Private Real Estate Investments
Refresher reading access
Introduction
Real estate investments are heterogeneous building and property assets in illiquid and fragmented local markets. While earlier learning modules addressed income-producing properties and publicly traded real estate, such as real estate investment trusts (REITs), we now turn our attention to private real estate investments. While this asset class spans a wide range of investments, including diversified and core funds, we focus here on the features, economic drivers, valuation, and portfolio characteristics of value-add and opportunistic real estate investments. According to the alternative investment data provider Preqin, private real estate is the third-largest private markets asset class, of which roughly one-third involves value-add investments, one-third is opportunistic, and the remaining third involves privately held core or other assets. Private real estate is expected to exceed USD2 trillion in assets under management (AUM) by 2027 globally, over half of which is expected to be in North America, despite rapid growth in Asia and Europe. Private real estate equity and debt investments typically exhibit more equity-like return characteristics. They often involve major property renovation, repositioning, or new construction. In contrast, raw and less developed land used in agriculture and forestry represents distinct segments of the private real estate market.
In this learning module, we first distinguish key features of private real estate markets. These investments often occur over a property development life cycle, unlike the more stable, consistent cash flows associated with core real estate. Farmland and timberland, in contrast, involve fewer or no physical improvements and derive their economic value from current and future agricultural use or the timber growth cycle, as well as capital appreciation. These differences give rise to specific investment characteristics for private real estate debt and equity investors, unique due diligence and valuation challenges, and distinctive risk and return features that define the role of these investments in a strategic asset allocation.
Learning Outcomes
The candidate should be able to:
- discuss important private real estate investment features;
- discuss economic value drivers of private real estate investments and their role in a portfolio;
- discuss the due diligence and valuation processes for private real estate;
- discuss the distinctive investment characteristics of timberland and farmland;
- discuss the risk and return among private real estate investments and as compared to other investments as part of a strategic asset allocation.
Summary
- Private real estate investments usually involve major property refurbishment, repositioning, or new development and exhibit more equity-like characteristics than income-producing property.
- Debt and equity instruments used in property development frequently differ from public real estate investments in terms of the timing, terms, and type of funding involved, which often vary over capital commitment, deployment, and distribution phases.
- Private real estate due diligence incorporates more complex private investment structure details and the capital and development life cycles, while valuation approaches often include scenario and sensitivity analysis in addition to income and sales comparison approaches.
- Timberland and farmland are unique forms of largely private real estate investment involving raw land whose value is derived from economic use associated with the timber growth cycle or agricultural use, as well as potential capital appreciation.
- Relative risk and return analysis of private real estate investments assesses the expected timing and volatility of expected income and price appreciation based on economic drivers and includes the complex compensation structures of these investments.
2 PL Credit
If you are a CFA Institute member don’t forget to record Professional Learning (PL) credit from reading this article.