Taking Stock
Melting the Illiquidity Myth
Did you know that REITs outperformed private equity real estate funds AND provided valuable li- quidity benefits over
a 15-year period?
I believe that even most of
us who have fully embraced the
REIT approach to real estate
investment are unaware of that
fact. In this column, I want to
conclusively puncture the myth
of the “illiquidity premium” and
articulate the benefits REITs
provide as the most efficient,
best returning way for institutions and individuals to own
commercial real estate.
A recent IREI/Kingsley Associates survey of the largest
U.S. pension plans, endowments
and foundations found that
the institutional investment
community is increasing its
commitment to REITs. The
survey showed the institutions,
on average, plan to increase
their REIT allocations to 10. 7
percent of their total real estate
portfolios in 2010, up from 8.4
percent in 2008.
Gary Landsman
For REITs, that is an encouraging sign. With $200 billion to
$300 billion in institutional real
estate portfolios, such a shift in
real estate allocations can mean
significantly more investment in
REITs.
Surprisingly, though, when
asked how they expect to commit
new capital to commercial real
estate this year, institutions said
the bulk would go to private
equity funds: 36 percent to core
funds; 20 percent to opportunistic funds; and 6 percent to
value-added funds. The investors reported they planned to
commit only 3.4 percent of their
new real estate capital to REITs.
Illiquidity Imposes
Big Costs
The findings are shocking because of the pain many private
equity funds caused their institutional investors in 2008 and
2009, when the plans could not
access their investment capital.
If we learned anything during
those years, it was that illiquidity imposes significant costs on
investors and that liquidity is a
precious characteristic that has
substantial value. Indeed, the
IRS valuation handbook suggests that illiquid investments
should likely be discounted by a
minimum of 20 percent versus
liquid alternatives.
The principal reason most
of these investors still funnel
more money into private real
estate funds than into REITs is
that they believe private equity
ultimately will deliver a margin-
ally higher return when com-
pared with public securities—a
marginal return known as the
illiquidity premium. In return for
the illiquidity risk that comes
from giving up access to your
money over a long period, you
will be compensated with higher
returns than liquid securities
provide. While many institu-
tions accept the concept of the
illiquidity premium as estab-
lished fact, the data show that
liquid REIT securities provide
higher returns AND provide the
benefit of a readily saleable asset.
Let the Numbers Speak
NAREIT has conducted an
analysis of public vs. private real
estate returns over the long bull
market from the trough of the
early 1990s to the recent peak.
Over this period, private equity
real estate funds using a core
strategy employing an average
of 20 percent leverage delivered
a total return, net of fees, of
341 percent. Value-added funds
with an average of 54 percent
leverage delivered a net return
of 430 percent; and opportunistic funds, with an average leverage of 67 percent delivered a net
return of 964 percent. By comparison, the F TSE NAREIT
Equity REIT Index exceeded
these net returns handily by
delivering a net return of 1,041
percent. And they did it with
less leverage (and therefore less
risk) than two of the three types
of private equity funds.
The facts are clear: REITs
have outperformed private eq-
uity funds over the long term. I
strongly believe that the reason
for superior performance owes,
