In an Apples-to-Apples Comparison, Public Real Estate Investments Outperform Private Ones

Both private and public markets provide access to real estate investment – but new research suggests that one can be more effective than the other.

In a new study published in the real estate issue of the Journal of Portfolio Management, authors Thomas Arnold, David Ling, and Andy Naranjo found that real estate investment trusts outperformed U.S. closed-end private equity real estate when compared. or PERE, fund by 165 basis points annually.

The study was based on a sample of 375 PERE funds, which the researchers compared to an index of listed REITs and an index of private real estate funds. To accurately evaluate performance, the authors took a “horse race” approach by comparing the realized return of each PERE fund with the return that investors in the indices would have achieved over the same investment horizon.

“It’s an apple-to-apples comparison,” said Arnold, the former global head of real estate at the Abu Dhabi Investment Authority. “And, on average, you’d be better off investing in the public markets and the outperformance is significant.”

At the global level, REITs outperformed a sample of 255 international PERE funds by an average of 194 basis points, according to the study.

And when public market risks such as risk, leverage, illiquidity and uncertainty were taken into account, REITs performed even better. In the risk-adjusted sample, the proportion of PERE funds that outperformed the REIT index fell by eight percentage points, while the proportion of funds that underperformed increased by eight percentage points. As risk increased, the authors found that the performance disparity between the PERE returns and the REIT index increased.

In the paper, the researchers realized that public markets have advantages over private ones, including leverage and liquidity. In the public markets, equity analysts act as a check of companies against over-indebtedness. But that level of oversight doesn’t exist in the private markets, Arnold said. Closed private funds have, on average, higher levels of indebtedness, which means that they host more debt.

Liquidity is also an issue in the private markets. While investors and managers can get in and out of the public markets at will, they have less flexibility when investing in private real estate funds.

“In the public markets, you can call your broker and invest today if you want,” said Arnold. “And if you decide to sell in six months, you can sell it. You may not like the pricing, but at least there is liquidity, which is not the case at all in the private markets. “

Arnold noted that the results don’t necessarily mean that private funds can’t outperform the public. But he said limited partners should be more strategic with their property allotments.

“If you had a crystal ball and you could find a top quartile private fund manager, you’d be pretty lucky,” he said. “But if you play the odds, you will be better off with a higher allocation in the public markets.”

Going forward, Arnold said, he expects investors to make larger real estate allocations in the public markets. He also believes that investors will increasingly take action against current fee structures in the private sector.

“The environment has changed dramatically, but the fee structures look very much like 25 years ago,” said Arnold. “It’s only going to change slowly, but I think investors will start pushing back.”