Private real estate may be suitable for clients looking to offset the volatility of stock markets. However, as an asset class it is not risk-free and is subject to a complex set of rules.
Public real estate investment trusts (REITs) are familiar to most investors. Private REITs offer the same trust structure but are not publicly traded. That’s the format preferred by Greg Romundt, CEO of Centurion Apartment REIT, a private investment vehicle focused on apartment buildings.
Romundt believes the private REIT market is quite limited.
“To get to the scale where organizing as a REIT makes sense, you need a certain amount of infrastructure. On a small scale, it can be very difficult to check whether the numbers were satisfactory for investors and operators,” he says. “And if you’re going to achieve a certain scale, there’s a temptation to take the company public. One of the reasons we have maintained privacy is to meet a fundamental need in an underserved segment of the market.”
Romundt notes that private REITs are limited to accredited or qualified investors. “The requirements are regional and based on where you live,” he says. “If you live in Ontario, you have to be an accredited investor or have at least $150,000 invested. Outside of Ontario, the rules are different because they provide exemptions for qualified investors.”
The lack of public trading means a lack of liquidity for private REITs. Centurion offers redemptions every month, subject to certain limits. Romundt emphasizes, however, that private REITs are intended to be long-term investments.
“Most people should be looking at a holding period of five years or more,” he says.
Most Centurion investors come to the company through its investment dealers and fall into two categories: retirees and non-retirees. “Retirees are looking for cash flow stability, some inflation protection and capital preservation,” Romundt says. “All of those things are consistent with real estate performance over the long term.”
In his opinion, income may be less important for people just before retirement, but tax efficiency and capital building are equally important.
“I would say that real estate should be in everyone’s portfolio, in addition to stocks and bonds, so it’s all part of a diversified strategy,” he says. “I wouldn’t tell anyone to be all in real estate; you want to have a diversified, well-thought-out plan.”
REITs aren’t the only private real estate investment. John Nicola of Nicola Wealth Management in Vancouver offers access to a private real estate limited partnership (RELP). Nicola notes that a RELP is similar to a REIT in that it involves flow-through taxation. “So anything that happens at the LP level is passed directly to the partners.”
The RELP market is larger than the private REIT market and has no restrictions on accredited investors. “We can recommend them to any of our clients, but they are generally assets for the sophisticated investor,” he explains.
And this structure is not without risk. “There have been recent cases of partnerships in the real estate industry that have gone into receivership, so from that perspective it can be risky. If RELP follows a certain set of guidelines, the risk is really quite low.”
Nicola tries to limit risk with “rigid and specific” asset purchase guidelines. First, he and his partners invest alongside clients, “so anything that causes a potential loss will affect us exactly as it would affect them.” Secondly, the company usually does not purchase any building without making a down payment of 30% to 50%. “This gives us a better mortgage price.”
The company also looks for a net income stream that is at least two percentage points higher than the mortgage interest rate.
Nicola says companies that have gotten into trouble have either been heavily strengthened or invested in things that are not profitable or not geared towards future growth. Nicola prefers a more conservative approach.
“You need to work with someone you can trust, who knows the ropes of a real estate partnership,” he says. “If you don’t see that, then your options are to buy a real estate investment trust, a real estate investment trust or a segregated real estate fund.”
Nicola says advisers and investors need to do their due diligence on structures like RELP. “With (public) REITs and mutual funds, you just buy the asset class and delegate the decisions to the manager,” he says. “If you’re going to get into actual direct property ownership, which is my personal preference, you have to do your homework.”
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