About Private Equity Real Estate

The cornerstones of the private equity business model.

Why Invest Indirectly In Real Estate?

Institutional investors often seek exposure to real estate because it is expected to offer attractive long-term returns, for example: higher than bonds as well as a strong hedge against inflation. This asset class is regarded as an attractive component in a well-diversified investment portfolio, since it generally has a low covariance with the stock market.

Investors can choose from either direct property ownership, which normally require substantial internal management resources, or from indirect real estate exposure through shares in listed property companies or real estate funds. Since listed property companies have a high degree of covariance with the stock market in general, real estate funds have become a common investment option over the past ten years.

There are mainly two types of non-listed real estate funds: open-ended funds where shares can be issued and redeemed at any time; and closed-end funds (private equity real estate funds) where shares are not redeemable for cash or securities until the fund is liquidated. Typically, investors acquire an interest in a private equity real estate fund when the fund is launched and hold the interest until the fund is liquidated.

Private Equity Real Estate Funds

Private equity real estate funds typically have life spans of between seven and ten years. Within this period, there is a three to four-year investment period during which properties are acquired as well as a holding period during which asset management will be carried out and the properties will be sold. Investments typically involve an active management strategy that can include everything from the moderate repositioning or release of a property to further development or extensive redevelopment.

When making investments, such funds generally follow core, core-plus, value-added, or opportunistic strategies. By core strategy, we mean the distribution of assets into investment-grade properties, while opportunistic strategies involve the investment in properties that require substantial improvements.

The risk-return profile for an investment in a private equity real estate fund is also heavily influenced by the portion of external debt used by the particular fund. On one hand, there are all-equity funds that acquire core properties. On the other, there are leveraged funds that acquire high-yielding properties with up to 90% debt. For instance, investments in core property with little gearing offer low but secure returns while investments in opportunistic properties with a high portion of debt offer higher but riskier anticipated returns.

Well Established Asset Class

The private equity real estate market has grown dramatically in volume over the last decade and many institutional investors have interests in several funds. As a result, it is now possible to benchmark actual performance as well as fund terms. Today, there is also an independent European Association for Investors in Non-listed Real Estate Vehicles (INREV), whose aim is to improve the accessibility of non-listed real estate funds by promoting greater transparency, accessibility, professionalism and standards of best practice. With more than 340 members, including some of Europe’s leading institutional investors, INREV members manage some €140 billion in combined real estate assets (www.inrev.org).

Investor Considerations

One cornerstone of the private equity business model is that management has a discretionary mandate over the lifetime of the fund to execute transactions quickly, creatively and discreetly – without having to seek investor approval. Because of this broad management mandate, investors need to be extremely cautious when evaluating which funds to invest in. Critical investment factors include: composition of the management team and its track-record, investment strategy, target returns in relation to risk, incentive structure for the management team, principles of corporate governance and the quality of financial reporting. Many of these factors are rigorously regulated in the fund agreements. At the core of it all, there must be a deep trust that the management team is aligned with investor interests concerning the risk-reward outcome in terms of fund strategy and time-horizon. A key criterion for alignment of interest is that the management team has invested a significant amount of its own capital alongside the investors’ in the fund and that no performance-related compensation is awarded to the management team unless the investors have obtained an attractive long-term return.

We have an investment style that’s enabled us to significantly outperform competing investments.

Hansi Danroth, Senior Partner