Future opportunistic returns in ‘mid-teens’

Opportunistic real estate investments will achieve returns of between 12 percent and 15 percent rather than the outsized IRRs of 20 percent or more during the height of the market, industry professionals have warned.

Despite an estimated $454.2 billion of private equity sitting on the sidelines of the US real estate market, the latest Emerging Trends report from the Urban Land Institute and PricewaterhouseCoopers insisted return expectations “must ratchet down”.

Interviewing 275 senior  property executives and surveying 600 more, the 2011 report found that “12 [percent] to 15 percent is the new 25 percent”, with one executive saying: “Get used to it.” By shooting for 14 percent to 16 percent returns, fund managers had to “hope inflation eventually brings up performance”.

Almost a quarter of the equity targeting the US was eyeing opportunistic investments, compared to 27.1 percent for core, the report went on. Returns for core deals in 2011 would be around 7.5 percent for institutional quality real estate and 8.2 percent for REITs.

“Opportunity investors may score on one-off deals, but will be hard pressed to realise consistent mid- to high-teens performance, especially in the absence of ample financing to fuel gains,” the report said.

GPs marketing funds with 20 percent-plus IRRs were therefore “out of touch or trying to snow prospects”, executives told the report.

More than $1.1 trillion of equity is currently targeting the US, while $2.9 trillion of debt was available for investment. Of that capital, pension funds were estimated to have $184 billion of equity available for investment, while foreign investors had about $95.2 billion.

Institutional investors, however, were prepared to settle for lower returns, especially for reducing the risk profile of investments.

“I learned life is too short,” one public pension executive told the report. “I get paid as much for achieving solid 8 percent returns through core as making bigger returns on opportunistic strategies without the higher risk of losing my job if I bomb.”

ULI and PWC predicted that Canadian investors would be among the most active foreign investors in the US in 2011, with mainland China investors also becoming “more of a force”.

The US real estate recovery would be a “long and difficult” one for many markets, but the report offered a glimmer of hope for opportunistic fund managers: the “huge spin game” of extend and pretend would start to run its course, with lenders finally “drop[ping] the hammer” on troubled loans and borrowers.

The 32nd annual Emerging Trends report interviewed a total of 875 people, including Equity Group Investments founder Sam Zell; Colony Capital president Richard Saltzman; APG Asset Management co-head of Americas Steve Hason and RREEF director Scott Koenig.