When you think of private equity, you probably think about these huge corporations who are able to take millions and millions of dollars and buy corporations.
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In some instances private equity groups have bought public companies and taken them back private in leveraged buy-out situations. The real estate sector also has private equity groups, although they don't always function in the same way as their leveraged buy-out partners. Here are a few things private equity investors do in the commercial real estate market.
Private Equity defined.
Private Equity groups are called that because that's essentially what they do. They provide equity financing to business and projects in return for ownership. Unlike debt providers, who provide a set sum of money in return for specific payments; private equity providers provide money in return for a certain slice of the ownership of the venture. In many cases this helps private equity groups lay claim to a significant portion of the upside of the ventures they invest in. .
For instance, if a bank loans money to a start-up company and they end up going public and making gobs of money, the bank will only get back the money that they invested on the basis of a simple amortization schedule. The bank gets their principal back with interest based on the terms agreed upon at closing. A private equity group has significantly more flexibility. They can invest and instead take a percentage of the ownership. If that some groups goes public and becomes a leader in its industry, the private equity group could garner enormous profits. .
Where do they get their capital?.
Different private equity groups, raise different funds for different purposes. They could raise the money from anywhere from insurance companies, pension funds, high net worth individuals, and even foreign governments looking to invest in America. The important thing with private equity groups is that they are able, in many cases, to acquire patient capital. Their investors are looking for a certain return, no doubt, but they don't necessarily require the immediate payback schedule that banks operate on. .
Private Equity in real estate.
In real estate, private equity groups are able to perform a few important functions. One of these is that they are able to source real estate purchases that many private companies cannot. They can come up with large sums of capital to make huge purchases all at the same time. This can be a significant advantage over companies restrained by traditional lending. In most instances, however, private equity groups will take advantage of the leverage offered by banks since it can juice their overall return. Their ability to come up with the required equity payments helps them to make winning bids on desirable properties. .
Another thing private equity companies do is to invest selectively in pieces of certain assets. If you, as an entrepreneur, are developing a project and need financing, you may not be able to secure all of the necessary financing from a bank. The bank may deem it too risky, or simply be constrained by the way it interprets the loan to value requirements. If you are unable to come up with the required equity to finance your project you may be able to develop a relationship with a private equity group to plug that gap. Although they will require a chunk of ownership in your project for their equity contribution, it may be invaluable in helping you get your company off the ground.