Small Real Estate Funds Outperform
Monday, May 09, 2011

Despite dominating the private real estate market in the years leading up to the financial crisis, North America-focused funds with USD1bn or more in commitments are being outperformed by funds of less than USD500m in size, according to Preqin’s performance quartile rankings.

Preqin's rankings show that 54% of small funds (less than USD500m) are outperforming the median; 30% are ranked as top quartile, and only 21% are in the bottom quartile. By comparison, 23% of USD1bn+ funds are producing top quartile returns while 60% are producing returns below the median.

The rankings also show that 2001 vintage USD500m+ funds have produced stronger returns than their smaller counterparts, with a median IRR of 30.2%. For each vintage year between 2002 and 2008, the median IRR of small funds exceeds that of USD500m+ funds. There is little difference between the median IRRs for USD500m+ funds and small funds of vintage years 2004 and 2005, but for vintage 2007 funds, the median IRR of small funds is -8.0% compared to a median of -20.0% for USD500m+ funds.

Although several USD1bn+ funds were brought to market in Q1 2011, there has been a general decline in their number since September 2008, says Preqin. In 2003, 15% of total capital raised was accounted for by USD1bn+ funds. This increased to 44% in 2006, and 56% in 2008. USD1bn+ funds contributed 47% of capital raised in 2010. Small funds accounted for 63% of capital raised in 2003, 35% of that raised in 2006 and 21% of capital raised in 2008.

In September 2008, there were 59 funds in the market seeking USD1bn or more, collectively targeting an aggregate USD125.7bn, according to Preqin. In April 2011, these figures stood at 24 and USD46.3bn respectively.

Of the 17 funds to close in Q1 2011, just one raised USD1bn or more. Eight USD1bn+ funds were launched between January and April 2011.

Although fewer in number, the 54 real estate funds launched in Q1 2011 are targeting a larger amount of capital (USD34.7bn) than the 74 funds launched in the same period last year, which were targeting USD24.6bn

The rankings are calculated by allocating each fund a quartile based on its performance relative to other funds of the same vintage.

"Given that many larger funds appear to have under-performed in recent years, investors might be expected to focus on the small to mid-size funds; the size of the funds which have been successful in raising capital in 2010 and 2011 certainly suggests that this is the case," commented Andrew Moylan, Manager – Real Estate Data. "A number of mega funds were launched in Q1 2011, so these managers clearly feel that investor confidence is returning, but while Preqin’s conversations with investors do indicate that they are more likely to make new commitments, fundraising will remain challenging given the number of funds on the road."

"Manager selection remains important, and there is a great deal of variation between the best and worst performing funds," Moylan continued. "As uncertainty remains in the real estate market, institutional investors are looking for managers that can prove that they can create value. Large, brand-name firms that have been successful in the past will no doubt continue to be successful in the future as confidence returns to the asset class. For firms whose funds have not performed as well, raising capital in 2011 is likely to be far harder, as institutions increasingly look to funds with more focused strategies."