A private equity (PE) fund is a collective investment model where money from separate investors is pooled together into a single fund and then used to make investments, most often in various illiquid equity and debt assets.
Typically, private equity funds are structured as limited partnerships with fixed holding periods during which investors are not able to access or receive back their money. The investors are typically limited partners and the partnership is managed by a manager or management group that earns money both through annual fees as well as taking a share of profits earned.
The typical fee structure of a private equity fund is a 2% annual management fee, and 20% of any profits earned by the fund, commonly referred to as the “two and twenty” model.
In real estate, private equity funds acquire properties and actively manage them in order to increase profits over a predetermined holding period, often 10 years. Funds are often differentiated based on their investment strategy, several of which are widely used in commercial real estate today:
Types of Private Equity Funds
A core strategy is the least risky of the typical investment strategies for private equity in commercial real estate and therefore is expected to earn the lowest relative return. This strategy usually seeks investments in stabilized commercial properties that do not require significant improvements and are located in areas or markets with strong demand and natural barriers to entry for new supply.
This strategy is similar to the core strategy, but offering a slightly higher risk-return profile. A fund following a core plus strategy will invest in properties that usually need minor improvements to bring the property to a level at which it can maximize its profit earning potential.
This strategy is a step above core and core plus in both risk and potential returns. Investments made under this strategy are often in buildings that need substantial physical improvements or a change in the way the property is managed to generate an acceptable return. Often, the fund will seek to sell the property at some point after the value additions have been made in order to capture profits.
This strategy offers the highest risk and potential returns. Properties acquired pursuant to this strategy will require the highest degree of improvements and may also involve investments in new construction or land. Developing a property from the ground up involves much more speculation and a longer timeline than simply acquiring a property that’s fully leased in a top metro area. This strategy will often involve selling a property rather than holding it, as well.
“Investing in Private Equity Real Estate” - Investopedia