- On average, closed-end U.S. real estate funds outperformed the MSCI U.S. Quarterly Property Index by a factor of 1.07 from the funds’ inception through December 2021. But only 1.01 if accounting for fund-specific leverage.
- 58% of funds in our study outperformed the unlevered index, but only around half did so once leverage was accounted for.
- Timing also mattered; 72% of funds from the 2005-2007 vintages underperformed the index on both an unlevered and levered basis. These made up one-third of all underperforming funds.
Global real estate markets enjoyed their strongest returns since the 2008 global financial crisis (GFC) as they bounced back from COVID-19-induced weakness last year. While still strong in Q1 2022, returns fell from their end-of-2021 highs, and by the end of Q2, market sentiment, proxied by listed real estate performance, weakened significantly. This roller coaster of market conditions is a reminder of how much and how fast funds’ operating environments can change, and that real estate funds don’t operate in a vacuum, not even closed-end funds with market-agnostic, absolute-return targets. While many closed-end real estate funds outperformed the market over the last 17 years, there were also many that did not. On average, the performance of closed-end U.S. real estate funds looks similar to what some might call “levered-up” index returns. Combining private real estate indexes with a public-market-equivalent (PME) calculation may help investors identify the funds that have added value beyond broad market exposure.
Comparing apples and oranges?
Relative-market-performance measurement and attribution are commonly applied to open-end portfolios. The performance of closed-end real estate funds, however — due to the uneven timing of cash flows and typical J-curve profile of returns, as well as their generally more actively managed, higher-risk and more-levered strategies — is often measured by internal rate of return (IRR) against an absolute target over the life of the fund. But these characteristics should, in theory, make them more financially and operationally geared to changing market fundamentals, all else being equal, and outperforming a broad-based, unlevered benchmark like the MSCI U.S. Quarterly Property Index might be considered a minimum expectation.
Applying private real estate indexes in PME calculations may actually be a more intuitive way to understand how closed-end funds performed against a market benchmark than a comparison of time-weighted returns. Repeating the analysis with fund-specific leverage applied to the benchmark may provide further information.
More than levered-up market performance?
We assessed the performance of 145 U.S.-focused, closed-end real estate funds from the Burgiss Manager Universe1 using the Burgiss Kaplan-Schoar Public Market Equivalent (KS-PME) calculator, with the MSCI U.S. Quarterly Property Index as benchmark. This index was applied on an unlevered basis, and again for each fund individually, with leverage matching that of the fund to strip out the impact of the fund’s leverage.2
For closed-end U.S. real estate funds of vintages between 2005 and 2020, KS-PMEs measured against the MSCI U.S. Quarterly Property Index varied considerably on an unlevered basis — between 2.2 and 0.08. The arithmetic average across all funds was 1.07, indicating a cumulative outperformance of the index.3 After applying each fund’s own leverage to the index, however, the average KS-PME was 1.01, barely above parity with the index, indicating that, on average, performance amounted to little more than levered-up market returns. That said, levered KS-PMEs also varied widely, but to a lesser degree, from 1.7 to 0.07. Many funds outperformed even after leverage was accounted for; but on the other hand, there were many that did not.
On average, performance was equivalent to levered-up market returns
How to interact with this plot: By using the dropdown, the funds’ performance can be sorted by either the unlevered or levered KS-PME series or the spread between the two. Vintages can be highlighted with the selector under the lot (use shift-click to select multiple vintages). Source: Burgiss, MSCI
Timing wasn’t everything, but it mattered
The chart below shows the KS-PME of each fund against both its unlevered and respective levered index. The lower a fund is below the black diagonal, the greater the benefit from leverage. While we’d normally expect leverage to be accretive (funds below the line where unlevered PME exceeded levered PME), this was most apparent for funds that originated in the post-GFC recovery period of 2008 to 2015.
We found that 58% of funds outperformed the unlevered MSCI U.S. Quarterly Property Index (quadrants B and D in the exhibit below). However, the 10% of funds in quadrant D outperformed only against the unlevered index, implying the outperformance was largely driven by leverage. Only those in quadrant B (48%) still outperformed once their benchmarks were levered to match fund leverage.
Counterintuitively, 4% of funds (quadrant A) outperformed their levered benchmarks despite underperforming the unlevered ones. These were all pre-GFC-vintage funds (2005, 2006 and 2007), where leverage magnified negative benchmark performance during the GFC, providing a lower performance target vs. the unlevered equivalent. The remaining 38% of funds (quadrant C), underperformed both the unlevered and levered-up indexes. One-third of these underperforming funds were pre-GFC vintages and constituted 72% of all pre-GFC-vintage funds, highlighting the potential impact of timing on relative performance.
78% of pre-GFC-vintage funds underperformed on unlevered and levered basis
How to interact with this plot: Use the clickable legend to select vintages (use shift-click to select multiple vintages). Each fund’s vintage, KS-PME (against unlevered and levered reference indexes) and spread can be viewed in the tooltip. Source: Burgiss, MSCI
Market benchmarking for closed-end funds
Using an appropriate MSCI index for private real estate in conjunction with PME calculations and Burgiss Transparency Data can help investors evaluate whether their exposure to individual funds, and their portfolios of closed-end real estate funds, delivered — and whether the greater active risks were rewarded irrespective of prevailing market conditions.
The authors thank the Burgiss team and Fritz Louw for their contributions to this blog post.
1Data was sourced from Burgiss Transparency Data, a holdings-level subset of the Burgiss Manager Universe. Only funds with complete since-inception holdings-level data were considered for inclusion in the PME analysis. Funds of vintages from 2005 to 2020 were included. Funds with no recorded leverage or limited-partner contributions were not included.
2We levered the MSCI U.S. Quarterly Property Index using the loan-to-value (LTV) ratios of the subject closed-end funds on a quarter-by-quarter basis. Interest expense was assumed to be the average of that incurred by funds within the MSCI/PREA U.S. ACOE Quarterly Property Fund Index. For the fund-by-fund analysis, we applied specific fund LTV at each point in time.
3The KS-PME provides a market-adjusted cash multiple where if the end value is higher than 1, the private-market fund has outperformed the respective public-market index. If it’s lower than one, it underperformed. The KS-PME of 1.07 indicates that the final wealth was 1.07 times what it would have been if one could invest in the reference benchmark