Attention all pension plans, foundations, endowments and other tax-exempt organisations: if you are like most institutional investors that think the best way to invest in real estate is through private equity real estate funds, then you may want to reconsider some of your assumptions.

A new research report published by Morningstar last month proves that private equity-style funds, on average, are not the best option. According to the report, publicly traded REITs have provided better returns for investors over a range of holding periods and therefore should represent a greater proportion of investors’ portfolios.

Based on more than 20 years of actual performance data, the Morningstar report demonstrates that publicly traded REITs have outperformed core, value-added and opportunistic private equity real estate funds over the long term, have experienced stronger bull markets and have recovered faster from downturns. In addition to the performance comparison, the research also highlights the public market attributes of REITs that can benefit an investment portfolio, namely greater liquidity and transparency and lower fees and expenses on average.

For the period of 1989 to 2009, REITs delivered compound annual net total returns of 9.3 percent, compared to 4.4 percent for core funds, 3.7 percent for value-added funds and 6.1 percent for opportunistic funds. During the same period, publicly traded REIT fees and expenses averaged one-half to one-fourth of the fees and expenses charged by private equity real estate funds. In addition, over the course of the last full real estate cycle, REITs produced a cumulative net total return of 801 percent, or 13.4 percent on an annualised basis, which was higher than the performance of core funds (272 percent, or 7.6 percent), value-added funds (320 percent, or 8.5 percent) and opportunistic funds (617 percent, or 12 percent).

According to Dr. Brad Case, senior vice president for research and industry information at the National Association of Real Estate Investment Trusts, which supports the findings, the performance discrepancy has much to do with the differences between the public and private business models. For example, the public markets force REITs to make better investment decisions, while private funds are hampered by structural restrictions that force them to buy and sell during specific windows, regardless of market conditions, he explained.

The findings are particularly relevant as public pension funds and other institutional investors increasingly are under pressure to boost portfolio returns and are looking to alternatives, such as real estate, to achieve that goal. At the same time, significant swings and uncertainty surrounding the performance of real estate investments over the past few years has caused institutional investors to reassess their real estate allocations and their strategies for implementing them.

That said, a significant percentage of those investors targeting real estate are looking to private equity real estate funds as their investment vehicle of choice. Indeed, according to a 2011 survey by Kingsley Associates, these investors plan to commit 92.6 percent of their real estate allocations this year to private forms of debt and equity, including 72.67 percent to private equity real estate funds, but only 7.4 percent to publicly traded REITs.

Moreover, recent data – including that in the Capital Watch section of PERE – shows that the bulk of the money being raised for and invested in real estate funds is being put towards the more risky, opportunistic strategies. That would seem to be counterintuitive given the heightened focus on improving risk management practices in the wake of the global financial crisis. Obviously, performance pressure is taking precedence over risk aversion in the minds of such institutions.

Given the performance advantages of publicly traded REITs relative to private real estate funds, institutional investors should re-evaluate how they balance their total real estate allocations using both private real estate funds and publicly traded REITs. “Investors believed they were getting better returns in these illiquid investments, but it turns out to be just the opposite,” Case said. “My hope is that this research will help institutions to do a better job of allocating their investment capital.”