3. Primary vehicles for real estate investments
The four primary ways for family offices to gain exposure to real estate are direct investments, funds, co-investments, and real estate investment trusts (REITs).
Direct investments require the highest level of expertise and capacity to identify potential investments, develop their business case, secure financing and complete the due diligence process. Direct investments also bring forward decisions about directly managing purchased properties or contracting with an outside operating company.
Real estate funds have varying structures, and lock-up periods differ, as do the types of property targeted. The “2 and 20” model is common in funds with the fund taking 2% AUM annually as a management fee and a 20% performance fee on profits, often with a hurdle rate of profit needed before it collects. Though, there has recently been downward pressure on fund fees. One key consideration for family offices without deep knowledge of real estate markets and operations is that funds can provide exposure to diversified real estate holdings curated by fund managers. However, the lack of control or, in some cases, transparency leads some institutional investors and family offices to build direct investment capacity rather than investing through funds. These downsides can be overcome by working with funds with a single mandate and possibly through gaining representation on the fund’s board.
Family offices may also have the opportunity to join with funds through co-investments. In many cases, these opportunities only become available after an initial investment in a fund. In other circumstances, co-investments may come through wealth management advisors or possibly from their private banking relationships.
REITs may either be publicly traded or privately held and their precise structure varies across legal jurisdictions. Shares in public REITs may be purchased on major exchanges like other listed equities and their value is generally correlated with broader indices. The value of privately held REITs is more directly connected to their underlying composition and typically have lock-up periods which decrease their liquidity. Funds may invest some of their capital in REITs as a risk management tool for their own direct investments.
Each investment vehicle has distinct advantages and disadvantages, which should be considered by family offices in relation to their interest in the asset class. The first-order question “why is my family office investing in real estate?” will help guide subsequent decisions about the type of property, subclass, strategy, and investment vehicle. It will help family offices decide if they are interested in scaling up their internal capacity, starting a separate company to manage their property holdings, or paying the fees of funds in exchange for a more hands-off investment.