When you’re considering investing in private real estate, chances are good you’re considering a number of investment options. Perhaps you’ve already decided not to invest more in the stock market because of its unpredictability. Maybe you’re following a strategy of diversifying your assets according to a model you got from a financial planner, and you think you should put 20% into real estate – but you’re not sure where or how. Perhaps you simply don’t have a good relationship with a fund manager and are unsure what to invest your money in. Whatever the reason, I’m glad you stopped by.
When it comes to private real estate, we’ve written additional posts about how to get started and what to consider when selecting a private real estate partner. We’ve even written an ebook: The Ultimate Guide to Private Real Estate Investing for High Net Worth Investors.
This post specifically covers nine best practices of private real estate investing once you’ve chosen this path. Some of these pertain to real estate investing you may do yourself, whereas many pertain to real estate investing through a 3rd party firm. Here’s our best advice:
1. Remember that all real estate is local.
Private real estate has a low correlation to the public market. Real estate – assets, their potential value, tenant opportunities – are all completely dependent on the local market in which they’re located. Keep this in mind when selecting an asset, or when partnering with an investment manager who will choose assets on your behalf.
2. Real estate can be tax advantageous; ensure this is the case for your own finances.
Tax situations vary for each person, and when it comes to real estate investments, the tax advantages can be great if the investing is done well. Talk to a tax professional or CPA when looking at investment options to determine if this is the case for your own personal financial situation and your plans for real estate investment. Ask your real estate partner if they have in-house tax personnel and CPAs, as well.
3. Verify the investment strategy you – or your investment partner – are pursuing.
There are a number of different investment strategies a person or a firm can pursue. These are the main three:
Opportunistic play – converting previous buildings to something new (development), completely changing that real estate and making it something new with a new use. For example, converting a manufacturing building to a building of offices would be an opportunistic play.
Benefits: With great risk comes great reward; there’s the potential to make excellent returns if the community around the property has changed enough that the new use of the building is incredibly profitable.
Risks: There’s the chance – and it’s somewhat high – that the cost to upgrade and convert the building will make this investment a poor choice relating to overall returns.
Value Add Strategy – keep the building use the same, but upgrade it (adding value) to increase rents or operating efficiencies.
Benefits: The community is used to the current use of the building; if surrounding rents are higher, you have the potential to realize higher dividends and a higher appreciation once the building sells.
Risks: The cost to upgrade the building may be too high to support the rents you’re able to ask for from tenants. It’s a balancing act.
Core Strategy – buying something that’s dependable and stable but may give lower returns because there aren’t a lot of improvements to make to increase the dividends.
Benefits: Dependability means that the building is already inhabited, rents are fair, and the building is updated.
Risks: Because the building is stable, you aren’t able to increase dividends by making improvements without losing tenants; returns are generally lower.
Always verify the strategy your partner is pursuing matches the ideal play you would want to follow.
4. Remember that any investment return carries a degree of investment risk. Be prepared.
Whether you’re investing in real estate, the public stock market, or even bonds, there’s always risk to consider. Be prepared for this risk by setting aside non-invested funds as a cushion to fall back on if necessary, and manage your portfolio to maintain the level of risk you’re comfortable with.
5. Prepare for the illiquidity of real estate.
Liquidity is based on how fast you can get your money back as cash. Real estate is a very illiquid investment, meaning it can take a long time to get your money out of an investment. You can’t sell it tomorrow at a market price. It could take a long time to sell. There’s a “cost” to not being able to get your money out quickly; investors in private real estate are putting their money away, typically, for a longer time without having access to it. Prepare yourself for this commitment to ensure that you’re able to live the life you’d like while some of your funds are working via investments.
6. Diversify, diversify, diversify.
Minimize risk by making sure that your investment portfolio has diverse investments (a mix of stocks, bonds, and real estate is considered diverse). In addition, protect yourself by mixing different types of stocks within your stock options, and include varying asset types, geographies, and managers in your real estate investments. This is where a fund structure of private real estate investment can come into play to help meet your goals.
7. Know how and when to expect your distributions.
The goal of any investment is to make more money than you originally put in. It’s always a risk. But ensure you’ve asked all the questions related to how distributions are allocated: when are your original funds paid back, how are dividends distributed, and how is appreciation valued and returned to investors? These are all important to know before making a decision on your private real estate investment.
8. Ask lots of questions before investing with a firm or in a property.
Always be learning when it comes to your money. Many investors don’t bother to ask because they’ve already formed a relationship with a fund manager or property owner; however, you should always be asking questions related to how your money will be spent, the business’s or firm’s practices for investing, and how they handle your capital. It’s an important part of trust building, but it’s also due diligence for your own money.
9. Don’t manage the property you bought.
Unless you’re a professional real estate manager, leave this important task to the experts. Real estate managers are in charge of managing any changes to the property, finding valuable tenants, ensuring tenants stay put, and handling dividends. This is incredibly important in order to get the highest returns possible for your real estate; trust an expert to get it done, and get it done well.
At the end of the day, you’re the one who has your best interest at heart; you know your own finances, what you’ll need, and what risk you’re comfortable with. But it’s also important to partner with an expert who has your best interest in mind, particularly if you’re new to private real estate investing. Follow these best practices for a great experience, and feel free to contact The Jeeranont for additional advice related to your decision!