Real estate has long been a great place for investors to find income and non-correlated returns for their portfolios. Historically, investing in real estate either meant buying a building or two outright or investing in publicly traded real estate investment trusts (REITS). Both offer plenty of pros and cons. There is a third choice, designed to bridge the gap between the two: private real estate funds.
These non-publicly traded REITs are designed to be long-haul vehicles, offering the benefits of owning a commercial building outright with the liquidity of publicly traded REITs.
That’s the theory anyway. But the recent real estate downturn is throwing some cold water on the private real estate market. All in all, it is a case of history repeating itself, and investors may want to consider other options when investing in the space.
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The Rise of Private Real Estate Funds
For the average person, buying a warehouse, apartment complex or office building is simply not in the cards. The initial capital constraints are just too great. This is the reason why the U.S. Congress created the REIT tax structure in the first place. However, there is a big difference between owning shares in a company that happens to own real estate and owning a property directly.
With investors seeking alternative assets and income solutions in the low interest rate environment over the last decade, owning physical real estate began getting the eye of investors. And thanks to changes in crowd-funding regulations and the ability for non-accredited investors to access new asset classes, private and non-traded REITs once again became popular. Start-ups like Fundrise, Cadre and Crowdstreet were launched, while major private equity firms like BlackStone, KKR and Brookfield all created their own investment vehicles for investors.
Ultimately, private REITs pool investors’ capital and purchase various properties based on the fund’s mandate. Dividends are paid and capital gains, if any, are shared. But unlike buying shares in a public REIT like Simon (SPG) or Public Storage (PSA) on an exchange, investors must purchase shares directly from the sponsoring firm. Moreover, sales of shares can only happen at certain times throughout the year. The idea is to own real estate for the long haul and ignore the ebb & flow of short-term price changes.
Click here to know more about the differences between a public and a private REIT.
Works Good Until It Doesn’t
It turns out that most investors actually like liquidity. This has been particularly true during the current downturn in real estate prices, higher mortgages and the general malaise. And with the Fed raising rates still, getting quality income from safe assets like Treasuries and even cash is now a possibility. Investors have been fleeing for the exits – or at least trying to.
The $71 billion Blackstone Real Estate Income Trust (BRET) saw investor withdrawals of nearly $9.9 billion last year. Both Starwood and KKR’s private REIT vehicles also saw a wave of multi-billion withdrawals. But even the smaller players – like Nuveen – have seen major outflows of investor capital. So much so that many of the major private and non-traded REIT funds have hit redemption limits and have started to apply gatekeeping rules for their funds. Meaning, investors need to get in line in order to get out of their investments.
The issue is that most private REITs don’t necessarily carry a ton of cash. The idea is that they are fully invested in real estate to get the most out of the asset class. So, when everyone runs for the hills, they are forced to sell properties potentially at fire sale prices, thereby, locking in losses.
If this sounds familiar, it should. We’ve been down this road before. This is exactly what happened to many private REITs during the first go-around during the Great Recession. Real estate plunged due to the crash in housing and the credit crisis. Investors looked to escape the sector.
Top private REITs like KBS Real Estate Investment Trust, Cornerstone Core Properties REIT and Retail Properties of America were closed, liquidated or sold at prices below initial offerings. Several of those REITs were purchased by Apple Hospitality (APLE) and American Realty Capital rolled up all its REITs into one, before being sold to Realty Income (O) for a song.
Part of the problem remains that private REITs aren’t required to use mark-to-market accounting for their NAVs. BRET is worth $X per share because that’s what BlackStone says it is. In the end, investors are locked into something that they can’t really evaluate nor can they exit quickly, which causes major issues during periods like this. History has basically provided us with the guide and framework. While many of today’s private REITs are massive compared to their late 2000’s counterparts, their growth has been due to the low-rate environment. But with factors for real estate dwindling and rates rising, they could get small very fast.
Look Elsewhere for Real Estate Exposure
Given the lack of liquidity and rising risks of private REITs, investors looking for real estate exposure may want to look elsewhere. Truth be told, most of us don’t really need to even consider private or non-traded REITs in the first place.
A quality ETF like Real Estate Select Sector SPDR Fund (XLRE) could be all you really need. Liquidity is instant, while the fund provides plenty of property exposure and a decent yield. A yield that is awfully close to that of the major private REITs.
In the end, investors may just want to give private REITs a big pass and focus on the public-side of the equation.
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