A recent article on MarketWatch touted, “These stocks have the highest dividend yields in the hot real-estate sector,” but a deep dive into the numbers revealed there was nothing to get excited about.
The article reviewed the past 12-month of returns for the 32 real estate dividend stocks on the S&P 500 Index.
Of the 32 real estate companies that pay dividends, 31 were REITs, and one was a real estate development company. That’s a significant number indicating that almost all dividend-paying real estate stocks are REITs. Back to the matter of yield, the average dividend yield among all the 32 companies for the past 12 months was 2.99%.
What’s all the excitement? It turns out that the article was touting these real estate stocks for dividend yield because it was the best performing sector in the S&P 500, and the returns were particularly outstanding compared to the 10-year treasury yield, which had fallen to 1.7%.
Sure, 2.99% is a reason for excitement when compared to the 10-year treasury, but there are better ways to get a better yield without Wall Street volatility.
The ultra-wealthy and institutions like university endowments have long preferred private equity real estate and private real estate syndications for higher risk-adjusted returns over REITs and other public options.
Private equity and private syndications are peas in the same pod. The only difference is a private equity fund is an open real estate fund that can invest in a variety of properties. In contrast, syndications are typically formed to invest in one particular property.
The members of exclusive investment club Tiger 21 routinely allocate 25% or more to real estate and private equity each, with an inevitable overlap between the two asset classes.
For the unfamiliar, Tiger 21 is an investing network of more than 700 members worldwide with a minimum of $10 million in investable assets. Collectively, they manage assets worth more than $70 billion.
The CEO of Tiger 21, Michael Sonnenfeldt, is routinely in the financial press, and he isn’t shy about why his members love private real equity real estate – namely, high risk-adjusted returns with capital appreciation and preservation.
The numbers back up private real estate’s advantages. Based on the NCREIF (National Council of Real Estate Fiduciaries) Property Index, a reliable measure of private commercial real estate performance and the NAREIT (National Association of REITs) All Equity REITs Index, a reliable measure of public REIT performance, private real estate delivered an average annual inflation-adjusted return of 6.6% vs. 5.5% for public REITs over the past 20 years.
A deeper dive into the numbers will reveal something amazing. Public REITs are all large public companies with billions in assets on the books, so the 5.5% figure is a fair representation of all REITs. On the other hand, the 6.6% figure is not a fair representation of all private real estate funds as that number is highly diluted by big hitters like Blackstone, Lone Star Funds, and Brookfield Asset Management with tens of billions in assets under management each. Blackstone had $115.3 billion in real estate assets under management in 2017.
Here’s a little known secret:
These private real estate giants aren’t providing the highest returns to investors among all private real estate funds. That’s because these large companies only deal in Class A core properties in the gateway markets where cap rates are driven down by competition – domestic and foreign.
With so much capital under management, these companies have no choice but to stick to big deals in big markets.
Smaller private funds are providing higher returns for their investors. That’s because they tend to focus on value-add and opportunistic properties that allow them to leverage management expertise and personal market knowledge to minimize risk and generate outsized returns. The numbers back this up.
Based on Prequin ROI data for private equity real estate funds between 2005 and 2015, the average net internal rate of return for funds with at least $1 billion in assets was 5.7%. For real estate equity funds at $200 million or less, net IRR was 11.2%.
6.6% average annual returns for private funds vs. 5.5% for REITs make private funds a no-brainer – especially considering private real estate is less volatile.
For measuring volatility, the Sharpe ratio is a reliable measure. When comparing risk-adjusted returns as measured by the Sharpe ratio, private funds blew away public REITs by an almost 2.2:1 margin scoring a Sharpe ratio of .87 vs. .33 for REITs.
6.6% vs. 5.5% is great. In the current year, 6.6% vs. 2.99% (average of 32 S&P 500 real estate dividend stocks) is better, but for the best returns, look to smaller private funds that focus on value-add and opportunistic properties that nearly double the annual returns for their investors vs. larger funds.
How does 11.2% compare to 5.5% or 2.9%? No wonder the ultra-wealthy love private real estate funds.
Invest for Success,