REIT and Private Real Estate Performance

October 13, 2021

A recent analysis of the performance of real estate investments held by 200 of the largest U.S. pension funds with a combined $3.6 trillion in Americans’ retirement assets shows that these financial advisors are likely offering sound advice. The pension funds’ experience shows that REITs outperformed private real estate, including properties managed by external managers and funds.

The study, by the pension benchmarking firm CEM Benchmarking, was based on the realized, aggregate fund level performance of pension fund investments over a 22-year period, 1998–2019, representing the latest end-date for which data was available. One of the unique benefits of the dataset used in the study is that it provided measures of performance at the pension fund level net of the real estate managers’ fees. The CEM dataset allows adjustment for illiquid asset reporting lags at the individual pension fund level. Reporting lag is the delay between when an underlying asset changes value and when that change in value is reported to the pension fund or investor. Illiquid assets like unlisted real estate have reporting lags.

The types of real estate included in the study were those most commonly found in pension fund portfolios: REITs; directly owned real estate; core real estate funds; value added/opportunistic real estate funds; and real estate funds-of-funds.

REITs delivered the highest average annual net returns over the study period at 10.68 percent. Internally managed core real estate was second, with average annual net returns of 10.10 percent. Net returns of the externally managed private real estate styles were significantly lower, reflecting their higher management costs. Core real estate funds had average annual net returns of 8.34 percent, and value added/opportunistic funds had average annual net returns of 8.66 percent. Average annual net returns of funds-of-funds style were 6.86 percent, reflecting this style’s additional layer of management costs.

The study showed all of the real estate styles provided comparable diversification benefits, showing similar levels of correlation with the most common building blocks of retirement portfolios: large-cap U.S. stocks and broad U.S. fixed income securities. REITs had a 0.56 correlation with stocks and 0.48 correlation with fixed income. Internally managed real estate showed a 0.54 correlation with stocks and a 0.43 correlation with fixed income. Core funds showed a 0.54 correlation with stocks and a 0.43 correlation with fixed income, while value added / opportunistic funds showed slightly more correlation with stocks at 0.61 and slightly less with fixed income at 0.38. The comparable diversification benefits of all the real estate styles were not surprising to the study authors, since all of the underlying real estate assets are fundamentally the same.

Volatility of real estate returns also was similar across styles after adjusting for reporting lag, refuting the contention that private real estate investment is meaningfully less volatile than publicly listed real estate. REITs had average volatility of 18.94 percent over the study period, compared to 18.12 percent for internally managed real estate; 16.99 percent for core funds; 18.49 percent for value added / opportunistic funds real estate and 18.93 percent for fund-of-funds.

REITs’ comparable volatility to private real estate, coupled with their higher returns, gave them a strong risk-adjusted return over the 22-year study period. REITs’ Sharpe ratio for the period was 0.44—the same as that for internally managed real estate. The Sharpe ratio for core real estate funds was 0.36; value added / opportunistic private equity real estate was 0.35, and fund-of-funds was 0.25 as a result of its lower returns.

For advisors, the results of the CEM Benchmarking study tell a clear story of the advantages of using REITs to gain real estate exposure for their clients. The REIT approach to real estate investment provides comparable diversification to private real estate with higher net returns and no trade offs in volatility. Advisors considering commercial real estate for their clients should take a closer look at REITs.

The full study can be accessed here.

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