Most real estate private equity funds are fairly similar. Regardless of a fund’s size, it’s a pooled investment vehicle serving a group of investors—all of whom are participating based on clear risk/return expectations—for the defined lifetime of the fund. (Often, 10 years.)
Beyond those basics, however, no two funds are exactly alike.
Real estate private equity (REPE) takes many forms, from mega-firms working with large commercial property groups to local funds buying into shopping centers. There’s no one-size-fits-all asset target for REPE funds, either, since risk exposure can vary drastically from one fund to another.
To work effectively with private equity funds, real estate developers and business owners should understand how the funds operate, and what opportunities are a good fit.
How It Works
A REPE fund comes together when a private equity firm or other institution starts soliciting capital commitments from investors. (Asks of at least $250,000 per investor, plus follow-on investments over time, are a common baseline.)
Firms look for alignment among fund investors across many areas. Working with relatively homogenous groups of investors (in terms of tax countries, currency exposures, and risk profiles) makes it easier for sponsors—who are compensated in fees and promoted interest—to keep them happy with chosen deals. The investor makeup may influence the fund’s risk exposure, or vice versa.
Investors may be high-net worth individuals, or group investment vehicles like pensions or insurance companies—the latter being most common among massive PE firms like Blackstone or KKR (which may have hundreds of investors in a given fund). Beyond the big firms, a common REPE approach among regional institutions is the “club deal” model of roughly 10 to 15 limited partners (LPs) per fund.
After a target amount of commitments is met, the sponsor and fund managers start seeking out property deals that align with their defined time horizon and risk profile.
Due diligence and selection processes for investment deals involve extensive research and analysis on the part of the PE firm, for things like financial modeling, building walkthroughs, and vetting of third-party teams involved with the project—such as construction firms, architects, or leasing agents.
Most REPE funds take the form of closed-end limited partnership vehicles designed to appreciate over a set period (i.e., 10 or more years). This focus on a long-term horizon creates a number of benefits for the property teams REPE funds work with.
It allows sponsors to be more entrepreneurial about the projects they select, with an emphasis on continually improving the portfolio to maximize long-term gains rather than focus entirely on short-term distributions). If a developer pursues value-add renovations to a fund’s existing portfolio asset, for example, the fund may participate in that financing round as a follow-on — giving the developer an equity alternative to financing through a bridge (or “mezzanine”) bank loan.
But before any financing can happen, one has to first have an asset that aligns with the fund’s goals. Those goals typically fall under one of three fund types.
1. Core/core-plus funds invest in mid- to high-quality properties in primary or secondary market locations. These types of funds have the lowest risks/rewards profiles, and typically offer between 6% and 12% net equity IRR to LPs.
- Common target assets: Apartment, retail, or office properties with mostly stable lease or occupancy rates, in low-volatility geographies
2. Value-add funds make investments related to releasing or redeveloping properties (or sometimes re-orienting their management or leasing strategies). They tend to offer between 11 to 15% net equity IRR to LPs, with portfolio decisions focused less on location/market strength than on the potential for value-add changes and appreciation to drive returns.
- Common target assets: Well-located properties being substantially renovated or upgraded, and/or facing challenges due to management or operational inefficiencies
3. Opportunistic funds focus on substantively repositioning and redeveloping poor-performing properties, making theirs the highest risk-return category* among the common REPE fund types. These funds typically seek to offer more than 15% net equity IRR to LPs.
- Common target assets: Low-occupancy or vacant properties being redeveloped
Keys to Success
A few best practices can help developers and business owners find fit for their projects in REPE.
Know what you need: REPE sponsors most often invest in the equity tranche of the capital stack that best aligns with their fund’s risk exposure (though some do get involved in the debt side). Before and while engaging with REPE funds, property teams should know exactly what kind of financing they need, and have a clear “why” for both the use of funds, and the overall real estate project.
Market your deals: Many PE firms rely on digital searches to find new portfolio assets, so they won’t find yours if there’s no online presence for your offering. Making sure investment opportunities are “findable” for REPE dealmakers requires, at minimum, posting info on a website or circulating it on social media platforms or real-estate email lists. To accelerate due diligence, interested parties should receive accessible informational resources about an investment opportunity as soon as they reach out for info.
Grow your network: Social media and email lists are no substitute for a viable network of known, trusted real estate contacts. Knowing which REPE funds are seeking out property investments like yours requires being known by people involved with those funds, and getting there can take decades of experience.
Real estate is ultimately a very local, very relationship-driven industry. REPE fund sponsors—like most financiers—want to work with proven developers who they know have track records of successful projects. As developers build those credentials, and build out their contacts, gaining access to the right funds becomes easier.
*Beyond these categories, some PE funds also make or purchase distressed debt/mezzanine loans with the intent (in many instances) of taking ownership in the event of default.