Real estate cycles and the stock market do not move in lockstep with one another. And while there may be a few good reasons to use publicly traded REIT indexes as a comparison for nontraded REIT performance, the values of nontraded REITs are more closely tied to the real estate cycle. As a result, direct real estate investment benchmarks such as the NCREIF (National Council for Real Estate Investment Fiduciaries) property index offer a more appropriate performance comparison tool.
Much like direct real estate investments, nontraded REITs, private equity, and other illiquid investments move through distinct stages such as raising capital, investing in a portfolio and managing properties, and liquidating after a period of several years. In addition, returns for nontraded REITs, like private equity funds, are often low or negative in the early years, due in part to upfront fees and to the time it takes to acquire portfolio assets and for those assets to appreciate in value. This financial principle, called the “J-curve effect,” means that an initial loss is followed by, hopefully, a significant gain.
Based on preliminary results from the soon-to-be-published 2014 Nontraded REIT Full-Cycle Study, actual data are available to illustrate this point. When we compared the performance of 35 nontraded REITs that had completed a liquidity event between 1990 and July 2014 to the NCREIF National Property Index Returns, we found that over a third outperformed the NCREIF results and an additional seven out of the 35 REITs were within 1.5% of the NCREIF returns over matched holding periods. If we recognize that the NCREIF index does not include any fees, it is meaningful that 20 of 35 nontraded REITs had better or comparable fee-adjusted shareholder returns to private portfolio investments in commercial real estate.
For nontraded REITs — like private equity — real progress is gauged over time. The strategy and efforts of the sponsor to acquire and manage real estate can take several years and can be evaluated only after equity offerings are concluded and independent appraisals are done.
Nontraded REITS in a League of Their Own
The time (at Blue Vault's 2nd Annual Broker Dealer Educational Summit) proved extremely informative.