Publicly traded real estate investment trusts (REITs) outperformed private real estate by nearly 200bps in US pension funds over 25 years, according to a new report by CEM Benchmarking.
According to the National Association of Real Estate Investment Trusts (NAREIT), the outperformance is not attributable to REITs being riskier or more aggressive but because they deliver more of their real estate returns to investors.
Historically, pension funds have tended to favour private real estate because it appears smoother, as valuations are estimated and appraisal-based, while publicly traded real estate investment trusts (REITs) appear more volatile, given that prices are immediately discoverable in public markets. However, the report suggests that over long periods, investors tend to pay for that smoothness through fees, cash drag and delayed recognition of losses, said NAREIT.
The analysis suggests publicly traded REITs have outperformed private real estate by nearly 200bps in US defined benefit (DB) pension plans. The findings are based on the performance of public and private sector plans over the 26 years ending in 2023 – the longest period for which consistent data were available.
Private real estate produced average annual net returns of 7.79% over the period, almost 200bps less than REITs, which delivered 9.72%, the fourth-highest average annual net return among the asset classes analysed.
Even after accounting for the reporting lag associated with private real estate, REIT outperformance remains “very meaningful”, said John Worth, executive vice president for research and investor outreach at NAREIT. “The difference in performance is just under 2% in both cases, looking at net returns as reported and at standardised returns, which are corrected for reporting delays.”
The study also shows that private and public real estate are highly correlated once illiquid returns are adjusted for reporting lags – as expected, given that both invest in fundamentally the same underlying assets.
“The surprise is the low correlation when the results aren’t standardised,” said Worth. “The impact is most significant in years of economic crisis. If we look at 2022, for instance – a year of intense economic disruption in the US – net returns for listed real estate were negative 18%, compared with a positive return of nearly 12% for the unlisted sector. This shows there is still work to be done in understanding the relative volatility.”
To explain the outperformance, Worth points to the fact that listed REITs deliver a greater share of real estate returns to investors. In the US, listed REITs are required to distribute at least 90% of taxable income to shareholders, but there is no similar requirement in private real estate, he said.
In addition, REITs appear to have a lower expense drag, with the study highlighting a fee drag of 1.17% for private real estate vehicles compared with just 0.48% for the listed sector.
Another finding of the study was that DB pension funds make the least use of the structures proven to deliver the strongest returns. Topping the list is the internally managed direct category with a net return of 10.22%, ahead of REITs, but less than 3% of pension fund real estate holdings are managed using this approach.
“I found it remarkable that the two types of real estate that perform best are the ones that don’t have a fundraising process,” said Worth, who distinguishes between capital raisers – including core, value-add and opportunistic funds – and capital allocators such as REITs and internally managed structures.
“Unlike private funds, REITs do not raise capital only when times are good – they can respond dynamically to the cost of capital and investment opportunities. This difference helps explain the outperformance of capital allocators versus capital raisers.”
To read the latest IPE Real Assets magazine click here.
