Equity Capital

The debt markets provide over $250 billion in new financing each year, but another $50-plus billion of equity capital is also required for new real estate investments. As noted above, large pools of capital, such as pension funds, have been attracted to real estate for its inflation-hedging characteristics. Large pools of foreign capital also participate in hopes of preserving asset values. Despite the great attention these investor groups receive, they actually contribute only about $5-10 billion per year.

The bulk of the equity funds comes from developers themselves and from individual investors. The developers typi cally invest their own cash as working capital for projects. Usually they expect to invest their profits as well ~ at least for a time. Many developers are also major property owners and will routinely reinvest cash flow from their portfolios. In fact, some of the major commercial real estate portfolios built in the 1960's and 1970's produce more cash flow than can be prudently reinvested in development ventures.

Individual investors participate in much the same way as developers, involving themselves as principals in individual properties or as partners with developers. Real estate syndication, the practice of organizing investment partnerships to purchase and develop properties, has enjoyed rapid growth since 1982. The Real Estate Securities and Syndication Institute (RESSI) reported that the top ten brokers in 1987 sold $3.4 billion worth of syndications through offerings registered with the U.S. Securities and Exchange Commission (SEC). Perhaps three times this amount was sold privately.

Investments in the public and private categories are quite different. Public offerings involve extensive formal documentation and review by the SEC. They are usually structured for many small investors, each contributing as little as $2,000. These funds have been used primarily to acquire existing properties, avoiding the possible pitfalls of construction and leaseup risk. Returns emphasize tax-sheltered cash flow and capital appreciation. Overall returns are lower than in the private placement investments. A group of major syndication firms called the "Big Six" accounts for a major share of this market. These firms offer one partnership after another through established marketing organizations, often led by major Wall Street brokerage houses.

Private placements are exempt from securities registration procedures under the provisions of the various federal and state securities laws. Private placements may nevertheless be quite formal and extensive in their documentation and in their marketing programs. These placements often involve the services of a syn-dicator, a firm or individual who organizes the partnership, structures and documents the investment, and coordinates the marketing program. Many small syn-dicators have entered the market since 1981, often working with licensed "brokerdealers" who sell the partnership units on a commission basis. Many developers organize investment partnerships themselves, thus avoiding the syndicator's often substantial fees.

Most private syndications appeal to wealthy investors. Many are structured exclusively for participation by "accredited" investors, as specified in a 1981 law. Other syndications require minimum income or net-worth limits which must be met by prospective investors. At the same time, many investments are informally negotiated between developers or promoters and individuals and existing investor groups. These informal private investments may require little documentation. A large portion of the private equity funds are used for new development ventures, although many also are used for acquisition of existing properties and "resyndication" of older properties.

The rapid growth in syndication investments may be traced in part to the tax incentives prevalent in the 1981-1986 period that increased depreciation allowances for income producing real estate and created tax credits for rehabilitation projects. Many investors moved into real estate after becoming disillusioned with oil and gas investment about this same time. It now seems that a demographic bulge of investors in their prime earning years is getting rich enough to appreciate the multiple benefits of real estate.

It should be noted, however, that real estate partnerships have been popular investment vehicles at various times in the past. Syndication has declined somewhat since these tax incentives were eliminated in 1986. However, syndication is likely to remain a substantial source of funds for future real estate investment.

What You Need to Know About Real Estate

What You Need to Know About Real Estate

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