The private equity real estate space is one that grew significantly in the years leading up to the financial crisis, securing a high level of commitment from institutional investors. Moving forward in the aftermath of the crisis, investors have become more sophisticated and consequently were carrying out extensive due diligence before deciding where to place capital. One area of evaluation is analyzing the performance of smaller real estate funds in comparison to their larger counterparts.
Although the larger funds come equipped with the resources and experience that are appealing characteristics to investors, there is evidence to suggest that the smaller, less experienced funds could provide better relative performance.
Using Preqin’s Performance Analyst, it is possible to directly compare the returns produced by real estate funds broken down by their size. As shown in the chart below, there is indication of a weak negative correlation between fund size and net multiple. Vehicles with a fund size less than $250mn produced a median net multiple of 1.33x, compared to 1.16x for vehicles with fund sizes greater than $1bn. Similarly, the upper quartile boundary for the smallest funds is 1.65x, compared to 1.325x for the largest.
In many cases the larger, more established fund managers follow investment strategies that stick more closely to the market and go on to produce consistent returns, which could explain the relatively lower net multiples. Smaller funds, by nature, are riskier investments, although they tend to be more nimble than larger vehicles.
Although past performance is not an indication of future returns, there is a suggestion that smaller, riskier assets have the potential for higher returns, although perhaps may not perform as consistently as larger, more established funds. Going forward, it will be crucial for investors to ensure that prospective funds match up with the risk profile of their portfolios in order to achieve the desired results from their real estate allocation.