REIT returns beat real estate funds, other alts

Real estate investment trusts topped returns of real estate funds — at least until this year, and continue to outperform other publicly traded assets, three new reports show.

A study by Chicago-based Morningstar Inc. found that REITs provided an annualized rate of return of 9.3%, compared with 4.4% for private equity core funds, 3.7% for value-added funds and 6.1% for opportunistic funds between 1989 and 2009.

The Morningstar study compared returns of four indexes for the 20 years between 1989 and 2009: the FTSE NAREIT All-Equity REITs index, which excludes mortgage REITs; the National Council of Real Estate Investment Fiduciaries' Open-End Diversified Core Equity index; NCREIF-Townsend Value-Added index; and the NCREIF-Townsend Opportunistic index.

The study also found that during the study period, REIT fees and expenses averaged one-half to one-fourth of private equity real estate fees.

Cohen & Steers Inc. came to a similar conclusion in a white paper released last month. Cohen & Steers compared the returns of REITs and core real estate funds through Dec. 31, 2010.

“Over 30 years, REITs outperformed by 487 basis points per year,” according to the paper, an update of one published by the REIT manager in June 2010.

Over the past year, “the long-term track record for most private real estate has not been particularly good,” said Jon Cheigh, a New York-based Cohen & Steers' senior vice president and portfolio manager, who co-authored the paper with Joseph Harvey, president and chief investment officer.

“Liquidity is not valued” by investors, Mr. Cheigh said.

Traditional asset allocation models fail to account for the value of liquidity, resulting in a systematic overallocation to private real estate, the paper asserted.

If an investment is riskier you should get a higher return, he said.

“That's what throws people for a loop in comparing private real estate with listed real estate or REITs,” he said.

During the first eight months of 2011, however, REIT returns lagged the NCREIF Property index, according to New York consulting firm Deloitte LLC's annual Commercial Real Estate Outlook. But, the Deloitte report noted, REITs continue to outperform other publicly traded asset classes.

And the outlook for REITs could be a positive one. Deloitte notes that following two lousy years during the recession in 2007 and 2008, REITs rallied to double-digit returns, besting the NCREIF Property index. This trend slowed in the first eight months of 2011, with REITs providing a 3.3% return, down from 27.6% in 2010. By comparison, the NCREIF Property index return was 7.6% for the six months ended June 30 down from 12.6% in 2010.

NCREIF's Open-End Diversified Core Equity index, which was used in the Morningstar comparison, consists of 18 funds with $96.2 billion of gross and $70.9 billion of net real estate assets. It is relatively new, introduced in 2005.

Until NCREIF released the ODCE index, comparisons between REITs and real estate equity returns were restricted by the NCREIF Property index, which is “a very comprehensive index for core properties,” said Michael Grupe, executive vice president for research and investor outreach at the National Association of Real Estate Investment Trusts, a Washington-based trade association. “We had information but it didn't represent reality,” Mr. Grupe said.

For NAREIT, the issue has been that institutional investors' real estate portfolios have been heavily dominated by private real estate equity, Mr. Grupe said. But the NCREIF Property Index measured unleveraged real estate, which did not reflect investors' private real estate portfolios. The newer NCREIF indexes provide a better measurement for comparison, he said.

Indeed, defined benefit funds in the largest 200 U.S. retirement plans invested a combined $22.5 billion in REITs compared with $167.7 billion in real estate equity in 2010, according to the Pensions & Investments data (P&I, Feb. 7, 2011).

But NAREIT doesn't suggest institutional investors ditch their direct real estate investments.

“We felt that it really shouldn't be viewed as an either/or choice on the part of large plan sponsors,” Mr. Grupe said. “There's good evidence of important diversification benefits in real estate portfolios by having exposure to public and the private side. … To get diversity, you need a somewhat more balanced approach between the private side and the public side investments.”