Private real estate opens the gates to new investors

The private real estate industry is opening its doors wide to retail investors – individual or nonprofessional investors who typically buy or sell securities through a brokerage firm or retirement account.

In recent years, there has been a proliferation of innovative fund structures across the world to tap the vast and under-penetrated private wealth channel, buoyed by evolving regulations. Investor demand for commercial real estate has grown in tandem, partly a result of the challenges arising from sticking to a traditional 60-40 liquid portfolio, especially in a higher inflationary environment, and partly due to increased access to and understanding of private real estate investing. The appeal of the asset class is also being driven by its inflation hedging capabilities, stable income, upside appreciation and diversification benefits.

“We believe the market for private real estate strategies in the channel is more advanced than it is for other private markets categories, such as private equity,” says Bernie McNamara, head of client solutions for CBRE Investment Management. “In fact, the breadth and depth of offerings in private real estate demonstrate to us that the market is past the introduction phase and well along into its growth phase.”

Courting retail investors

Private investors were the most active buyers in commercial real estate in 2022, investing $455 billion – higher than the institutional investors’ share at $440 billion – according to data provider Real Capital Analytics’ analysis published in property consultancy Knight Frank’s outlook report for 2023. A survey of 500 high-net-worth investors conducted by Knight Frank earlier this year revealed that a third of the respondents want to increase their residential holdings, while 28 percent want to invest more in commercial property.

In response, an ever-increasing number of managers have enhanced their footprint across the private wealth channel and launched a range of perpetual life vehicles. In the US, Blackstone, BentallGreenOak, Starwood Capital, KKR and Brookfield Asset Management, among several others, operate non-traded REITs.

Meanwhile, London-based private equity investment firm Schroders Capital launched the Global Real Estate Total Return fund in Europe this year, its first dedicated commingled private fund for the asset class. The vehicle is also structured as a semi-liquid fund, targeting real estate investments across private equity, public equity, private debt and public debt.

Kieran Farrelly, head of Schroders’ global solutions real estate business, says private wealth portfolios are significantly underallocated to private assets compared with their institutional equivalents.

“Estimates vary,” says Farrelly, “but while institutional investors have steadily increased their allocations to as much as 20-30 percent, the allocation of individual investors is estimated to be less than 5 percent. In our view, this reflects a historical lack of appropriate access points rather than a fundamental difference in appetite.”

Farrelly also notes that the “combination of evolving regulation, technological innovation and more funds that specifically address access in a way that meets the liquidity needs of such investors will help adjust this imbalance over time.”

This so-called democratization of private markets – which, simply put, means opening up the industry to new investors and smaller entities and not just large, established institutional LPs – has been decades in the making.

Brendan McCurdy, managing director and co-head of the financial adviser solutions team at global alternative investment manager Ares Management, says: “Real estate was really the first private market asset class to democratize broadly for everyday investors.

“We saw the first ‘NAV REIT’ launched in the market more than a decade ago in 2012. Although that structure is non-traded, it has created an attractive entry point for individual investors looking to gain access to alternatives given a number of benefits, including the ability for continuous purchases and dollar-cost-averaging, enhanced liquidity options, transparency and reduced fee layers to streamline costs.

“Each of these elements of the product have improved over time and have made non-traded REITs much more accessible to individual investors. In addition, because NAV REITs regularly strike a new NAV, financial advisers have become more comfortable with their clients holding NAV REIT investments within brokerage accounts and fee-based accounts.”

“The access to information that can facilitate a retail investor’s ability to be thoughtful about [investments] has made the real estate investing world far more transparent today”

Nitin Chexal
Palladius Capital Management

The momentum in the space has grown over time due to regulatory changes, as well as the development of new crowdfunding platforms and registered investment advisers (RIA) to serve this investor pool.

Matt Weibring, director of investor relations at Velocis, a Dallas-based real estate fund manager, says about half of the firm’s investor base now comes from the high-net-worth and resident investment advisers’ channel. Weibring says more and more RIAs are building out platforms to provide clients with access to private investments.

“One reason for the accelerated growth is because local and regional RIAs can outsource their private investment sourcing and due diligence to firms like iCapital and CAIS,” he says. “These firms bring an institutional approach to finding quality managers across all private strategies and provide access to RIAs that otherwise would not have the resources. The number of firms that are providing RIAs access to the alternative investments continues to grow every year, which speaks to the demand from the HNW investor.”

Having these intermediaries also helps retail investors increase their understanding of the risk and reward dynamics of any real estate investment.

“There are a lot more channels available to retail investors to have an additional layer of review on top of their own analyses,” says Nitin Chexal, chief executive of Palladius Capital Management, a real estate investment management group headquartered in Texas. “The access to information that can facilitate a retail investor’s ability to be thoughtful about where and how they make investment has made the real estate investing world far more transparent today.”

