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An Elegant Arbitrage Play Beckons Investors. But Can They Catch It?
Real estate’s alluring valuation gap.
A yawning valuation gap exists between public and private real estate at the moment, and investors are jostling to take advantage.
With few properties changing hands in the last few months, asset managers including BlackRock, Legal & General, Schroders, and UBS have created waiting lists to redeem money or suspended investor cash-outs altogether. They have also cut distributions from their private real estate funds.
Managers that can’t — or won’t — sell assets can’t meet redemptions.
At the same time, publicly traded real estate investment trusts (REITs) reflected the pandemic-prompted market crash almost immediately in their pricing. Public investors also benefited from REITs’ access to equity, debt, and other capital sources that private funds haven’t had.
“There is an allocation opportunity for private core property fund and private REIT investors that should be highlighted. Many funds have had to put up their redemption gates or have significant redemption queues because the funds’ underlying retail properties are illiquid,” said Joe Harvey, president of Cohen & Steers, which manages REITs, infrastructure, and other real assets.
Harvey explained that if a fund hasn’t suspended redemptions, investors should sell at net asset value before private values decline, then reallocate to the public markets where mark-downs have already occurred.
“Even before the pandemic, there wasn’t a lot of liquidity in the retail property sector. So fast forward to the pandemic, now property markets are freezing up because of liquidity and valuation uncertainty. If a fund can’t calculate its NAV with confidence, it can’t facilitate redemptions without legal risk,” added Harvey.
Investors in private markets funds, whether private equity or infrastructure, deal with valuation opaquity, but the issue is most stark in real estate where there is a publicly traded option. Private real estate funds also generally offer quarterly or even monthly redemptions, whereas other private funds lock up capital for 7 to 10 years.
“These crisis periods put some of the structural differences between public REITs and private real estate into stark relief,” said John Worth, executive vice president of research at NAREIT, a trade group for public real estate companies. “First and foremost, is liquidity. REITs are fully liquid, there are no redemption queues.”
“We see REIT prices immediately reflect property valuations. Those are only reflected with a lengthy lag and a great deal of smoothing on the private side,” he said.
Worth is a professional REIT booster of course. But he pointed out that that during the last global financial crisis, the valuations of private real estate funds eventually aligned with their public counterparts. “After about a year or year and a half, private valuations caught up with what happened nearly immediately in the REIT market,” he said.
In March, the all equity REIT index fell by 18.7 percent, after losing 7 percent in February.
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One institutional investor in real estate, who declined to be named because of the sensitivity over moving money out of private real estate funds, said REITs at this point are trading at discounts to NAV.
“They also are going to be more resilient going forward, given their access to capital and other advantages,” he said. The investor added that the current situation is reminiscent of what happened in 2008. With some funds gated, investors turned to funds that stayed open for redemptions. “Funds that gated ticked off investors. Funds that didn’t gate gained good will.”