In a context of low interest rates, investors are looking for assets that provide income and stability to replace usual fixed income products such as bonds. Core real estate potentially offers these attractive characteristics. First, core real estate generates regular income, as long as rents are collected. Focusing on pristine assets in prime locations, core real estate also provides a reserve of value, which can increase and generate capital gains over the long term. Moreover, as rents and value increase with inflation, core real estate is considered as a rather good hedge against it. The flipside is that these assets are in high demand. As a consequence, in large cities and prime locations, core real estate assets tend to be richly valued. Open-ended funds investing in the sector are therefore considered essentially as vehicles providing regular income – and generating only marginal additional capital gains.

Interestingly, private equity-style structures (closed-end funds) also target core real estate. This could come as a surprise, as open-ended funds already collect significant amount of capital. Open-ended funds tend to charge lower fees than closed-end funds, as they amortize them on larger amounts under management. Moreover, the plain vanilla assets that they target do not require very active management. Open-ended funds reinvest proceeds when assets are sold while closed-end funds require regular fundraisings, adding to costs. How can private real estate structures compete if they chase core real estate assets, where open-ended funds have a cost advantage and easy access to capital?

The answer might lie in definitions. Closed-end funds are usually associated with differentiated and significant value creation. Open-ended funds compete to deploy large pools of capital. They acquire and operate fully developed assets let to solvent tenants in prime locations over the long term. Closed-end structures, like private equity funds, enable fund managers to be more selective and apply a specific strategy. Private real estate fund managers might focus on smaller assets, which might be under the radar of large open-ended structures – and require a bit more work.

Often, private real estate fund managers will also target so called “core-plus” assets, which exhibit similar characteristics to typical core assets and provide yield, but also present opportunities for higher capital gains. They also might decide to focus on specific assets where they have a differentiating angle in terms of management or value improvement. For example, these assets might not be standard commercial or office properties, but maybe medicalised senior homes. Core-plus assets also might offer an opportunity to improve the tenant base and increase rents by refocusing assets.

Figure 1 – Core real-estate benchmark IRR quartiles by region

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