Performance of Private Equity Real Estate Funds Ilkka Tomperi ERES 2009 – Stockholm 25 June 2009 Session 1D – Investment and Finance

Study The study investigates the performance of private equity real estate funds. Private equity real estate funds are non-listed closed-ended limited partnerships. Investors are typically institutional investors including pension funds and insurance companies. Funds are managed by general partners (sponsor) who are either large real estate or private equity companies or more entrepreneurial boutiques. We use a global sample of value added and opportunistic private real estate funds to study the fund and sponsor related factors’ correlation with fund performance.

Private Equity Real Estate Funds Similar structures than traditional private equity funds (buy-out or venture capital). Market has experienced a period of rapid growth both based on capital commitments and number of funds raised. INREV data shows the total amount raised in Europe to exceed €54 billion in 2005-2008. Preqin data shows the total global fund raising to exceed $349 billion in 2005-2008.

Private Equity Real Estate Funds Total Commitments Raised by Private Equity Real Estate Funds Globally in 2000-2008 Source: Preqin

Private Equity Real Estate Funds Average Fund Size per Closing Year of Funds Closed in 2000-2008 Source: Sample of this study

Background Kaplan & Schoar (2005): private equity returns are positively linked to both size and sequence number of the fund; show evidence of persistence in realised returns Phalippou & Zollo (2005): private equity performance co-varies postively with both business cycles and stock markets Hahn et al. (2005): showed that past funds‘ performance is linked to future real estate funds‘ performance; used only performance data but excluded other factors and size

Data A sample of 896 funds from 1980-2009. Sourced from Preqin database and authors‘ own database to enable as large as possible data set. Performance measured with IRR and money multiple (TVPI = total value to paid-in capital). Where performance is used, sample is limited to funds with DPI>80% (DPI = distributed to paid-in capital) to guarantee reliability. Fund size and target size as well as fund managers‘ year of establishment, name of the fund, sequence number of the fund, fund vintage and geography are collected where available. Market data includes US GDP growth, US inflation (CPI), US direct property returns (NCREIF) because remarkable share of funds in the sample are either US focused or global (with US allocation).

Data Source: Sample of this study

Five Models Performance Size and Sequence Number Persistence of Performance Factors Affecting the Performance Size 4. Factors behind the Fund Size 5. Growth Drivers

1. Fund Retuns: Size and Sequence Fund size has a positive linkage to the realised returns. Sequence number is negatively correlated to IRR unlike previously reported with a sample of private equity funds but supporting the case for emerging managers.

2. Fund Retuns: Persistence of Returns We evaluate the persistence in fund returns to see if historical returns can be a guide for future success. The results show that past performance is an indicator of future success in private equity real estate while growth in fund size has a negative linkage to IRR. Positive link between fund size may be an indication of established managers but also a result of the sample requiring at least two funds to be raised.

3. Fund Retuns: Factors Regressing the key quantifiable factors possibly connected to the fund performance and both fund related characteristics and market factors shows that funds raised during periods of low GDP growth are likelier to perform better. We also show, unsurprisingly, the positive linkage between underlying direct real estate market performance during the fund life but also confirm a significantly positive correlation between inflation during the fund life and subsequently realised returns.

3. Fund Retuns: Factors ...cont‘d

4. Size: Factors Larger funds typically have larger sequence numbers providing support to the fact that only well performing managers are able to continue in the business and raise multiple follow-on funds. The realised returns from the predecessor funds support the increase in the fund size and non-US focused funds are larger possibly because a wider range of target markets. Smaller funds are raised during periods of high GDP growth possibly linked to the fact that these periods attract new players to enter the fundraising market.

4. Size: Factors ...cont‘d

5. Size: Growth in Fund Size The growth rate declines along the increase in sequence number. Stronger growth is supported by good track record (higher realised IRR of the predecessor fund) and booming property markets during the fundraising year.

The Case for Emerging Managers Average and Median (dark and light) Fund Size and IRR by Sequence Number Source: Sample of this study

Conclusions Emerging managers and earlier funds are shown to have higher returns and realised returns of past funds are shown to be a reliable indicator of future success. Managers should not focus on growing assets under management (fund size) but on quality investments. Investors should pay a lot attention on the performance of past investments in their due diligence while choosing new funds to their portfolios. Market timing is of certain importance and funds raised during non-booming years are likelier to perform better and underlying market returns (beta) are an important contributor even to value-added and opportunistic property funds’ returns.

Conclusions More detailed research would be needed in order to differentiate the true alpha generated by private equity real estate funds and to show that the good returns are not just compensation for the illiquid nature of the investments or market returns ballooned via the use of leverage as some previous studies on buy-out matkets . In order to use more reliable indicators on the investment environment, one should consider using more focused regional or global GDP and inflation data and consider replacing the NPI index with regional IPD indices where available.