May
REITs vs. Private Equity
Lost in the wake of recent weeks’ market excitement was this article in the Wall Street Journal [$] detailing the REIT industry’s effort to persuade investors to allocate more real estate investment dollars in the public market via REITs. REIT supporters lament the possibility of losing capital to private equity firms under false assumptions that private equity generate better returns. In addition, they also decry the pension-fund advisers for putting fees above their clients’ interest.
Real estate, private equity and institutional advisory services were prominent topics of David Swensen’s seminal book, Pioneering Portfolio Management (see my review of this book). David Swensen, the influential architect of Yale University’s endowment fund investment strategy, de-emphasizes liquid stock and bond investments in favor of illiquid areas such as real estate, private equity and commodities. Yale’s success means this blueprint has been copied by many other institutions, with mixed results.
Swensen generally favors private equity over public markets due to the efficient market pricing found in the broader stock and bond markets. However, Swensen holds out some large caveats — only the top-tier private equity firms generate alpha and are worth their fees; the rest of the pack are simply riding the market. Thus, only those institutions with the ability to engage the best private equity firms should pursue this strategy.
Swensen also shows much disdain for pension-fund advisers and their ilk, feeling they offer cookie-cutter advice and little value to their clients.
And while Swensen favors less capital allocation to public markets and dismisses the idea of using stocks as proxies for different asset classes (i.e. buying oil stocks in lieu of the actual commodity), he makes a notable exception for REITs. Since REITs can trade at a premium or discount to net asset value at any given time due to market sentiment, investors will have opportunities to buy assets priced below intrinsic value. Due to the structure of REITs, investors are “closer to the assets” than a regular corporate stock, where management has much greater leeway to affect shareholder returns.
I, along with many commentators, have been waiting for a prime buying opportunity due to a commercial real estate (CRE) crash for years now — an opportunity which has yet to materialize. While some chances have presented themselves, for the most part, blood in the streets has been avoided thus far. Whether CRE is out of the woods or not remains to be seen.
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