How do private real estate investors potentially make money?
Returns depend entirely on the structure. A private real estate investment might pay interest on a loan, distributions from property cash flow, a share of appreciation or sale proceeds, or some combination. There is no universal return for private real estate, and projected returns are never guaranteed. Ask exactly where the money is expected to come from and what has to go right for the investment to perform as projected.
“How much will I make?” is the question everyone asks first. The more useful question is “how would I make it, and what has to go right?” The answer is different for every structure.
The common ways capital gets paid
- Interest. You lend money to the project; the borrower pays a stated rate for a stated term, and your principal is returned at maturity or when the property sells or refinances. Debt sits ahead of equity in line, which is why lenders usually accept a stated rate rather than upside. The rate is paid only if the borrower pays.
- Preferred return. In an equity deal, investors may be entitled to a set percentage before the operator shares in profit. “Preferred” describes the order of payment, not a guarantee.
- Profit participation. After capital and any preferred return are paid, remaining profit is split between investors and the operator according to the agreement.
- Distributions from cash flow. For properties that are held and rented, periodic payments from net operating income.
- Exit proceeds. The sale or refinance of the property returns capital and, if the project worked, gain.
What determines whether the money shows up
For a renovation project, the math is roughly: after-repair value − (purchase + rehab + holding + financing + selling costs) = profit. Every one of those inputs can move. The purchase price is fixed at closing; the rest are estimates until the project is done.
Questions worth asking on any projection:
- What sale price or rent does this assume, and what recent comparables support it?
- What is the rehab budget, who built it, and what is the contingency?
- How long is the timeline, and what happens to my return if it runs six months long?
- If the property sells for less than projected, who absorbs the shortfall first?
What “double-digit returns” does and does not tell you
A headline rate says nothing about the risk taken to earn it, the position of your capital, or what happens in a bad outcome. Two opportunities that both project the same return can be very different investments. Compare the structure, the collateral, the operator and the downside, not just the number. And treat any projected return exactly as what it is: a projection. See What are the biggest risks?