Investing in real estate as a silent partner can be a much more favorable option than direct real estate investment, depending on the scope of your investment. Small landlords lacking adequate funds to hire a real estate management firm may spend a lot of time and energy on rent collection, repairs and maintenance, among many other issues. As your level of sophistication rises, you may feel more comfortable participating in larger, and hopefully more lucrative, deals.
In the real estate market, private debt consists of conventional mortgage loans and whole loans, both of which are loans that are collateralized by the property purchased using the loan proceeds, and that have not been securitized. Conventional loans meet certain established guidelines regarding credit score, income requirements, and the amount of the down payment. Silent partners are passive investors who do not participate in the day-to-day operations of the business. If you want to invest in private real estate debt passively, there are a number of ETFs that specialize in this sector. Exchange-traded funds (ETFs) allow individual investors to participate in asset classes most individuals were previously excluded from for a variety of reasons. There are also real estate investment trusts (REITs) and closed-end funds (CEFs).
Private equity in the real estate market consists of direct ownership interests in real estate. Within this sector of the real estate market you can invest passively through the use of ETFs, REITs and CEFs. Another option is the use of real estate limited partnerships (RELPs), which require at least one other entity or individual to serve as a general partner. RELPs are limited partnerships, which are actively managed by a general partner, while limited partners are passive investors with varying level of input into corporate affairs based on how the partnership agreement is drawn up.
Public real estate debt consists of publicly-traded mortgage securities, which includes collateralized mortgage-backed securities (CMBS), securities issued by Fannie Mae and Freddie Mac, and private mortgage issuers. Fannie Mae and Freddie Mac are quasi-governmental agencies that were organized to provide government backing to mortgages in order to nudge lenders into issuing mortgages to more borrowers with lower credit ratings. President Obama has initiated the winding down of the two agencies so that private investors regain control of mortgage lending and the proceeds can be returned to taxpayers. The two agencies are still issuing debt, although now without the federal government’s guarantee. It is not yet known how long the winding-down process will take, and what expected proceeds to taxpayers will be.
Public equity consists of securities such as REITs that invest either in private equity or other REITs, and also publicly traded real estate operating companies (REOCs). Public real estate equity securities tend to have high correlations with the stock market, and, for this reason, are not the best routes for diversification using real estate. Different REITs and CEFs have their management agreement drawns up differently, with wide variations in the percentage of funds available which must be invested in cash, real estate and equity securities. It is important to delve into these differences when choosing among various real estate investment securities.