Another Look at Private Real Estate Returns by Strategy

Abstract

This article examines the risk-adjusted, net-of-fee performance of noncore funds and generally finds that investors would have been better served by merely placing additional leverage on their core investments rather than investing in noncore assets. Using several datasets to create a mosaic-like view of the performance of private real estate investments, the authors find that over the 2000–2017 study period, value-added funds have, on average, generated an alpha of –3.26%; similarly, opportunistic funds have generated an alpha of –2.85%. Consequently, had investors in core funds used more leverage (loan-to-value ratios of 55% to 65%), they would have saved approximately $7.5 billion per year in unnecessary investment-management fees. The higher fees charged by these noncore funds were a material factor contributing to their negative alphas. Value-added funds charged approximately three times as much in fees as core funds, and opportunistic funds charged approximately four times as much. How and why these fee structures might change in the future is also explored. However, the fee differentials (relative to core funds) are insufficient to explain the entirety of the negative alpha associated with value-added and opportunistic investing. These conditions imply that noncore managers have, on average, overpaid for (and/or mismanaged) fund assets.

TOPICS: Real estate, other real assets, private equity

Key Findings

• • This article examines the risk-adjusted, net-of-fee performance of noncore funds and generally finds that investors would have been better served by merely placing additional leverage on their core investments.

• • Over the 2000–2017 study period, value-added funds have, on average, generated a negative alpha of −3.26%; similarly, opportunistic funds have generated a negative alpha of −2.85%.

• • Had investors in core funds used more leverage (loan-to-value ratios of 55% to 65%), they would have saved approximately $7.5 billion per year in unnecessary investment-management fees.