial mortgage-backed securities (CMBS). These tranches represent different levels of risk and return within a CMBS structure.
• Leverage
  Debt funds often use leverage, or borrowed capital, to enhance equity returns. However, leverage also increases risk.

Debt investments offer 8 to 12% net equity internal rate of return (IRR) to a limited partner.

Pros and cons of investing in private equity real estate

Let’s discuss a few pros and cons of private real estate investing.

Pros

These are the most notable benefits:

1. Higher returns
   Private equity averages net returns of 11% based on 21 years of performance analyzed by the CAIA Association. For comparison, that’s 4.1% higher than public market investments.
2. Passive income
   Investing in real estate private equity firms might be a preferable option for high-net-worth individuals, or family offices, seeking passive income. Once the money is invested into a private equity fund and entrusted to a general partner, investors don’t have to worry about doing market research, property maintenance, or dealing with the headaches of real estate asset management.
3. Interest alignment
   Private equity funds require general partners to invest around 20% of the total capital. Most importantly, general partners will not profit from the deal until investors receive their distributions, typically returns of 6–9%. This alignment of interests motivates both partners to maximize returns for all parties involved.
4. Tax advantages
   Private equity real estate (PERE) funds enjoy favorable tax treatment in the form of pass-through taxation and potential tax deductions.

Cons

These are the most significant drawbacks:

1. Management fees
   Private equity real estate operating companies offer investors expertise, professional tools, and real estate brokerage. In exchange, private equity asset managers charge fees commonly ranging from 0.5% to 2% of returns.
2. High entry point
   Many private equity real estate funds require as much as $20 million in initial investment. However, some funds set entry deposits in the $250,000–$500,000 range. Additionally, such funds accept only accredited investors with substantial annual income, investing experience, or successful careers in the financial industry.
3. Long investment period
   Institutional and individual investors should anticipate profits over a long investment period. Growing returns may take three to five years on average or, sometimes, decades. As a result, investors expose themselves to market risks, like falling property prices in rapidly changing economies.

Top 10 real estate private equity funds

Let’s explore the top 10 real estate private equity firms according to the amount of capital raised for private equity investments over the last five years.

1. Blackstone Inc.

Blackstone is a global private real estate investment firm founded in 1991 and headquartered in New York. It serves pension funds with over 31 million pensioners in the US alone, having over $339 billion in capital under management and managing a substantial global real estate portfolio valued at approximately $600 billion.

2. Brookfield Asset Management

With over $267 billion in assets under management, supported by a workforce of 30,000 employees, Brookfield actively manages institutional-grade real estate companies and platforms diversified across various sectors and geographic locations, encompassing more than 500 million square feet of commercial space worldwide.

3. TPG

TPG Real Estate Partners (TREP) was founded in 2009 as TPG’s opportunistic real estate equity investment platform. With an emphasis on thematic investing, TREP manages a diverse portfolio, primarily in the United States and Europe. Currently overseeing approximately $11.7 billion in assets under management, TREP uses its $6 billion-plus investment experience to deliver returns across various real estate-rich platforms.

4. BGO

BGO, with $82 billion in assets under management, operates globally across 13 countries. Specializing in real estate investment and management, Brookfield provides comprehensive investment strategies across North America, Europe, and Asia, catering to over 750 clients and partners. Brookfield’s award-winning asset management teams also focus on enhancing properties to make them preferred destinations for tenants and residents.

5. GLP Capital Partners

GLP Capital Partner oversees a substantial $124 billion in total assets under management, with $113 billion allocated to real assets and $11 billion to private equity. Specializing in logistics real estate, data centers, renewable energy, and related technologies, GLP is recognized for its role as a global business builder and operator.

6. Cerberus Capital Management

Operating in 14 countries, Cerberus serves as a strategic partner, addressing both short-term and long-term capital needs while utilizing proprietary and third-party platforms for expert property management and portfolio optimization. Since 2004, Cerberus has deployed approximately $40 billion in real estate transactions. It has a team of over 90 dedicated real estate professionals.

7. Blue Own Real Estate

With a credit-first approach, Blue Owl aims to deliver predictable current income and attractive risk-adjusted returns to investors while prioritizing downside risk mitigation. Since its inception, Blue Owl has closed over 190 REPE deals. The firm manages assets totaling $27.2 billion, encompassing a diverse portfolio of over 2,000 real estate assets across various asset classes and geographies.

8. Ares Management

Ares Management’s Real Estate division oversees comprehensive public and private equity and debt strategies, managing approximately $48.8 billion in assets. Supported by a vertically integrated platform, a proven track record, and a seasoned team, Ares Real Estate employs a thematic investment approach. This strategy enables them to capitalize on attractive opportunities with compelling risk-reward profiles.

9. Hines

Hines, with over 66 years of experience in real estate investment and $93.2 billion in assets under management, leverages trend analysis, extensive local market knowledge, and deep operational expertise to capitalize on opportunities quickly and optimize real estate assets. The firm manages a diverse portfolio, including 109 million square feet of third-party property-level services, and operates through 65 strategic investment vehicles serving over 300 institutions, 700 high-net-worth individuals, and numerous retail investors.

10. ESR

ESR Group Limited (ESR) is a prominent Asia-focused real estate services and investment company specializing in logistics properties such as warehouses and distribution centers. Headquartered and listed in Hong Kong, ESR is incorporated in the Cayman Islands. Following its acquisition of ARA Asset Management in 2022, ESR is now one of the largest real estate investment management firms globally.

Key takeaways

• Private equity real estate involves investing in real estate properties through private equity firms or funds, offering alternative investment opportunities to accredited individuals and institutional investors.

• There are various types of private equity real estate investments, including core, core-plus, value-added, opportunistic, and debt investments, each with its own risk and return characteristics.

• Pros of investing in private equity real estate include higher returns compared to public market investments, passive income generation, and potential tax benefits.

• Cons of private equity real estate investing include management fees, high entry points, and long investment periods, exposing investors to market risks.

Some of the largest real estate private equity firms include Blackstone Inc., Brookfield Asset Management, TPG, BGO, GLP Capital Partners, Cerberus Capital Management, Blue Own Real Estate, Ares Management, Hines, and ESR.

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