Favored strategies and sectors

The private wealth segment encompasses a number of different groups, including HNW and ultra-HNW investors, the mass affluent and emerging affluent, as well as DC or 401(k) pensions and mom-and-pops. Their approach to real estate investing has differed, depending on their size and investing experience. HNW investors that are new to the private investment space and have assets in the $3 million to $5 million range typically favor strategies that provide recurring distributions. Meanwhile, investors with more experience in alternatives and with over $10 million of assets tend to have a larger appetite for higher-risk strategies that generate higher returns and multiples.

“Real estate was really the first private market asset class to democratize broadly for everyday investors”

Brendan McCurdy
Ares Management

When it comes to preferred sectors and strategies, PERE heard a range of opinions. Ares Management’s McCurdy says the most demand is coming from “growth and income investors” who are looking for yield with the opportunity for upside capital appreciation. Think of core, core-plus and value-add strategies with lower-to-moderate risk.

“One of the largest portions of the demand is currently for diversified funds, which can pivot to in-favor sectors as those change over time. Today, for example, that looks like industrial and logistics properties, multifamily housing, data centers and student housing, across all levels of the capital stack.”

CBRE Investment Management’s McNamara says: “We’re also seeing an evolution of investment strategies from investing just in stabilized properties – ie, buildings 90 percent or more occupied – to ones that include both stabilized properties and ground-up development projects.”

From a geographical perspective, Schroders’ Farrelly believes investors are also showing some interest in markets beyond the US. “This is due to the less synchronized cycles and trends playing out in Asia-Pacific, Europe and other regions that provide both further diversification benefits and a broader opportunity set.”

Liquidity concerns during market volatility

Despite the growing opportunities and investor demand, the current environment has also put the spotlight on the challenges of investing in private real estate. Liquidity is a key issue. There are natural constraints that come with investing in structures with underlying assets that are illiquid, including fund redemption limits, which protect managers from having to sell assets at potentially suboptimal valuations, especially during market dislocation. At the end of 2022, for example, some non-traded REITs had to gate redemption requests following an increase in investor withdrawals.

“The concern for us as a real assets manager is to be sure private wealth investors understand the products in which they’re invested,” says McNamara. “In today’s market, the focus is on understanding the risks of capital depreciation and limited liquidity.”

Balancing the risk/reward ratio

Ultimately, the question is whether semi-liquid investment vehicles offer sufficient liquidity protection for retail investors. Do the returns outweigh the inherent risk of investing in such structures? And if so, how do managers provide investors with liquidity while also protecting the fund’s performance?

Ares’ McCurdy says perpetual private market vehicles do offer sufficient liquidity for individual investors to use them as a meaningful part of their portfolios. “Even still, most investors will want to retain some portion in fully liquid securities. However, when the market turns, investors often find that even securities that seemed fully liquid on the way up are in fact only liquid at large discounts on the way down.

“By not being forced to sell into the teeth of a downturn, managers of semi-liquid private market vehicles can dispose of assets responsibly in a way that best protects remaining shareholders.”

In Farrelly’s view, what matters more is how liquidity is structured in these funds. Schroders Capital’s semi-liquid range of funds have a uniform three-month redemption notice period and capped quarterly redemptions, which helps strike a balance between enhancing liquidity and reducing the arbitrage opportunity associated with shorter notice periods seen in some funds. “The spotlight shone on the format in the past 12-18 months reflects a first test for such structures, but in our view this has highlighted exactly how the mechanism is designed to work – liquidity management tools preserving value by preventing disorderly exits during a period of market turbulence.”

“The market for private real estate strategies in the channel is more advanced than it is for other private markets categories”

Bernie McNamara
CBRE Investment Management

Most industry observers who spoke to PERE believe that some of these challenges will get resolved over time, as investors gain more familiarity and understanding about investing in private market funds. They also recommend that individual investors should make their first forays into the asset class through a financial adviser or other intermediaries to help them appropriately evaluate each investment.

“Investors are being compensated for the illiquidity premium,” says Khoo Kian-Jin, head of private wealth, Asia Pacific, at real estate services firm JLL. “It is about education, and understanding why there are lockups or illiquidity. Having said that, private wealth investors are also considering the duration premium, or how long the lockup is and trade-offs in terms of deployment.”

As the industry moves further in the direction of democratization and market headwinds subside, individual investors will become more comfortable with understanding the trade-offs that come with investing in a risky, yet resilient, asset class.

“There are ways to create liquidity, maybe with new technology in the future, but liquidity is genuinely more a feature for the public markets,” says Martijn van Eldik, head of corporate finance, Asia Pacific, at JLL. “Private markets come with specific features, which will always be part and parcel of the private industry. So, it doesn’t necessarily make it more challenging because there is a legacy – and private markets have a fairly decent share in investors’ portfolios now, and it will remain so.”