Even for investors who have significant resources and a higher tolerance for illiquidity, listed real estate can offer benefits beyond those found in private equity real estate.
For more than three decades, REITs have provided an attractive intersection of benefits to those seeking commercial real estate investments. A performance advantage over private equity real estate (PERE) funds, now documented by rigorous academic research, simply underscores the opportunity for all investors, according to Virtus.
A recent article in the Journal of Portfolio Management delivered important findings for investors who maintain an allocation to real assets. Researchers Thomas R. Arnold, David C. Ling, and Andy Naranjo found that closed-end PERE funds underperformed listed real estate investment trusts (REITs).
“Given the liquidity premium and other factors, many allocators have assumed the opposite is to be true. The researchers used a ‘horse race’ methodology to analyze returns of PERE funds versus REITs. Rather than simply comparing index returns, this methodology uses fund-level data to account for variables including inception dates and investment horizons of individual PERE funds. The study’s sample of 375 U.S.-focused PERE funds underperformed listed real estate, as measured by the FTSE EPRA/NAREIT U.S. Net Total Return Index, by an average of 165 basis points annually when analyzed over the last 20 years,” Virtus wrote.
According to Virtus, in order to provide a sound comparison, the researchers also examined returns after adjusting for the different risk profiles of REITs versus PERE funds. During the study’s sample period, researchers noted “…REITs generally engaged in low-risk core real estate investment strategies focused on high-quality stabilized properties.“ Further, they noted how REITs “… typically take on less development and operational risk and deliver a significant portion of investors’ total returns through quarterly dividend distributions.” In contrast, many PERE funds sought “…moderate-to-high risk/return opportunities with short-to medium-term horizons” with more leverage typically employed. In some cases, PERE funds pursued riskier development or conversion projects, with the aim of delivering an even higher percentage of total return from value appreciation.
As a result, Arnold et al. developed a series of adjustments to compare returns on a risk-adjusted basis. In this analysis, PERE funds’ underperformance increased with each assumed risk adjustment. The researchers also found that macroeconomic factors contributed to the performance difference between PERE funds and REITs, as the difference increased with interest rate variables and decreased with rising GDP growth, according to Virtus.
Investors looking to gain exposure to REITs should consider the Virtus Duff & Phelps Global Real Estate Securities Fund VGISX, a five-star fund, as rated by Morningstar, that offers exposure to a diverse array of global real estate markets.
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