By Eric Lam
There’s something unsettlingly ephemeral about owning stocks and bonds in this era of default and constant volatility, which explains why many investors are thinking of turning to physical assets such as real estate.
But the problem with owning tangible real estate is all the work involved in maintaining it. When you’re a landlord, every leaky faucet, broken window and dirty swimming pool is your problem.
For the less hands-on investor, a product growing in popularity is the real estate limited partnership or RELP.
A RELP is a private equity fund similar in concept to a real estate investment trust (REIT), which is publicly listed. In a RELP, however, investors pool their cash to either directly, or through a manager or management team, purchase and manage one or more real estate assets. Investors then receive regular distributions through the operation, lease or sale of said properties, minus a management fee, and everybody goes home happy.
There are hundreds of closed-and open-ended RELPs on the market, and, as with most private equity products, there are endless variations in strategy, leverage, fee structure, and buying and buy-out restrictions. They are also generally only accessible to accredited investors, those that have a certain level of assets and income and, presumably, the ability to handle risk.
“There are different kinds of RELPs, but it all comes down to a group of people getting together to buy a building or buildings,” said John Nicola, chief executive at Nicola Wealth Management in Vancouver.
Mr. Nicola’s firm manages two open-ended RELPs, Spire LP with a $277-million portfolio of Canadian retail, industrial and self-storage properties, and Spire U.S. LP, which holds about US$100-million in office and multi-family properties in the United States. Spire managers collectively have about $10million invested in the two funds.
The main benefit of buying into a RELP is the promise of higher returns and less volatility than a REIT, which can have its value skewed by market forces external to the real estate market.
There are also several key limitations. For one, RELPs are much less liquid, which allows fund managers to deploy more capital. This means investors can only cash out on certain dates – problematic in a cash crunch.
“You want to make sure this is an investment you want to stay in for a while,” Mr. Nicola said.
There are other pros and cons to joining a RELP. “One of the pros is you can get into the real estate market without being a property manager, or getting a mortgage,” said Don Campbell, president of the Real Estate Investment Network, a Calgary-based real estate research group. “One of the cons is each of these things is structured completely differently.”
Investors must ask management whether their asset transactions are done at arms length and whether there is any “lift” involved. Lift is the profit when management buys a property and then sells it to the fund. This information can be found in the prospectus, but most people fail to read the often dense documents, Mr. Campbell said.
“The lift can affect the yield. Now, if you’re still giving me 9% return, you can have all the lifts you want,” he said. “You absolutely have to ask, because the prospectus can be worded many different ways.”
Another important issue is whether or not the managers are also invested in the RELP.
“If they’re in there with limited or no lift, they’ll focus on the results,” Mr. Campbell said.
Investors also need to make sure they are on board with management’s investment philosophy and comfortable with their level of experience in real estate.