What it means
A fund manager, called the general partner, raises capital from investors, called limited partners, and uses it to buy property. The manager then runs the assets, often with local operating partners, and returns cash as rents are collected and when properties are sold.
Strategies are commonly grouped by risk. Core funds hold stable, fully let buildings, value-add funds buy properties that need improvement or re-letting, and opportunistic funds take on development or distressed assets in search of higher returns.
Returns come from rental income and from growth in property value, and are boosted by borrowing against the assets. This leverage (using debt to increase the size of an investment) raises returns when values go up and magnifies losses when they fall.
Because the investments are private, they are hard to sell quickly and valuations are based on appraisals rather than daily market prices. Investors accept this illiquidity in return for a higher expected return than listed property companies.
Managers are paid a management fee on committed or invested capital, plus a share of profits above an agreed return. Investors should look at returns after all fees and compare equity multiples and annualised returns, not only headline gains.
Timing matters as much as the final profit. Money returned early in the life of the fund lifts the annualised return, while money returned late lowers it, which is why two funds with the same multiple can look very different once measured by internal rate of return (the yearly return that makes the cash flows add up to zero in present value terms).
In practice
Real-world examples.
Example
A pension fund commits $50,000,000 to a value-add fund that buys ageing apartment blocks and refurbishes them. Rents rise after the work and the fund sells the buildings after six years. The pension fund values the holding quarterly using the manager's reports and checks those values against independent appraisals at the year end.
Example
A family office invests $5,000,000 in a logistics warehouse fund. The fund borrows 60% of the purchase price and the tenants sign long leases with annual rent rises. The family office expects steady income and accepts that it cannot sell its stake on demand.
Example
A university endowment backs an opportunistic fund that buys a half-built hotel and completes it. The risk is high because costs may overrun. The potential return is higher than that on a fully let building, but so is the chance of losing money if the hotel opens into a weak market.
Formula
Calculation
Equity multiple = total cash returned to investors / total equity invested
Suppose an investor puts $10,000,000 into a fund that buys an office building. The fund pays out $1,000,000 a year in rental distributions for five years, then sells the building and returns $12,000,000 of sale proceeds.
Total cash returned = (5 x 1,000,000) + 12,000,000 = 5,000,000 + 12,000,000 = $17,000,000.
Equity multiple = 17,000,000 / 10,000,000 = 1.7x.
The investor therefore made a profit of 17,000,000 - 10,000,000 = $7,000,000 over five years, before any fees or taxes not already deducted.Case study
Seen in the real world.
Cedar Ridge Capital is an illustrative, fictional manager that raised $200,000,000 for a value-add apartment fund. It bought four buildings for a total of $300,000,000, using $100,000,000 of borrowing, and planned renovations to raise rents.
Three years in, rising interest costs reduced the cash available to investors. The manager extended the fund by one year instead of selling at a weak price, and used the time to finish the improvements.
On sale, the buildings fetched $360,000,000. After repaying the $100,000,000 loan, the fund had $260,000,000 for investors, an equity multiple of 1.3x on $200,000,000 before fees. In this illustrative story, patience helped, but the extra year lowered the annualised return.
Watch out
Common mistakes.
- Comparing a headline equity multiple across funds without considering how long the money was tied up, since a 1.5x over three years is far better than 1.5x over ten.
- Assuming appraisal-based values are the same as the price a buyer would pay today, when they can lag the market.
- Ignoring fees and borrowing, which can turn an average property return into a good or poor investor return.
Questions
People also ask.
Is private equity real estate the same as a REIT?
No, a REIT is a company whose shares usually trade on an exchange and can be sold daily, while a private fund is unlisted and ties up capital for years.
Who can invest in these funds?
Usually institutions and wealthy individuals who meet minimum wealth or experience tests set by regulators, because the funds are not offered to the general public and the investments carry a high risk of loss and limited ability to sell.
What does it mean when a fund calls capital?
The manager asks investors to send the money they promised, typically in stages as properties are bought, rather than all at once on day one.
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