What's Wrong With Capital Appreciation in Core Real Estate?

| About: Vanguard REIT (VNQ)

Real estate investment provides investors a fundamental return pattern that’s both simple and appealing: A strong flow of current income from lease rents, with a little capital appreciation thrown in for long-term investors.

Here’s a shocker, though: The capital appreciation part of that deal seems to have gone AWOL for most investors in private real estate and private equity real estate funds.

The National Council of Real Estate Investment Fiduciaries (NCREIF) keeps track of the returns on real estate investments by large pension funds, whether those returns come from owning buildings directly or from investing through private equity funds following core, value-added, or opportunistic investment strategies.

Since the beginning of 1978—that’s 32½ years of data—the average property held in a core fund has gained ZERO in capital appreciation. Directly held core properties have done hardly better, gaining only 1.0% per year over the same period. (Data on value-added funds go back only to the second quarter of 1983, but since then they’ve done even worse, losing 0.5% per year.)

And that doesn’t even take inflation into account. In inflation-adjusted terms, the average institutionally-owned core property has lost 2.85% of its value each year, while the average core real estate fund has lost 3.76% per year. (Data on opportunistic funds go back only to the fourth quarter of 1988, and over that period they’ve lost 0.10% per year.)

Publicly traded REITs have provided much stronger capital appreciation, gaining on average 4.21% per year since the beginning of 1978 and keeping ahead of inflation by 0.25% per year.

Meanwhile, income holds up its part of the deal, averaging 7.69% per year for institutionally owned core properties, 7.74% for core funds, and 7.93% for publicly traded REITs. (Value-added and opportunistic funds averaged 7.0% and 5.8%, respectively, over their shorter periods.)

If you have any ideas why institutional investors have so completely failed to enjoy capital appreciation on their direct property investments, I’ll be interested to hear your comments.

Disclosure: Author is long Vanguard REIT Index Fund and ING Real Estate Fund

Disclaimer: The opinions expressed in this post are my own and do not necessarily reflect those of the National Association of Real Estate Investment Trusts ((NAREIT)). Neither I nor NAREIT are acting as an investment advisor, investment fiduciary, broker, dealer or other market participant, nor is any offer or solicitation to buy or sell any security investment being made. This information is solely educational in nature and not intended to serve as the primary basis for any investment decision.