Businesspersons working in an office.
Source: Getty Images

Often, as a real estate investor, it can be tempting to look for an alternative investment opportunity to add to your portfolio. If you're an accredited investor, private equity real estate investing is one avenue worth considering.

With that in mind, below is a guide to this investment strategy. Keep reading to learn more about what private equity investing is, how it works, and the unique advantages and disadvantages that come with it. After reading what we have to say, you should have a better idea of whether or not investing in a private real estate fund might be the right choice for you.

What is private equity real estate investing?

To start, private equity real estate investing involves a firm pooling capital from outside investors and then using that capital to acquire and develop properties for a short period of time before selling them. However, before getting into more detail about how these funds typically function, we should note that this method of investing is typically only available to institutional investors or accredited (high net-worth) investors. Usually, in order to take part in a real estate private equity fund, an investor must make a minimum contribution of at least $250,000. Though, for some funds, the minimum contribution can reach into the millions.

While a private equity fund may sound similar to a real estate investment trust (REIT), there are a few key differences that set these two investment vehicles apart. For one, while REIT investments are highly liquid because of the nature of being a public shareholder, private real estate funds often require the contributions to be held for several years. Further, while REITs are highly regulated, private equity funds don't face the same level of oversight or strict requirements.

Pros and cons of investing in private equity real estate

Now that you know a little bit more about what private equity real estate is and how it works, the next step is to take a look at the advantages and disadvantages of following this type of investment strategy. Similarly to any other type of investment opportunity, there are always going to be benefits and risks to consider. We've laid them out for you below. Read them over so that you can have a better understanding of whether or not it's worth adding one of these real estate assets to your portfolio.

Pros

As you might be able to guess, the biggest benefit of investing in private equity real estate is the returns. By virtue of their investment, private equity investors are entitled to a portion of any income or profits made from each underlying investment. These returns are often substantial, given the quality of investments that these firms are able to purchase with that amount of pooled capital. However, in addition, private equity investors also benefit from diversification since these firms tend to invest in a wide variety of real estate assets. Finally, by handing the asset management portion of investing over to a fund manager, investors can enjoy returns in exchange for very little active effort on their part.

Cons

With that said, it's important to note that working with a private equity firm often comes with other costs in addition to your minimum contribution. In particular, you should be prepared to cover certain management fees. However, since these funds receive very little oversight, there is no limit to the number of fees that you can be charged. In addition, many of these funds are considered need-based investments, which means that they can require you to contribute capital on an as-needed basis. If you're unable to meet a capital call, it's not uncommon for the fund to force investors to forfeit their entire share.

Types of private equity real estate investments

With all that in mind, if you are an accredited investor who is interested in exploring private equity investment, it's important to know that there are several different types of funds that you can choose from. They are as follows:

  1. Core: Core funds are a good fit for those who are risk averse. These funds tend to invest in high-quality, high-value real estate assets, such as fully-leased multifamily properties. They offer predictable cash flow but often bring lower returns because of the low level of risk.
  2. Core plus: Meanwhile, core plus funds offer a mix of core and value-added properties. In this case, they tend to offer slightly higher returns in exchange for their investors accepting more risk.
  3. Value added: With value-added funds, the asset manager purchases properties, engages in some level of redevelopment, and then sells them when the real estate market is doing well. Investing in his type of fund typically involves taking on a medium-to-high level of risk but offers the potential for greater returns.
  4. Opportunistic: Lastly, opportunistic funds provide the greatest opportunity for returns, but this method also includes taking on the highest level of risk. These funds often invest in alternative investments, such as undeveloped land or underperforming markets.

Related real estate topics

The bottom line

Truthfully, there's a lot to consider before you tie your money up in private equity real estate investments. If you're thinking of going this route, your best bet is to speak to a financial advisor who can make sure that you are fully aware of the benefits and risks. However, in addition, you're going to want to do your research on any funds to which you are considering contributing. It's important to make sure you understand how each fund handles its costs and investment structure. After all, it's only once you have a full picture of how each fund works that you can decide whether or not it's the right fit for you and your portfolio.

The Motley Fool has a disclosure policy.