Real estate outperforms other private capital asset classes

Real estate is outperforming other private capital asset classes with high median IRRs, although there are already signs that this can no longer be sustained, according to Preqin’s Real Estate Spotlight published this month.

The private equity real estate market has witnesses several years of strong performance, and funds of the most recent vintages have outperformed all other private capital asset classes. For vintage years 2013 and 2014, real estate funds have posted higher median net IRRs than all other private capital asset classes, returning 14.3% and 12.2% respectively, according to Preqin. This strong performance may in part explain why a significant majority (88%) of investors felt their real estate investments met or exceeded their expectations in 2017, while 91% felt the same about their portfolios over the past three years.

However, this could be about to change, Preqin’s head of real estate products, Oliver Senchal, told REFIRE: ‘Fund managers are of the opinion that returns could fall by around 2% this year,’ he said. ‘Most investors still see the best investment opportunities in traditional markets, namely in Europe and the US.’

In addition, it is becoming increasingly hard for smaller fund managers to raise capital, Senchal warned. ‘It’s become really challenging,’ he said. ‘Last year marked a decade low for first-time fundraising, at $7b. Investors are more likely to invest with big fund managers with a proven track record.’

More than half of the fund managers surveyed by Preqin believe that the market has reached its peak. Crucially, 61% of fund managers that are bringing a fund to market have said they are reducing their targeted returns, and a quarter of investors expect performance in 2018 to be worse than in 2017.

Nonetheless, that is not putting a visible dampener on investment: 26% of investors plan to invest more in 2018 than in 2017, while the proportion that will reduce their exposure fell to 16% in December 2017, down from 24% a year earlier.

Pricing, however, remains a concern, Senchal said: ‘Pricing concerns are at an all-time high, and significant proportions of both investors and fund managers feel that the market is currently at a peak. That managers are lowering their targeted returns is a sign that they do not know if the current level of performance is sustainable. This does not mean the real estate industry is set to lose its lustre for investors. It is also worth noting that performance relative to expectations may remain on course: investors value factors beyond headline figures, such as diversification, inflation protection, low correlation and risk adjustment. The high-point in the market may mean that top-level returns in the years to come may not match current levels, but real estate is likely to play an important role in investors’ portfolios nonetheless.’