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Research Insights, May 30, 2016

What’s In Your Core Fund? Looking Beyond the Name

Core, value-add, and opportunistic have become well-established classifications for real estate strategies.  But just as Capital One’s credit card commercials ask credit card holders “What’s in your wallet?,” real estate investors would similarly benefit from asking themselves “What’s in my real estate fund?” While many fund strategies may carry the same label, the risk profile of the underlying assets may be very different.  

Often we see investors spending a significant amount of time speculating about what they can’t control – when the next recession will occur, whether prices have peaked, or concern about interest rate increases. Instead, it may be more effective for investors to focus on what they can know – the characteristics of the funds in which they invest and how their strategies will perform in various economic environments.   

Getting to Know Your Core Fund

The characteristics of core funds can vary significantly across a number of important factors, including:   

  • Number and type of fund investors
  • The number of properties
  • Geographic and industry allocations
  • Property sector allocations
  • Lease duration and tenant size
  • Financing
  • Percentage allocation to non-core strategies, and
  • Percentage and type of development

Investor Composition

Among the 24 funds included in NCREIF’s National Fund Index - Open End Diversified Core Equity (“ODCE”), the number of investors in each fund varies widely.  At one end of the spectrum, one fund is comprised of 426 investors, while at the other end, another fund has six investors. The index median is 111. 

While 426 investors may not be necessary to achieve an acceptable level of investor diversification, relying on only six investors elevates the risks involved with investor redemptions.  In general, funds with a larger number of investors have reduced risk related to the impact of investor exits. 

In addition to the number of investors, the type of investors may vary widely.  Some funds may have more domestic investors, while other funds may have large allocations from foreign sources of capital. Some funds are more heavily skewed toward public employee pension fund investors, while others have more corporate pension funds. Knowing the type of investors in a fund can be useful as there can be differences in the “stickiness” of different sources of capital.  Having a small number of skittish investors may create a recipe for redemption risk.

Property Composition

The number of properties owned by each fund also varies significantly.  One ODCE fund has 341 properties, while at the other extreme, another fund owns ten properties. The median is 77. While having 341 properties is not necessary to achieve an acceptable level of property diversification, having only ten properties in a fund creates greater asset concentration risk.  All other things being equal, much like a 341-stock portfolio would generally be lower risk than a 10-stock portfolio, owning 341 properties will generally be lower risk than relying on 10.

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