THE BLOG
08/25/2016 10:07 am ET | Updated Aug 25, 2016

5 Reasons To Choose Private Equity Real Estate Funds

Sell everything. That's what famed investors such as George Soros, Carl Icahn, Jeff Gundlach, Bill Gross and Stan Druckenmiller have been preaching about equities since May, noted Barrons this August--at the same time CBOE's Volatility Index fell to its lowest level in two years.

Despite the fact that the 2016 S&P 500 is up 5.9 percent on a price basis in the face of uncertain times (think Brexit, the U.S. elections, the record low yields of the U.S. 10-Year Treasury Note and more), the stock market can't and won't go up forever. Bad news drives interest rates lower, and lower rates support loftier valuations, said Barrons.

Bonds are equally risky. In a weak business climate, the fixed yields of bonds look more attractive as stock prices fall. But that traditionally inverse relationship between stocks and bonds has broken down in the last two decades, noted The Wall Street Journal.

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A 2016 McKinsey Global Institute report suggests the combination of higher interest rates, lower economic growth and weak corporate profits is here to stay - and a portfolio made up only of stocks and bonds will generate lower returns for years to come.

Commercial real estate has the potential to offer long-term returns that are both healthy and stable. Most significantly, when added to a traditional portfolio of stocks and bonds, this asset class can decrease volatility and increase returns. But it's important to understand the different types of real estate investments you can make, and each one's potential impact on your portfolio.

For instance, an investor recently asked us why buy into our Fund III at Origin Investments instead of a successful publicly traded REIT such as Realty Income Corp. (O-NYSE)? Both products boast similar target returns, and the REIT has a lot going for it. This includes:
  • A proven long-term record of 14 percent returns (compared to Origin's Fund III's targeted return of 17-19 percent), with a current dividend yield of 3.76 percent;
  • Dividends that have increased over time; and
  • Liquidity, since the REIT is traded on an exchange and can be sold like any other stock.

In truth, when it comes to deciding between a publicly traded REIT and a private equity real estate fund, it isn't an "either-or" proposition but rather an "and" proposition; you don't necessarily have to choose between the two. Here's why, along with four other compelling reasons to invest in private equity real estate funds:

1. Unlike REITs, private equity real estate isn't tied to stock market fluctuations.
While public real estate products can be lucrative investments, they are highly correlated to the stock market. That means they rise and fall based on what's happening in the economy, and their values can be impacted by events that have nothing to do with real estate fundamentals. Because of this, adding publicly traded REITs alone will not necessarily improve your portfolio's risk-adjusted returns.

2. Public equity real estate funds achieve different investing goals.
When evaluating a potential investment, it important to look at alpha and beta. Beta measures the volatility of a fund relative to the market by gauging how much the fund's returns move up or down given the gains or losses of its benchmark market index. Alpha is the difference between a fund's expected returns based on its beta and its actual returns, and it is sometimes interpreted as the value that a portfolio manager adds, notes Morningstar.

Public REITs are a good example of the difference between alpha and beta.

With pubic REITs you are essentially buying beta, while a private equity real estate fund seeks to achieve alpha--and does with strategic business plans for properties and skilled asset managers. Origin's goal is to outperform the market on a risk-adjusted basis and achieve returns well above the index. We focus on finding high quality, underperforming commercial real estate properties that can be turned around. Our philosophy is that this is the best way to protect the downside while maximizing the upside of each deal.

3. REITs are a volatile asset class.

When the economy tanks, REITs can get hit hard. "In 2007 and 2008, REITs lost 15.7 percent and 37.7 percent, respectively," the Wall Street Journal noted recently. Also, since 2000, REITs "are second only to emerging-market stocks as the most volatile asset class. And with interest rates likely to rise, the next few years could be tough," especially for investors buying REITs now, concluded the WSJ.

4. Funds minimize risk exposure.
Our private equity funds are one of the most effective options for investors because they are a diversified investment. At Origin, each of the properties in a fund are run as a separate businesses. So if one underperforms it doesn't impact the others. A deal by deal investment strategy does not offer this same benefit.

To better gauge how well a fund will perform, it also helps to look at a company's other products. In our case, our earlier Funds I and II had projected returns of 17-19 percent, however Fund I is on track to generate a 28 percent net return and Fund II is on track to deliver a 26 percent return. Preqin, an industry leader that tracks performance of private equity fund managers, ranked these two funds in the top quartile as of June 2016.

5. Consider the manager's alignment of interests.

According to Towers Watson, a leading global advisory company, co-investment is the most effective way to align the interests of a manager and investors. We started Origin to invest our own capital, and maximizing investment performance remains our primary goal. We continue to keep our skin in the game with Fund III by committing $10 million of our personal resources.

If private equity real estate isn't part of your portfolio, it needs to be; asset allocation is a large determinant of investment success. Private real estate has low correlation to other asset classes, high expected returns and low volatility. That makes it a trifecta, since most asset classes only have one or two of these qualities.






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