It isn’t exactly an investing strategy secret that diversification is key to mitigating downside risks and improving long-term returns. And, as we’ve mentioned once or twice before, we think real estate is one of the best ways to diversify your portfolio.
Today, instead of talking about particular investment vehicles, or categories of real estate asset classes — like, say, office vs. multifamily — let’s tackle a more fundamental issue: why your portfolio should include private real estate.
The term “private real estate” can mean different things. For the purposes of this article, please understand “private real estate” to mean any investment real estate that isn’t held via a publicly-traded security.
So what counts as private real estate?
It’s easiest to answer that question by starting with what is not private real estate. Arguably the lowest-effort way most investors can get exposure to real estate is via publicly-traded real estate investment trusts (REITs).
REITs are companies that own or finance real estate assets and make ownership shares available to investors. Buying shares in a public REIT works the same as buying shares in any other publicly-traded company, and shareholders can earn returns in the form of dividends.
But, there’s a problem with public REITs...they’re public.
Real estate has almost everlasting and tangible value. Stock prices can be influenced by many external factors out of investors’ control. Real estate benefits from resilient demand rooted in the fact that humans will always need a place to live.
Investors who want to take advantage of the benefits that real estate investing offers, but prefer to avoid the risk that comes with public exchanges, invest in private real estate. The most common types of private real estate include:
- Direct ownership
- Private equity real estate funds
- Real estate crowdfunding
- Syndications
- Private or non-traded REITs
A person can invest in private real estate in multiple ways and all options with pros and cons.
The critical question: what are the differences between private and public real estate and why should your investment portfolio include private real estate?
What are the benefits of private real estate?
Private real estate is more stable. Celebrities cannot quickly tweet away returns and uncontrollable market forces cannot impact your investment. Investor confidence, the prices of non-real estate securities, and the rhythms of trading and business cycles all impact the market and returns.
More control. Private real estate lets investors make their own decisions based on their knowledge and financial goals. If an investor purchases an apartment building, they are in charge. Investors in a partnership can have peace of mind and the power to make their own decisions that protect and expand their wealth.
Opportunity for higher returns. Private investors who create a partnership or syndication can increase their returns through exposure to a variety of asset classes and spreading out risk by increasing the number of assets owned.
Deeper strategy. Private real estate investing opportunities exist for almost every combination of asset class, geography, and risk profile. This allows investors to focus on opportunities that fit their investment strategy and financial goals.
Tax benefits. Private real estate investors get a few extra perks. Investors in private real estate investment funds usually pay the capital-gains rate on their returns. Public real estate investment funds are usually taxed as income. Private inventors can also utilize other things like Section 1031 exchanges, which has capital gains tax benefits. Private investors can also use loans to finance deals that have some tax benefits and deductions.
More fun. Private investment gives investors a great learning opportunity and front-row seat to their hard work paying off.
What are the disadvantages of private real estate?
Less liquidity. Buying, selling and trading assets on an exchange can be done by calling a broker or opening a mobile trading app. Private real estate investors are typically committed to a partnership or fund for a longer period of time.
Direct ownership or creating a partnership can be hard work. Buying a house, fixing it up, and renting it out can be profitable and satisfying but it isn’t an ideal investment strategy for those who don’t have time. However, other private real estate investing options (such as private equity and REITs) are passive income opportunities.
Private real estate investment opportunities typically own a smaller variety of properties. Public investments can own upwards of $100 billion of real estate assets. Some investors prefer a private investment opportunity that closely aligns with their investment goals. But, an all-office partnership that invests exclusively in Class-C property in Sacramento is riskier than a massive, and diversified public REIT.
Private real estate can be complex. Private funds have different structures with various terms and nuances. As with any investment, investors should do their due diligence and read the fine print before writing any checks.
Concluding thoughts
As personal finance gurus, we must say that most portfolios should include more than just real estate investments. For many investors, public real estate investing opportunities are great options. For real estate investors who are comfortable with longer fund lifespans and a greater tolerance for illiquidity, private real estate can offer unparalleled returns and protect investors’ capital from the unpredictable movements of public markets.