Why wouldn't I invest in a REIT where there is liquidity?
The value of a private real estate fund is based on the actual value of property held by the fund. Conversely, in a public REIT, the share price value is determined by daily market forces, which means the share price of a public REIT may not reflect the actual value of the underlying real estate. In some cases, the share price can value the REIT 30% higher or lower than the actual value of the underlying real estate. Private real estate values don’t move much on a daily basis but rather appreciate slowly over time, which is why private investments are less volatile than their public counterparts. Both vehicles have pros and cons and the optimal portfolio has a combination of both. Public markets offer liquidity, but that comes at the expense of volatility and private investments offer investors low volatility, but with that comes illiquidity.
Please read this article here that takes a closer look at the pros and cons of each.
Should I invest in a Fund or individual deal?
It goes without saying that each situation will have a different scenario, however here are the high level points to note.
Investors who select individual deals have the freedom to pick and choose what deals they invest in, but this also requires a large amount of time and may not result in the most diversified portfolio. Investing in a real estate fund means giving up control of selecting individual deals to a disciplined manager, but also means saving substantial time and, ideally, receiving a well-diversified group of real estate investments.
1. Time Commitment
With a deal-by-deal approach, an investor would have to source a large number of deals and evaluate every opportunity. Finding a good, trustworthy manager is not easy and the investor only has to find one if investing in a fund.
In a fund, investors receive consolidated quarterly performance reports on their entire portfolio, rather than dozens of individual reports. Each update will follow the same format and illustrate how the individual deals within the portfolio are performing and the overall investment performance at the fund level. Additionally, year-end tax reporting is much easier in a fund structure because K-1’s, a tax document sent to partners that lists out their share of income and loss for the year, are consolidated into a single document for tax reporting purposes. But an investor in 20individual deals will likely have to manage 20 K-1’s and the costs associated with filing them.
Diversification is one of the easiest ways to reduce risk. In real estate, investors need to make sure they are not overexposed to any one deal or geographic region. Our funds have minimums of$100,000, but that capital could be spread across 15 to 20 deals. Investing$100,000 on a deal-by-deal basis could easily lead to a portfolio of four to six deals and a single property could easily make up 30% or more of the portfolio. Real estate downturns can often be isolated to a single city or region and having too much concentration in one area can lead to unnecessary risk. Our funds target multiple markets for diversification.
In a fund, the performance fee is paid based on the overall performance at the fund level. In contrast, managers of individual deals get paid based on the performance of each and every deal. This is important because if one deal generates a 20% annualized return and another deal generates a 20% annualized loss, the manager is entitled to an incentive fee on the deal that did well and knows they won’t make money on the underperforming deal. The manager operating in a deal-by-deal structure may be more incentivized to focus on the deals doing well and ignore those doing poorly where they are least likely to earn a fee. The fund manager, in contrast, is highly incentivized to revive underperforming deals.
Are there more fees than public market investments?
Unlike the public markets, real estate is not a business where you want to base a decision on fees alone. There is a big difference between price and value and low fee real estate deals can end up being very expensive. The quality of a business plan and the asset manager who runs it make the most impact on the success of a real estate investment. Fees are a function of the complexity of a business plan and should be correlated to the value the manager is able to create. Someone must find the property, negotiate the price, create marketing materials and legal documents, raise equity, manage the day-to-day operations of the property, formulate and execute the business plan, report to investors, provide K-1’s, sell the asset and distribute the proceeds. A great team does not come cheap, but the overall return far outweighs the cost.
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