Alex Beath is a senior research analyst at CEM Benchmarking. Nareit recently collaborated with CEM to analyse more than two decades of U.S. pension fund performance data.
What makes the CEM data and this analysis unique?
First, and probably most important, is that the data we present are actual returns from some of the largest U.S. defined benefit (DB) pension funds with nearly $4 trillion of assets, not index returns or benchmarks returns. Real returns net of costs means that this is what big U.S. investors actually got from their investments net of all fees.
Second, we have true-time weighted returns from private equity and unlisted real estate. We have annual returns and not IRR (internal rate of return) as often is reported. Because of this, we can make apples to apples comparisons between listed and unlisted assets, like private equity to public equity, or listed real estate (REITs) to unlisted real estate.
How do REITs perform over time?
REITs have been a really strong performer over the 21 years compared to just about anything, neck and neck with (but not correlated to) private equity. On a simple average basis, that’s over 10% per year, and a little under 9% on a compound basis. But private equity is a lot riskier, and so on a risk-adjusted basis REITs have performed better than even private equity.
What does a comparison of REITs and private or non-listed real estate show in terms of returns, correlations, and volatilities?
This is an important comparison. Returns for REITs have been better though by nearly 2.7% per year. There seems to be this pervasive belief among pension funds that REITs and unlisted real estate are somehow different asset classes, but we don’t see that at all. Our data shows them to be two sides of the same coin. That comes with some caveats though. Pension funds investing in unlisted real estate report returns that are about a year out of date, and so at first blush REITs and unlisted real estate aren’t correlated, but they are about 90% correlated.
Why REITs have outperformed private real estate is a good question, frankly the jury’s still out. The volatilities are so similar it’s hard to see unlisted real estate having anything but a similar amount of leverage. But cost definitely seems to be part of it; unlisted real estate, like private equity is expensive, more than two times the cost of an active REIT program.
How do REITs perform relative to different styles of private real estate ownership?
When we look at performance of unlisted real estate by style, we see what one might expect. Opportunistic funds outperform core/core+, and fund-of-funds trail badly, mostly due to cost. Internally managed real estate seems to do better, again something we believe is mostly driven by cost.
But interestingly, REITs historically have outperformed all styles of unlisted real estate. Why is a great question—leverage differences, cost differences, sectors, and geographic differences might play a role, but at the end of the day the clear fact is that U.S. DB pension funds would have achieved a better net return if they had more REITs and less unlisted real estate whatever the style, all with a similar level of risk and more liquidity. Costs matter in the equation.