The benefits of adding private real estate to your portfolio

Andy Sinclair © Midloch Investment Partners

You’ve probably heard the term alternative investments. These are investment vehicles other than stocks, bonds and cash. Many high-net-worth people invest in alternatives for different reasons.

In some ways, private real estate is the least alternative of alternative investments because investment properties can generate income, like stocks can pay dividends, and real estate can appreciate over time, like stock prices can rise.

At the same time, private real estate differs from stocks in a couple of notable ways. For one thing, the value of private real estate assets doesn’t typically rise and fall in tandem with the stock market. In other words, their performance is not correlated. For this reason, real estate represents diversification from stocks and presents the opportunity to do well when the stock market is flat or even down. Another difference is the tax benefits. Depreciation deductions from real estate investments can offset income from real estate investments, thus reducing the tax burden.

Private real estate has become increasingly appealing to high-net-worth investors, especially people with patient capital who recognize that real estate is a long-lived asset class. Patient capital allows for an income property’s business plan to be implemented and realized to maximize the investment opportunity for income and appreciation. Patient capital isn’t in a hurry or, in the case of the stock market, prone to panic sell when stocks go down.

Benefits Include Income, Appreciation, Tax Savings and Inflation Hedge

Real estate’s performance is a function of many factors, including supply and demand, location, demographics, macro and microeconomic growth, the quality of the investment and asset management teams, and the business plan for the assets or portfolio.

The potential benefits of real estate investing include the following:

• Income from the cash flow of investment properties, which is akin to dividends from stocks.
• Appreciation from the gain on the sale of investment properties.
• Tax benefits, including depreciation and passive losses.
• Diversification relative to stocks and bonds, as well as real estate diversification by property type and geography.
• A hedge against inflation, particularly for property types such as multifamily that can increase net operating income through more frequent rent increases as leases roll over. (Inflation also tends to increase the cost of capital, which makes new construction of additional supply less attractive.)

Many financial planners recommend including alternative investments in your portfolio. There’s no consensus on the correct allocation; it comes down to what’s right for you. Delta Wealth Advisors, as one example, recommends that between 25% and 40% of an investor’s net worth, including their home, be in real estate.

At my firm, Midloch Investment Partners, we target annual returns of 13% to 17%, net of fees, for our investment funds. Since inception, we’ve surpassed our target, doubling investors’ money on fully cycled investments as of year-end 2024. (Of course, past performance is no guarantee of future results, and there is a risk of losing the invested principal.) We succeed at Midloch by leaning into an investing philosophy that identifies at least two or three ways to make money with every investment.

Kicking the Tires on Private Real Estate Fund Managers

There’s more to investing in real estate than the properties themselves. You’re investing in people, too. So, kick the tires of the sponsors behind the projects or funds before you invest. In other words, get to know who you’d be doing business with.

How do you do that? A good place to start is by asking these five questions:

What's the sponsor's track record?

It sounds simple enough, and it is. But it’s amazing how many firms squirm when you ask them to detail their performance on a deal-by-deal basis. That’s what you want to see, if only to verify that the sponsor is disclosing the poor or middling performers as well as the winners. (There’s no shame, by the way, in necessarily having some poor performers. Overall performance counts most, especially if you’re investing in diversified funds that hold multiple properties.)

Do they hit their targeted underwriting goals?

Before making investments, sponsors analyze them, determine how they intend to make money, and essentially develop a business plan for each asset or portfolio. Asking sponsors how well they’ve done at underwriting reveals how thoughtful, thorough and accurate the sponsor was in their planning versus their actual performance. It also shows the role of luck (good or bad) and how extenuating circumstances may have affected their projected versus actual performance.

How do they react when their underwriting assumptions don’t pan out?

In other words, can they pivot to a plan B to turn a property into a performer or otherwise exit a deal in a way that minimizes losses?

How well do they communicate with investors?

You can gauge this by assessing the frequency and transparency of a sponsor’s investor communications, their willingness to be available and answer your questions, and speaking with others who have done business with them.

How much of their own money are they investing alongside yours?

A sponsor should always have skin in the game, plain and simple. Ensure the “House” is invested alongside you in any deal or fund.

Net-net: Who you do business with is as important as the fundamentals of the deals you invest in. As you seek to build a diversified investment portfolio with alternative assets, including income-producing real estate, you should be comfortable with the notion of patient capital and the sponsors who are the stewards of your money.

Andy Sinclair is CEO and principal of Midloch Investment Partners, a Chicago-based real estate investment fund manager and operator.