A hedge fund is a type of investment vehicle and a business structure that aggregates capital from multiple investors and invests that capital in securities and other investments. Hedge funds are different from mutual funds—they are willing to take on more risk and their leverage is not capped by regulators.
Key Takeaways
- A select few hedge funds invest heavily in real estate, making them real estate hedge funds.
- Real estate hedge funds tend to invest in publicly traded real estate companies, mostly real estate investment trusts (REITs).
- The other way a real estate hedge fund invests is through the acquisition of actual properties, generally underperforming ones.
- Angelo, Gordon & Company, Cerberus Real Estate Capital Management, Cliffwood Partners LLC, and The Praedium Group are key players in the real estate hedge fund market.
- Real estate hedge funds often use leverage and can charge higher fees since they are usually limited to institutional investors.
How Real Estate Hedge Funds Invest
All real estate hedge funds invest heavily in real estate, obviously, but the way in which they invest varies by managerial investment strategy. For the most part, real estate hedge funds invest in the publicly-traded stock of existing real estate companies, mainly real estate investment trusts (REITs).
A REIT is a corporate entity—structured similarly to a mutual fund—that invests exclusively in real estate and is given a tax exemption for doing so. In return, REITs are required to pay at least 90% of their income out as dividends—although that income may be subject to tax for the REIT’s investors.
A second way a real estate hedge fund invests its money is through the acquisition of actual properties, usually underperforming ones, at low rates. These properties can be purchased in one specific region or around the globe, but they all tend to be up for sale normally due to a lack of liquidity on the part of the seller. So, unlike the REIT-investing hedge fund, these real estate hedge fund actually owns real estate.
Note
While they normally favor liquid assets, hedge funds can invest in different types of investment products. Lately, hedge fund managers lately have been adding real estate to their lists of nontraditional investments.
Specific Real Estate Hedge Funds
TPG Angelo Gordon is one of the larger real estate hedge funds with more than $78 billion invested in credit and real estate assets. The company has adopted a strategy of investing in investment-grade securities that the company deems to be underpriced.
Cerberus Real Estate Capital Management, formerly known as Blackacre Capital Management, is another large real estate hedge fund. This is the real estate arm of Cerberus Capital Management.
Other hedge funds include Cliffwood Partners LLC and The Praedium Group, both of which have unique strategies of their own. Founded in 1991, The Praedium Group has the goal of making profits from the differences in indexes in the public and private equity real estate markets. Cliffwood Partners, one of the first real estate hedge funds, has a long-short strategy in the real estate market.
Real Estate Hedge Funds and Leverage
Leverage is a core tool used by real estate hedge funds to amplify returns. By borrowing funds to finance property acquisitions or development projects, hedge funds can control assets worth significantly more than their equity investment.
For example, a hedge fund might use $10 million in equity to secure $50 million in real estate assets, with the remaining $40 million financed through debt. This strategy allows hedge funds to enhance their potential returns because the income generated from the leveraged asset—such as rental income or resale profits—can exceed the cost of borrowing. Note that post-pandemic, with commercial real estate having less demand and interest rates being higher, this is sometimes a more difficult strategy.
To manage these risks, hedge funds often employ advanced financial strategies such as hedging. They may use interest rate swaps to mitigate the risk of rising borrowing costs or engage in derivatives contracts to hedge against currency fluctuations in international investments. Some hedge funds limit their leverage ratios, maintaining a buffer in which they are not allowed to exceed.
Real Estate Hedge Fund Properties
Real estate hedge funds may hold a variety of properties, including but not limited to:
- Commercial Properties: Office buildings, retail centers, and industrial warehouses, often chosen for stable rental income and long-term leases.
- Residential Properties: Single-family homes, multi-family apartments, and rental communities, targeting rising housing demand or redevelopment opportunities.
- Mixed-Use Developments: Combines residential, commercial, and retail spaces in one project.
- Hospitality Properties: Hotels, resorts, and short-term rental properties.
- Senior Housing and Assisted Living: Facilities catering to aging populations, valued for steady demand and government or private funding.
- Student Housing: Housing near colleges or universities, designed for consistent occupancy tied to academic cycles.
- Land Development: Undeveloped or underdeveloped land, targeted for future construction or speculative appreciation.
- Specialty Properties: Unique assets such as data centers, self-storage facilities, or logistics hubs, often serving niche markets with high growth potential.
Downsides of Real Estate Hedge Funds
One of the most significant risks is the use of leverage. The leveraged nature of these investments, discussed above, means that even a slight downturn can result in significant financial stress, potentially wiping out the fund’s equity.
Another downside is the illiquidity of real estate assets. Unlike publicly traded stocks or bonds, real estate properties are not easily converted into cash. Hedge funds may impose lockup periods, which restrict investors from withdrawing their capital for several years. This makes it difficult to access funds in case of an emergency or market volatility.
Finally, real estate hedge funds often charge high management and performance fees, which can erode investor returns over time. These fees, typically in the range of 1-2% for management, are designed to incentivize fund managers to maximize returns but can be burdensome for investors, especially when the market performs below expectations. The fees are typically charged regardless of the fund’s success, meaning that in suboptimal market conditions, investors may pay significant fees without seeing much of any returns.
How Do Real Estate Hedge Funds Work?
Real estate hedge funds are investment vehicles that pool capital from accredited investors to invest in real estate assets or related financial instruments. These funds aim to achieve high returns through strategies like property acquisition, development, distressed asset repositioning, or financial derivatives tied to real estate markets.
How Do Real Estate Hedge Funds Differ From REITs?
While both invest in real estate, hedge funds are privately offered and less regulated than Real Estate Investment Trusts (REITs). Hedge funds typically employ aggressive strategies and leverage, whereas REITs focus on steady income generation and are accessible to public investors.
Who Can Invest in Real Estate Hedge Funds?
Real estate hedge funds are typically open only to accredited investors, as defined by regulatory bodies such as the SEC. Accredited investors must meet specific income or net worth thresholds—such as earning $200,000 annually (or $300,000 jointly with a spouse) or having a net worth of $1 million excluding their primary residence.
How Are Real Estate Hedge Funds Regulated?
Real estate hedge funds are regulated by the SEC but face fewer restrictions compared to public funds like mutual funds or REITs. These funds are typically exempt from registration under the Investment Company Act of 1940.
The Bottom Line
Real estate hedge funds operate by pooling capital from accredited investors to invest in various real estate assets, aiming for high returns through strategies like leverage, flipping, and distressed asset acquisition. These types of hedge funds invest in a variety of properties while emphasizing the importance of due diligence and risk management practices.