Recent years have been extremely challenging for the private real estate fund industry, with both fund managers and institutional investors facing a range of difficulties. The industry today is very different from the one from even just a few years ago. Fundraising for fund managers is very tough, but there are also many obstacles investors face when they look to construct a successful real estate fund portfolio. With a record number of funds on the road and a vast difference between the best and worst performing funds, manager selection is extremely difficult.
Investors in private real estate are now more sophisticated than ever, with a detailed understanding of the asset class and are increasingly seeking to have more control over their portfolios. However, access to unbiased, up to date, and accurate intelligence can be difficult to source. This information can be key to ensure the building of a successful portfolio and to form long lasting and fruitful partnerships with fund managers.
Real estate investments may be attractive to investors for a number of reasons. Real estate portfolios can offer diversification, act as an inflation hedge, and provide a steady income stream. Most investors, however, will still expect real estate, and in particular private equity real estate funds, to offer strong performance compared with traditional investments. There is a financial and liquidity cost associated with getting access to private equity real estate funds; consequently, returns above and beyond other asset classes are required to justify this.
Since 2000, the PrEQIn Real Estate index has outperformed Standard and Poor’s free-float capitalization-weighted index of 500 US-based large cap stocks (S&P 500), and has remained above the S&P 500 in every quarter shown. For the latest data available, the PrEQIn Real Estate index stands at 187.8, just below the PrEQIn All Private Equity Index, which stands at 189.6, but significantly above the S&P 500 which stands at 95.3.
While the private real estate fund industry delivered very strong performance in the years prior to the global downturn, the story has been very different since then. While the PrEQIn All Private Equity Index has returned to the levels seen in 2007, the PrEQIn Real Estate index remains well below its peak of 337.0 from June 2007. Investors that committed significant amounts of capital between 2005 and 2007 were significantly affected by the downturn.
There are some encouraging signs in the performance of the most recent vintage funds however, with the median IRR for 2009 vintage funds standing at 13.9%. It is very early in the life spans of these vehicles, and the performance of these funds is likely to change a great deal, but it does indicate potential for private equity real estate funds to provide investors with strong returns in the future.
The private real estate fundraising market is extremely overcrowded at present and given mixed appetite among investors to invest in real estate funds, it is clear that there is not the supply of investor capital for all these funds to be successful. The aggregate target of $165bn represents more than three years’ worth of fundraising at the levels seen in 2011. Despite the tough environment, the number of funds in market continues to increase, with the number of funds on the road increasing from 363 in Q1 2010 to 473 in Q3 2012.
For investors, it is hard to indentify the best opportunities given the sheer number of funds being marketed. They may also have to decide whether to re-up with existing managers, or whether other funds on the road are more attractive.
Identifying the top performing fund managers is one of the hardest tasks facing institutional investors. There is a significant difference in performance between the best and worst performing funds, demonstrating the importance of investors selecting those firms most likely to achieve the strongest returns. Top quartile funds have never produced negative IRRs for any vintage year, while bottom quartile offerings of 2004–2008 vintage years are deep into negative territory.
For investors looking to indentify the strongest managers, track record will be one of the best indicators. Past performance is of course no guarantee of future success, but it can be a positive indicator of the skill of the investment team. In particular, many investors want to see evidence that fund managers can succeed in tough markets, as well as good ones.