Know the Facts: Private Equity Real Estate & Private Real Estate Debt
Investors seeking exposure to Canadian real estate have several avenues available to them. Real estate private equity, which involves the ownership of physical properties, is one increasingly popular option. Private real estate debt, which represents an investment in mortgages and other types of financing, is another. Though the differences between these investments seem intuitive, investors often assume they share more similarities. However, property ownership and providing real estate financing carry significantly different risks and rewards.
Below, we examine key considerations for investors exploring private equity real estate and private real estate debt and the opportunities these can offer.
Returns come from three main sources: rental income, increases in property values, and equity growth. They are typically taxed in the year they are received. However, certain funds offer return of capital, which the government only taxes upon disposition.
Key risks include market and financing risk, both of which change with the prevailing interest rate environment. Geographic diversification, active management, and a conservative leverage strategy with fixed, long-term financing and staggered maturity dates can help manage these risks.
Active management can include making strategic decisions to enhance returns, such as increasing rents, attracting high-quality tenants with targeted marketing, and implementing physical and operational improvements.
A company’s rigorous due-diligence process, ability to identify property improvements, and strong governance and financial practices demonstrate its expertise.
Private equity funds have no obligation to disclose performance in detail. However, some funds like the Equiton Apartment Fund focus provide easy access to audited financial statements and regular reporting.
Investors exchange capital for shares of a fund, such as a mortgage investment corporation (MIC), which loans out the funds to companies or individuals. Some debt funds buy large pools of debt, such as mortgages, in addition to the loans they originate.
Private real estate debt can include mortgages, bridge loans, construction financing, and land loans, among others.
Income is generated through interest on loans, which may be secured by collateral to help protect the lender, and repayment of principal when a loan matures. Variable-rate terms can help mitigate interest rate fluctuations, while fixed rates can provide a more predictable cash flow. The government taxes interest income in the year it is received.
