Size Matters

by Andrew Moylan

  • 06 May 2011
  • RE

The private equity real estate market grew significantly in the years leading up to 2008, and funds became larger as increasing numbers of investors made commitments to the asset class. However, many institutions have re-evaluated their real estate portfolios as a result of the economic crisis, and institutions are carrying out increasingly detailed due diligence on potential commitments. Investors are also analyzing fund performance and comparing the returns of the multi-billion dollar funds to those of their smaller counterparts.

Between 2003 and 2008, average real estate fund sizes increased and so called mega funds became more widespread. In 2003, just 15% of total capital raised was accounted for by funds worth $1 billion or more. This increased to 44% in 2006, and by 2008 the figure stood at 56%. Average fund size has since declined, but funds which raised over $1 billion still accounted for 47% of capital raised in 2010 and smaller funds have become less significant. Those of less than $500 million contributed 63% of all capital raised in 2003, but just 21% by 2008. The booming real estate markets, coupled with investors increasing their allocations to the asset class, helped fuel the expansion of fundraising. Fund managers set larger targets for each subsequent fund in a series and the huge investor appetite led to fundraising targets typically being met or exceeded, often by significant amounts.

But did these real estate funds actually serve their investors? Using Preqin’s quartile rankings, which allocate each fund a quartile based on its performance relative to other funds of the same vintage year, we can analyze the quartiles of North America-focused real estate funds of 2003 – 2008 vintages by fund size. From this analysis it appears that smaller funds have actually proved to be more successful. 54% of real estate funds which raised under $500 million outperformed the median, with 30% being ranked as top quartile and only 21% ranked bottom quartile. In contrast, the largest funds are often not producing such high returns. 60% of those which raised $1 billion or more are currently producing third or fourth quartile returns, with only 23% producing top quartile returns.

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