Co-investing in real estate projects has become an increasingly popular way for investors to gain exposure to real estate assets. It involves investing directly in a real estate asset alongside an experienced sponsor or operator. Co-investing provides opportunities not available in traditional real estate funds while also posing some unique risks. In a co-investment, the investor takes an ownership stake and may participate in management and decision-making. This article will analyze the benefits and risks of co-investing in real estate.
Diversification and access benefits of real estate co-investing
One of the main benefits of real estate co-investing is diversification for an investor’s overall portfolio. Real estate investments have historically had low correlations to stocks and bonds. Co-investing provides direct access to real estate deals that an investor may not be able to access on their own. The investor taps into the skills and networks of an experienced real estate operator or fund sponsor. Many co-investment opportunities are in large-scale projects or niche sectors not available to individual investors. With lower minimums than traditional real estate funds, co-investing opens up opportunities for a wider range of investors.
Potential to enhance real estate investment returns
Co-investing provides the potential to earn higher returns than investing in a commingled real estate fund. The investor may benefit from lower fees and expenses compared to traditional real estate funds. There is also often greater transparency and control over the asset and investment decisions. Unlike a passive limited partner in a fund, co-investors can actively engage in critical decisions about the asset. This provides opportunities to help create value and improve returns through direct involvement in areas like leasing, redevelopment and financing.
Lack of diversification a key real estate co-investing risk
While co-investing provides concentrated exposure to a single asset, most real estate fund investments are diversified across geographical areas, sectors and property types. Lack of diversification concentrates risk for co-investors. Issues with a single poorly performing property can significantly impact overall returns. Traditional real estate funds provide inherent diversification by investing in dozens of assets across multiple markets and sectors. Co-investors miss out on this risk mitigation benefit.
Due diligence challenges with real estate co-investing
Co-investing puts greater due diligence responsibilities on the investor. Because there is no fund manager oversight like in a commingled real estate fund, the co-investor takes on more individual asset evaluation and risk assessment. For passive real estate investors without extensive analytical expertise, this can pose major challenges. Areas that require greater scrutiny include the operator’s capabilities, leverage use, environmental risks, lease terms, local market conditions and property management practices. Co-investors need the skills and resources to thoroughly assess each specific deal.
Though co-investing provides unique benefits like targeted exposure, enhanced returns and lower costs, the strategy also comes with risks like lack of diversification and increased due diligence responsibilities. Weighing these pros and cons allows an investor to determine if real estate co-investing has an appropriate role within their broader portfolio.