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A question I’m often asked involves the merits of investing in private real estate as an alternative to publicly available REITs (the latter vehicle is our recommendation). To answer that question, I will turn to the historical evidence, which we have courtesy of Cambridge Associates.
Cambridge Associates’ private investment database is an extensive collection of institutional-quality private fund performance. It contains historical performance records for more than 2,000 fund managers and their more than 7,300 funds. In addition, it captures the gross performance information of more than 79,000 investments underlying venture capital, growth equity, buyout, subordinated capital and private equity energy funds.
Cambridge Associates’ database allows us to compare the performance of these institutional private real estate funds with the performance of publicly available REITs. For the 25-year period ending 2017, private funds in the database returned 7.6%, while the FTSE NAREIT REIT All Equity Index returned 10.9%. For the privilege of investing with the greatest institutional managers, many of whom are not available to the general public, and in return for sacrificing the daily liquidity available with public REITs, the private, illiquid institutional investments underperformed by 3.3 percentage points a year for 25 years.
As bad as that sounds, the reality was actually far worse. The reason is that the private real estate investments used much higher amounts of leverage.
Private real estate study
In a 2017 article, “Comparing Listed REITs with Private Equity Real Estate: What the Cambridge Associates Data Have to Say,” Brad Case, senior vice president at NAREIT, showed that while private real estate investments were producing lower returns, they also were taking on much greater risk in the form of higher leverage.
Quoting Case: “The now-defunct NCREIF/Townsend Fund Indices reported that average leverage for the funds in its sample during the available period 2007Q4-2013Q3 was usually between 51% and 56% for value-add funds and between 53% and 64% for opportunistic funds – but over the same period it was usually between only 36% and 47% for equity REITs. [Cambridge Associates] doesn’t report average leverage for the funds in their benchmark, but they do report that ‘in terms of limited partners’ total paid-in capital, the [Cambridge Associates] Real Estate benchmark is 71% Opportunistic and 29% Value-Added.’”
Read the full article here by Larry Swedroe, Advisor Perspectives