ArticlePublisher preview available

How do Non-Core Allocations Affect the Risk and Returns of Private Real Estate Funds?

Authors:
To read the full-text of this research, you can request a copy directly from the author.

Abstract and Figures

This paper documents that funds with greater non-core allocations have higher market risk exposure, β, but lower returns. Additionally, it documents that one reason their returns are lower is because they poorly time their investment into these properties. Open-end private real estate funds have higher non-core allocations at the top of the market and lower allocations at the bottom. As such, these funds are disproportionately exposed to the downside of the market. Lastly, I find that reaching for yield and fund flow pressure are important determinants of this phenomenon. Funds buy relatively more non-core properties when either the market return expectations or their net queues are smaller. Buying more core properties when queues are larger enables managers to place capital quicker, but it also hurts existing investors by decreasing their market risk exposure at the time when it is the most desirable and beneficial.
This content is subject to copyright. Terms and conditions apply.
Journal of Real Estate Finance & Economics
https://doi.org/10.1007/s11146-022-09886-0
How do Non-Core Allocations Affect the Risk
and Returns of Private Real Estate Funds?
Spencer J. Couts1
Accepted: 4 January 2022
©The Author(s), under exclusive licence to Springer Science+Business Media, LLC, part of Springer Nature 2022
Abstract
This paper documents that funds with greater non-core allocations have higher mar-
ket risk exposure, β, but lower returns. Additionally, it documents that one reason
their returns are lower is because they poorly time their investment into these prop-
erties. Open-end private real estate funds have higher non-core allocations at the top
of the market and lower allocations at the bottom. As such, these funds are dispro-
portionately exposed to the downside of the market. Lastly, I find that reaching for
yield and fund flow pressure are important determinants of this phenomenon. Funds
buy relatively more non-core properties when either the market return expectations
or their net queues are smaller. Buying more core properties when queues are larger
enables managers to place capital quicker, but it also hurts existing investors by
decreasing their market risk exposure at the time when it is the most desirable and
beneficial.
Keywords Asset pricing ·Risk factors ·Factor loadings ·Commercial real estate
JEL Classification G11 ·G12 ·G13 ·G14 ·G23 ·R33
I am grateful for comments and advice from two anonymous referees, Zahi Ben-David, Brad Cannon,
Moussa Diop, Jeffrey Fisher, Richard Green, Andrei Gonc¸alves, Dongxu Li, Crocker Liu, Haoyang
Liu, C. Jack Liebersohn, David Ling, Greg MacKinnon, Gianluca Marcato (discussant), Andri
Rabetanety (discussant), Andrea Rossi, Ren´
e Stulz, Chongyu Wang, Michael Weisbach, and Lu
Zhang as well as seminar participants at the 2020 Real Estate Finance and Investment Symposium,
the 2020 UNC Commercial Real Estate Data Association Real Estate Research Symposium, the 3rd
Annual REALPAC/Ryerson Canadian Commercial Real Estate Research Symposium (2020), and
the Annual Private Markets Research Conference (2019). All errors are my own.
Spencer J. Couts
couts@usc.edu
1Lusk Center of Real Estate, University of Southern California, 319 Ralph & Gold Lewis Hall,
650 Childs Way, Los Angeles, CA 90089, USA
Content courtesy of Springer Nature, terms of use apply. Rights reserved.
ResearchGate has not been able to resolve any citations for this publication.
Article
Private equity funds hold assets that are hard to value. Managers have incentives to distort reported valuations if these reports are used by investors to decide on commitments to subsequent funds. Using a large dataset of buyout and venture funds, we test for the presence of return manipulations. We find that some underperforming managers inflate reported returns during fundraising. However, those managers are less likely to raise a next fund, suggesting that investors can see through the manipulation. In contrast, top-performing funds appear to understate valuations. A simple theoretical framework rationalizes our empirical results as well as those of related papers.
Article
This article empirically analyzes whether core and noncore private income producing properties have different investment returns, using a large sample of about 5,000 individual properties during the 1997-2014 period. We use a holding-period factor model to control for both systematic risk, including loadings of both public equity factors and a real estate factor, and nonsystematic risk. We find that core properties have lower systematic risk but higher returns than noncore properties before and after adjusting for both systematic and nonsystematic risk.
Article
General partners (GPs) in private equity (PE) report the performance of an existing fund while raising capital for a follow-on fund. Interim performance has large effects on fundraising outcomes. The impact is greatest when backed by exits and for low reputation GPs. Faced with these incentives, GPs time their fundraising to coincide with periods of peak performance through two strategies: (1) exit and fundraise and (2) net asset value (NAV) management. Consistent with the former, performance peaks are greatest for funds with high realization rates. Consistent with the latter, low reputation GPs with low realization rates experience performance peaks and erosions in performance after fundraising.
Article
Real estate strategies broadly fall into three categories: core, value-added and opportunistic. This empirical examination of net returns from these three strategies indicates that, on a risk-adjusted basis, the value-add funds have strongly underperformed and the returns from opportunistic funds have weakly underperformed the returns available from core funds. In so concluding, this article departs from standard asset-pricing models in two important respects: the total risk is used and the cost of borrowing increases as leverage increases. While the first departure has no substantive effect, the second departure lowers the estimate of the underperformance of non-core funds. This article is protected by copyright. All rights reserved
Article
This article examines real estate's role in institutional mixed-asset portfolios using both private- and public-real estate indices, as a means of examining varying real estate-related risk/return opportunities. In so doing, this article also examines the effects of: (1) increasing the investment horizon, (2) placing constraints on the maximum allocation to any one asset class, and (3) varying the risk preferences of investors. The empirical results suggest—using infinite-horizon returns and all of the caveats that accompany such a perspective—that real estate allocations of approximately 10–15% of the mixed-asset portfolio represent an upper bound for most investors. For those investors preferring low-risk portfolios, (unlevered) private real estate is the vehicle serving this allocation preference; for those investors preferring high-risk portfolios, public real estate (with its embedded leverage of 40–50%) is the vehicle serving this allocation preference—with such vehicles serving as substitutes for a variety of noncore real estate strategies. In some sense, the distinction between private and public real estate is more about the use of leverage. For those investors preferring moderate-risk portfolios, an intermediate-leverage approach seems optimal.