Why do many PE firms avoid buying companies with a lot of real estate holdings? (1 min)

Many mid-market PE firms which focus on buying companies for their cash flows and do not have any real estate groups will try to avoid having to buy a lot of real estate in order to complete an LBO. This is because they simply don’t have the expertise to analyze and value the real estate accurately.

If the company they are targeting has a lot of real estate, they may do a sale-leaseback upon acquisition. This is where they sell the real estate to another party and pay rent to them on previously agreed terms.

PE firms may avoid large real estate holdings if they specialize in buying companies and do not want the complexities of managing real estate. Real estate analysis is typically very different from analyzing the recurring cash flows of a company, and it also carries certain risks. For example, if the target company owns real estate in which they are making rental income, the PE firm needs to a separate analysis on the net operating income derived from its tenants. They would have to analyze the creditworthiness of tenants and how long tenants have stayed, as well as the various lines of business they’re in assuming it’s commercial real estate. The PE firm would also have to analyze the local real estate market as well as any shifting trends and demographics.

In other words, real estate analysis is an entirely different world than standard PE acquisitions of companies with recurring cash flow, and the PE firm may not be well equipped to perform this very specialized analysis which is often very different depending on the geography and type of real estate. Larger PE firms with real estate groups, however, may be more willing to collaborate and perform this type of analysis, so this avoidance of real estate is more common in mid-market PE funds that may not have a real estate investment group.