The public market has historically been the most common playing field for investors due to its availability, level of liquidity, and emphasis from the media (brokers, financial institutions, etc.). Private investing has been perceived as high-risk, and until very recently, only very few sophisticated families and individual investors have had access to opportunities in the private investment world. In 2012, the SEC (Securities Exchange Commission) made it available for alternative opportunities to be marketed to the general public (JOBS Act). Until then, if you weren’t in the room, then these types of opportunities were out of reach. Nowadays, more and more investors realize the level of security, benefits, and amount of wealth that can be created by investing alongside best-in-class operators and entrepreneurs.
Understanding Private Equity
Private equity, which fits in the ‘alternatives’ category, distinguishes itself by allocating only to private companies and Real Assets (Real Estate and Infrastructure). By definition, Private Equity is a form of alternative investment in which the investors purchase shares of privately held businesses. Commercial Real Estate fits under the private equity umbrella.
Private investments are considered ‘illiquid’ because of the amount of time it can take for shareholders to exchange their equity investment for cash. These types of investments trade less frequently and have minimal volume compared to the stock exchange which trades thousands of times per day. Because of the lack of liquidity, and volume, private investments are considered to be difficult to value due to the fact that the seller needs to seek a buyer. While some investors prefer liquidity, other investors specifically allocate to private equity in order to earn the demanded Risk Premium.
Private equity is generally broken down into two strategies; Leveraged Buy-outs (LBO), and Venture Capital. LBOs are a strategy to back companies that are more mature and produce cash flow. There may be a lack of management or the company is not growing at its potential, or may even be distressed. In some cases, Private Equity firms acquire public companies and take them private. The ‘leveraged’ part is what it sounds like, using debt and equity to purchase a company. The reason why banks will lend against these companies is due to the fact that the company has a balance sheet, and is stabilized enough to service debt.
Venture capital, on the other hand, is typically backing earlier-stage companies with an open road with massive growth potential. Venture capital is considered to be at more risk as these companies are in early stages and may not be in a stable, cash-flowing position. Because of this, VC companies typically allocate a smaller amounts of capital to fund strategic growth phases.
Understanding Commercial Real Estate Investments
Commercial Real Estate, which sits under the Private Equity umbrella, offers investors the ability to own private shares of Real Assets. Although Commercial Real Estate comes in many different types and sizes, investments are typically broken down into four main categories; Core, Core Plus, Value-add, and Opportunistic, which are used to describe the risk and return profile of a given investment.
The term ‘Core’ is typically used to describe a Class A asset that has a minimal leverage and offers stabilized income. Core investments are considered to be very low risk as the property has little or no deferred maintenance and has credit-worthy tenants. Think of a newer industrial building in a prime location leased to Amazon.
Core Plus represents income and growth and offers investors a low to moderate risk profile. These properties still hold true to being stable, with great tenants, but the property may have some deferred maintenance or room for upside. Think of an apartment building in a prime location that could use a slight makeover to compete with the new supply.
Value-add typically represents an investment that needs improvement to become stabilized. These types of investments are presented as moderate to high risk, but offer investors larger upside potential. Think of a run-down retail center that has major deferred maintenance that needs to be executed in order to release the property at market rates.
And last but not least, Opportunistic. Opportunistic investments fall into the ‘growth’ category and are considered to be at the most risk. The reason for this is that the asset in most cases does not produce stabilized income and needs certain ‘Key-Events’ in order for the property to become stabilized. Think of raw land that needs entitlement, construction, and leasing to be executed in order for the property to become stabilized and qualify for permanent financing. Opportunistic investment profiles are considered to be at the most risk, but also offer investors the most upside potential.
The Bottom Line
More and more Investors have increased their attention to private equity for many reasons, mainly to boost returns, generate cash flow, and reach their investment goals. Both Private Equity and Commercial Real Estate offer an array of investment profiles, and great benefits such as; cash flow, appreciation, tax benefits, leverage, longevity, amortization, and the potential for major upside.
One of the most attractive parts of investing in Private Equity, and Commercial Real Estate is the ability to have more control. Unlike investing in Stocks, like the S&P 500, which is a diversified index across many different companies, sectors, leaders, business plans, etc. Private investments give investors the ability to choose many factors; the Operating team (the company that oversees the asset), the Market (people are biased toward markets – Ie Sunbelt States), the business plan, and the basis (price and terms). There are many other benefits, but being able to invest alongside best-in-class operators is the ultimate way investors can achieve the most risk-adjusted returns with large potential upsides.