A report issued today by Preqin, which collects data on private equity investing, details what it calls "real problems" in the private equity approach to real estate investment. Preqin cites quite a litany of reasons why, as it says, "private equity real estate fundraising continues to flounder," including "the state of the real estate market, the drop in property valuations and the poor performance of private equity real estate funds of recent vintages." Preqin focused in particular on the fact that "performance of (private) real estate portfolios has remained poor, failing to show the same levels of improvement as other asset classes."
To get a handle on the problems, Preqin conducted a survey of the most important reasons that investors are wary of investing in private equity real estate funds:
- 26% "said that the illiquid nature of private real estate investments is an issue for them"
- 21% of investors "are worried about current real estate valuations"
- 18% of investors cited "the misalignment of interest between fund managers and investors"
- 16% cited "the level of leverage utilized by private real estate fund managers and prevailing debt financing issues"
- 10% were concerned about "fund terms and conditions and the fees charged by real estate firms"
- 10% "thought that the poor performance and returns generated by private real estate funds were key issues"
- 8% of investors stated "there is a strategy-to-market fit discrepancy, reasoning that a significant proportion of funds in market are not well positioned to succeed in the current market"
One interesting tidbit is that "funds that held a final close in 2010 spent on average 17.7 months in market, almost twice the length of time it took to close a fund in 2006 and 2007." That means private equity funds are spending a huge amount of their time and money on (mostly unsuccessful) fundraising rather than on acquiring and managing property portfolios.
That gives some perspective to two enduring problems with the private equity approach to real estate investing:
- Private real estate funds are a hugely expensive way to access the real estate asset class. Opportunistic funds, for example, average 226 basis points of fees and expenses; value added funds 136; core funds 107. Compare that to the publicly traded REIT approach, where, for example, the Vanguard REIT ETF (VNQ) has an expense ratio of only 0.13%.
- Private real estate funds aren't aggressively buying properties, even though we're currently at the bottom of the market, while publicly traded REITs are the most active buyers. That's partly because private funds don't have good access to capital, but perhaps it's also because they're spending too much of their time on the road trying to raise it!
What does this mean for REIT investors? The more trouble that private-side real estate investment managers have raising capital, the less competition they'll provide to publicly traded REITs in terms of property acquisitions. Accretive acquisitions are already considered one of the two main drivers of likely REIT earnings increases going forward -- and continued "floundering" on the private side just makes that engine of REIT earnings growth fire more strongly.
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.
Disclosure: I am long VNQ and ING Global Real Estate Fund.