Private Equity Real Estate (PERE) – Past Peak June 2022

Uniplan Whitepaper PERE Past Peak June 2022 – Pdf Click Here

The outlook for returns from Private Equity Real Estate (PERE) has materially declined which, we believe, leaves Public REITs looking relatively attractive.

• Higher inflation (8.2% Y/Y CPI in May) has forced the Fed to raise interest rates (FFR +75bps in June to 1.25%) with expectations of several more increases to come. This has increased the Cost of Capital (immediately so regarding debt) and put downward pressure on asset prices. For Commercial Real Estate (CRE) this meant upward pressure on Cap Rates (lower income multiples).
• Over the last 10-15yrs, an exceptional, extended period of low inflation/low interest rates enabled PERE to produce attractive returns – many funds providing annual returns to investors in the mid-teens. PERE funds typically used elevated leverage (~65% Loan-To-Value) and held their assets for several years while cap rates declined (and property values increased). Returns benefited disproportionately from cap rate compression and leverage and less from property income growth, in many cases.
• Looking ahead, it seems likely that inflation will take some time to be reduced, interest rates will remain elevated by comparison with the last decade and there is a non-trivial risk of a recession/stagflationary environment prevailing. Against that background, it is difficult to believe that property cap rates will decline – cap rates for the most sought after residential and industrial properties are at historic lows of 3.5-4.0% (Alternatively said 25-30x EBITDA). Rather, it seems prudent to think cap rates will rise and put downward pressure on property values that would translate into much weaker returns from PERE. Moreover, it is likely that operational growth/improvements will be a larger driver of future returns compared to capital gains from cap rate compression.
• We believe Public REITs offer an increasingly attractive option to institutional and individual investors versus PERE funds and Non-Traded REITs (which have similar characteristics to PERE funds but are aimed at individuals). Most Public REITs operate with lower financial risk (LTV’s ~35-40%), are focused on one property type (apartments, retail, self-storage, etc.) and have full-time, internal management that have specialized experience. We think this offers investors a superior play on operations than the PERE model of high leverage, multiple property types and external management arrangement with notably higher fees.
• An investment in public REITs is volatile (like any public equity stock) but they offer daily liquidity, pricing and high levels of transparency into their businesses. By contrast, PERE funds and Non-Traded REITs offer limited liquidity, less frequent pricing, typically less transparency and usually operate with higher financial risks.

David Harris
June 2022

All investments carry a certain degree of risk, including possible loss of principal. REITs are subject to illiquidity, credit and interest rate risks, as well as risks associated with small and mid-cap investments. It is important to review your investment objectives, risk tolerance and liquidity needs before choosing an investment style. Value style investing presents the risk that the holdings or securities may never reach their full market value because the market fails to recognize what the portfolio management team considers the true business value or because the portfolio management team has misjudged those values. In addition, value style investing may fall out of favor and underperform growth or other style investing during given periods.

Uniplan Investment Counsel is a registered investment advisor. The views expressed contain certain forward-looking statements which can be speculative in nature. Uniplan Investment Counsel believes these forward-looking statements to be reasonable, although they are forecasts and actual results may be meaningfully different. This material represents an assessment of the market at a particular time and is not a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding any particular security and is subject to change without notice. Past performance does not guarantee future results. Prices, quotes and other statistics have been obtained from sources we believe to be reliable, but Uniplan Investment Counsel cannot guarantee their accuracy or completeness. All expressions of opinion are subject to change without notice. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of this security. A list of securities purchased and sold in the portfolio during the past year, including the purchase or sale price and the current market price, is available upon request by calling 262-534-3000.

Uniplan Investment Counsel, Inc., does not advise on any income tax requirements or issues. Use of any information from this report is for general information only and does not represent personal tax advice either expressed or implied. You are encouraged to seek professional tax advice for personal income tax questions and assistance.