Private Equity, the Presidential Election, and Real Estate Investing
If you have turned on the nightly news recently, you have probably heard the phrase “private equity” thrown around by news hosts, politicians, and reporters quite often. You probably heard sound clips discussing Bain Capital, whether private equity is good or bad, if it creates jobs or destroys them, and on and on. It seems to be the most recent catchphrase that is everywhere – from one of President Obama’s reelection campaign speeches using it as a negative, to presidential candidate Mitt Romney’s campaign defending his career record in private equity at the company, Bain Capital. Everyone is talking about it. Needless to say, there is a lot of information and misinformation out there.
So, what exactly is private equity and where does it come from?
Simply put, private equity is money from private companies or individuals that is invested into companies, real estate, and research. Private equity, unlike public equity, is not quoted on a public exchange like the NASDAQ or NYSE, but is invested privately. You can’t just walk into your stock broker’s office and invest in private equity investments. Instead, private equity consists of individual or institutional investors and funds that make investments directly into companies. This private equity money is invested in companies with the intent of making a profit from the investment over a period of time. This private money is invested with a certain amount of risk. There is no guarantee that the investor’s money will make money or that their money will be returned. Private equity can also be invested into research or new inventions with the hope of creating something that will eventually make a profit.
For instance, another company that has been making the news recently is SpaceX, who just sent the first private spacecraft to the international space station. A percentage of their funding came from private equity investors. They invested privately in the company and the research being performed in the hope that they will be able to create space travel, and that they can earn a profit.
The majority of private equity comes from institutional investors (insurance funds, pension funds, etc.) and accredited (high net-worth) individual investors. These investments usually have a longer-term outlook and require investors who can invest large amounts of money for unspecified periods of time. The longer period of time is needed to, for example, turn around a struggling company or investment and maximize the investment dollars.
So, how does it work?
These private equity funds, individual investors, or groups of individual investors seek out potential investments in businesses, real estate, new inventions, and other enterprises. They may seek opportunities where they believe that they can buy the business and use their capital to enhance the operations and generate a profit. They can consist of a group of investors pooling their money together to buy a business that has bloated expenses due to excess layers of employees or inefficient processes, with the intent to control the business and fix those problems, and in turn raise the value of the company. The business would then be sold or operated for a substantial return on investment for those private equity investors. This is similar to what Bain Capital does. They would essentially buy companies that are failing, trim them down, and turn them around.
Why does private equity get a bad name?
You might be asking yourself, if what private equity does is invest in businesses, research, and inventions with the hope of making a profit, how does it get a bad name? I know I’ve asked myself that as well when listening to the nightly news interviews and campaign sound bites. This definitely isn’t a political article, but generally speaking, when campaign season comes around things can sometimes get a little distorted. When you hear words like “vulture capital” referring to private equity, what they are referring to is a small percentage of private equity companies that buy companies and immediately fire a large portion of the employee base or break the company down to smaller parts and sells them off individually, doing away with the company but making a big profit in return. Some people do not like these actions because it can destroy jobs or do away with the company, while others argue that the company was most likely struggling and would have gone out of business anyway. At least by doing this, part the company lived on (even if it became part of another company) and protected some of the jobs.
How is private equity used in real estate investing?
Private equity is also commonly used in real estate investing. Private equity is often used to buy larger investment properties such as multifamily communities, retail centers, or office buildings. A private equity investor or group of private equity investors will often pool their money together to buy and invest in an apartment complex. They might buy an apartment complex that needs major improvements or they may purchase a complex in an area where they feel they will receive substantial appreciation over a longer period of time. They hope to buy the property, improve it, and earn a return on their investment. In the case of a multifamily community with poor management or one that needs major capital improvements, the private equity investors would purchase the complex, renovate it or improve the operations and expect to operate and sell it for a profit.
Our company does just this. We bring private equity investors together to purchase multifamily investment properties with the intent of improving and making a profit from the operations and sale of the property. We target multifamily properties that need improvements done either with the operations or physical condition of the property. We then use the private equity to renovate the property and increase the income that it generates. By doing this, we create value to our private equity investors, improve a multifamily community, and provide a return on our private equity investors’ capital.
Next time you turn on the news and hear the words “private equity,” stop and think for a minute about what they are discussing. Private equity is a general term, but can mean a lot of different things. In general, private equity individual investors or companies invest in businesses, real estate, and inventions with the intention of improving them and adding value to their investors and to the companies themselves. Private equity fuels a lot of the products, services, and businesses you love and will be around long after this Presidential election.
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Good summary. I worked for a company that fell apart, and some private equity guys (Cerberus actually) came in and bought the company. They brought in their upper level management to control things — they want to make sure their investors are being looked after, so bringing in their own C-level and upper management makes sense. Then, they bought a second company in the same industry (good technology, but having some cash flow problems, etc) and began to merge the two together to create some value.
Once it was all done, they sold the new combined company, & made some money for their investors. They also had some positive cash flow over 3-4 years while the integration efforts were taking place. Some very high level employees left during the transition, but nearly all the rank and file folks stayed and many are still there today.
It sure beat a bankruptcy and mess of things. It was a good example of how private equity can work well.
Great real world example. I went through a similar example during my corporate days when some private equity guys came in an provided capital for the company I worked for to expand. It made a huge difference and later they sold for a big profit, but the company stayed together and actually over doubled in size of employees.
Thank you for your comments.