Since the 2008 Economic Recession, many of the maxims that investors have lived by have been challenged and proven wrong. One of these, albeit hasty and uninformed, maxims—that real estate is a safe investment that will continuously appreciate in value over time—has been convincingly disproven to anyone who has paid attention to the volatility of the real estate market since October 2008.1
Nevertheless, especially in investing, extraordinary downturns are often followed by extraordinary opportunities. Small and large investors alike sought, and continue to seek, ways to profit off of real estate investments in this “buyer’s market.”2 However, not every low price in an economic downturn is a sound investment opportunity. So, what types of investment managers have the expertise, experience, and risk tolerances to most profitably seize the newfound distressed real estate investment opportunities still flowing from the recession? Private equity firms. One of the fundamental strategies of private equity investing entails seeking out failing companies, buying them, and turning them into income-producing assets.3 This strategy is directly applicable to real estate, and many firms are taking notice. Thus, for anyone interested in private equity as a career or otherwise, it is important to understand what real estate private equity is, how it functions within a large investment manager, and how it can be distinguished from real estate investment trusts (REITs).
Although several prominent private equity firms have been active in the real estate sector for a long time (e.g., Blackstone, The Carlyle Group), the abundance of investing opportunities following the 2008 Economic Recession have caused many of them to ramp up their real estate function, and some to create one for the first time. For example, Kohl, Kravis & Roberts (KKR), one of the world’s most respected private equity firms, raised $1.5 billion for its first real estate fund in December of last year, which purports to invest as much as 75% of its capital toward properties in North America.4 Ralph Rosenberg, KKR’s global head of real estate, offered insight into the current state of real estate private equity investing while discussing the fund by claiming, “We have a deep and robust pipeline of opportunities…It’s harder to find things today than a year ago, but there is still a whole world of things to do with capital to help reposition assets.”5
Not only are Rosenberg’s comments indicative of real estate private equity market generally, but they also bring to light a key difference between REITs and real estate private equity, most notably the flexibility to take advantage of unique investment opportunities.6 In general, REITs have a well-defined investment focus (e.g., geographical regions, a particular asset class, etc…) and are established to offer real estate investing options to small-time investors who often do not have enough capital to purchase properties on their own.7 Conversely, real estate private equity functions like a traditional private equity fund. Their fundraising efforts are focused on institutional and high net worth individuals looking to pool their capital in hopes that the skill and expertise of the fund’s managers will provide them with above-market returns.8 Often, real estate private equity funds will have a broad scope, allowing fund managers to seek to employ this capital wherever opportunities may arise. Some large real estate funds will “limit” the fund’s geographical scope by choosing to focus on a certain continent, while others choose not to confine the fund to one continent.9
Another competitive advantage that private equity firms have over other real estate investment managers is their superior value-add and financing expertise. A traditional real estate investing strategy consists of buying properties for a low price, renovating them, and then selling at a premium.10 Private equity firms have been able to effectively apply this strategy on a significantly larger scale. Real estate private equity groups can add value to real estate in much the same way traditional buyout groups add value to portfolio companies: by creating operational efficiencies, securing advantageous financing, driving down expenses, and increasing cash flow. For example, a firm can take advantage of its operational expertise and immediately improve the manner in which the property is managed, or increase cash flow by seeking out favorable refinancing options.
In the future, it is likely that real estate private equity will continue to be a focal point for many private equity firms, and they will continue to find new ways to make substantial profits off of the real estate investment opportunities that exist. In fact, Blackstone recently announced a strategy that entails securitizing debt tied to single-family homes and selling tranches of the debt as bonds to investors.11 This creative strategy has been coined “Wall Street’s latest trillion-dollar idea” by New York Times’ Dealbook.12 Nevertheless, firms will continue to face challenges persuading hesitant investors to commit capital after witnessing such a huge downturn in the market only a couple of years ago and convincing lenders to fund their investment ideas. Judging by the recent real estate fundraising efforts of private equity firms, investor and lender fears are beginning to subside.
See https://www.google.com/finance?q=NYSEARCA:IYR, (last visited Feb. 7, 2014). ↩
See generally Gary W. Eldred, Investing in Real Estate, (7th ed. 2012). ↩
Private Equity, Investopedia, http://www.investopedia.com/terms/p/privateequity.asp. ↩
Hui-yong Yu, KKR Raises $1.5 Billion for Its First Real Estate Fund, Bloomberg Personal Finance (Dec. 24, 2013, 12:00 AM), http://www.bloomberg.com/news/2013-12-24/kkr-raises-1-5-billion-for-its-first-real-estate-fund.html. ↩
REITs Versus Real Estate Private Equity Funds: Who Wins?, Commercial Property Executive (Dec. 28, 2011), http://www.cpexecutive.com/newsletters/capitalmarkets-newsletter/reitscolumn/reits-versus-real-estate-private-equity-funds-who-wins/. ↩
See generally George D. Lambert, How to Invest in Private Equity, Investopedia (Feb. 12, 2012), http://www.investopedia.com/articles/mutualfund/07/private_equity.asp. ↩
Hui-yong Yu & Devin Banerjee, Blackstone Said to Gather $2 Billion for Real Estate, Bloomberg News (Sept. 25, 2013, 1:02 PM), http://www.bloomberg.com/news/2013-09-25/blackstone-said-to-gather-2-billion-for-real-estate.html; see also Yu, supra note 3. ↩
See generally Eldred, supra note 2, at 163. ↩
Michael Corkery, Wall Street’s New Housing Bonanza, Dealbook (Jan. 29, 2014, 8:51 PM), http://dealbook.nytimes.com/2014/01/29/wall-streets-new-housing-bonanza/. ↩