WHAT IS PRIVATE REAL ESTATE?
Commercial Real Estate
Commercial real estate refers to the many different kinds of properties that are used for business or investment purposes with the goal of generating capital appreciation, income, or both. Private commercial real estate investments are typically negotiated directly and do not trade in public markets.
Commercial Real Estate Sectors
Different types of commerical real estate include:
Commercial Real Estate Classifications
Class A
Highest quality real estate properties in prime locations; often new construction or recently renovated
Class B
Middle-quality, generally older, functional and usable space that may require some upgrades or renovations
Class C
Lowest quality, old or outdated property that may not be operated or maintained well
Private Real Estate Equity and Credit
There are two main categories of real estate investments
- Real Estate Equity
- Real Estate Credit
Equity represents ownership interest in a property
- The value of an equity interest represents the value of the property minus outstanding debt, such as a mortgage.
- Return on an equity investment is derived through rental income, property value appreciation, or the sale of the property.
A loan, often a mortgage loan, where an institution lends money to the owner of a real estate property and earns interest on the loan
- Helps to fund commercial property purchases, finance new development, and allow existing property owners to refinance assets
- Lenders may include banks, insurance companies, government-sponsored enterprises, asset management firms, or specialty real estate lenders.
Commercial Real Estate Capital Stack
The real estate capital stack helps illustrate how both real estate equity and credit factor into the total value of a property.
Real Estate Equity and Credit in Different Market Environments
Fluctuating property values affect equity and debtholders differently. Debtholders typically have more certainty and downside protection than equity owners.
In the example on the right, we show that the initial equity is $40, the debt is $60 and the gross property value is $100. In the middle bar example, we see the gross property value increase by 20%, causing the equity value to go from $40 to $60, but the debt principal is unchanged at $60. On the right bar example, we see the gross property value decrease in value by 20%, causing the equity value to go from the initial $40 to $20, but once again the debt principal is unchanged at $60.
ATTRIBUTES OF REAL ESTATE INVESTMENTS
Private Real Estate Investments Typically Seek to Deliver...
- Exposure to a Large and Differentiated Market
- A Potential Inflation Hedge
- Portfolio Diversification
Commercial real estate is the 3rd largest asset class in the U.S.
Private real estate income has generally outpaced inflation since the mid-1990s.
U.S. Real Estate Net Operating Income (NOI) vs. CPI Inflation
Private real estate may provide the potential for meaningful portfolio diversification.
A thematic private real estate strategy that includes real estate credit and equity has shown low correlation to stocks and bonds
CONSIDERATIONS FOR REAL ESTATE INVESTING
Evaluating Commercial Real Estate Investments
There are several factors to consider when investing in commercial real estate equity and credit.
1
INVESTMENT PURPOSE AND TIME HORIZON
2
EXPECTED CASH FLOWS AND PROFIT OPPORTUNITIES
3
NEW CONSTRUCTION VS. EXISTING PROPERTY
4
PROPERTY VALUATION
5
LEVERAGE
6
OVERALL REAL ESTATE MARKET
7
PROPERTY LOCATION
8
TENANT QUALITY
Commercial Real Estate Risk Investment Categories
All of the factors above play a part in determining the risk and return profile of a commercial real estate investment. The common risk classifications below provide a framework for understanding risk and return expectations across different types of real estate investments.
- Core
- Core-Plus
- Value Add
- Opportunistic
- Credit
Core
- High-quality, fully-leased properties in diversified metropolitan areas
- Low risk/return, low leverage
Example
New, full-leased, multifamily luxury apartment building in a great location
Core-Plus
- Well-occupied properties with potential to increase cash flows through light property improvements
- Moderate risk/return, moderate leverage
Example
Well-occupied, multifamily apartment in a good location but in need of light upgrades
Value Add
- Properties that could be improved at a modest expense with the intention of improving the asset and increasing cash flows to sell at a higher value
- Higher risk/return, higher leverage
Example
Renovation and modernization of a multifamily apartment building
Opportunistic
- New construction, redevelopment or major repositioning
- Highest risk/return potential, highest amount of leverage
Example
Construction and lease-up of a brand-new multifamily apartment building
Credit
- Origination or acquisition of a loan(s), or part of a loan(s) that are secured by real estate (providing capital in the form of debt)
Example
A senior mortgage loan on a multifamily apartment building
Types of Commercial Real Estate Investment Vehicles
There are four primary ways to invest in commercial real estate today
Characteristics of Real Estate Investment Trusts (REITs)
REITs typically offer the following characteristics, although the benefits and risks of each REIT investment are unique and should be evaluated independently.
Benefits of REITs
| Diversification Potential | Professional Management | Regular Income Potential | Growth Potential | Potential Tax Advantages |
Diversification across property types, geographic locations, and tenants Potentially different risk/return characteristics than stocks and bonds | Professional management by experienced, well-resourced experts
| Legal requirement to distribute 90% of income through dividends can provide investors with a steady income stream | Portfolio appreciation can benefit investment value and drive dividend growth while rent growth may support dividend growth | Favorable tax treatment of REIT dividends Return of Capital (ROC) may enhance tax-efficiency of REIT dividend income |
Publicly Traded REITs vs. Private REITs
Publicly Traded REITs | Private REITs | |
| Access | Investors buy and sell shares on public exchanges | Investors invest directly with the manager or through an intermediary; not traded on an exchange |
| Investments | Portfolios of real estate properties or loans that may be diversified by property type and/or geography | Portfolios of real estate properties or loans that may be diversified by property type and/or geography |
| Liquidity | Exchange-traded: Investors buy and sell shares, enabling them to access their money more quickly if needed | Illiquid or semi-liquid: A level of periodic liquidity is typically provided subject to certain thresholds and requirements |
| Pricing depends on public market sentiment | Investors buy and sell at a share price that may be different than the underlying value of the REIT’s portfolio | Investors subscribe and redeem at net asset value |
Explore Other Private Market Asset Classes
Dig deeper into three other private market asset classes to learn what they are, why they matter, and how they may fit within existing portfolios.