Once hot, nonlisted real estate funds are meeting their Waterloo in 2023
- May 1, 2023: Vol. 10, Number 5

Once hot, nonlisted real estate funds are meeting their Waterloo in 2023

by Sheila Hopkins

Public nonlisted real estate funds, especially nontraded REITs (NTRs), have been on fire the past two years. 2021 proved to be a record-setting year with $36.5 billion raised, and 2022 wasn’t far behind. 2023 is a different story altogether. Fundraising among nontraded real estate investment trusts in February 2023 sank to just $489 million, a low not seen since August 2020, while reported monthly redemptions have exceeded $1.7 billion, an amount reflecting 351 percent of fundraising and about 1.6 percent of reported net asset value (NAV) for the industry, according to Robert A. Stanger and Co.

When redemption requests outpace capital inflows, it’s time to take a deeper look.


So why were so many investors putting capital into these funds in the first place? It wasn’t too long ago that nontraded or nonlisted real estate funds were on a par with Kryptonite. They were risky and opaque, involved fees on top of fees and primarily seemed to be a way for sponsors to make money at the expense of their investors. No RIA worth its salt would include them in client offerings.

But all of that changed during the past decade or so, as management firms with institutional investment expertise began offering private and public nonlisted funds to their retail clients. Fees and strategies were transparent and reasonable, and the types of strategies available offered options. Investors can choose funds that span the risk spectrum from core to opportunistic, from highly levered to debt-free (which are designed to help mitigate risk by avoiding the potential for lender foreclosure), from sector- and geographic-focused to diversified, from blind pools to investment-specified pools, and everything in between.

In addition, fees now tend to be tied to actual costs, with management and participation fees being the standard. Those who charge a performance fee believe this promotes an alignment of interest between the manager and investor and will also often pass on excess returns to investors if the fund clears specific hurdles.

The total sum of the fees is typically less than standard private equity fees, but the cost still makes this investment relatively expensive when compared to most non–real assets investments. However, the consistent monthly distributions, which have averaged well above fixed-income payouts during the past few years with less volatility than equities, and the prospect of realizing additional returns via asset appreciation, can make investors comfortable with the fees and upfront costs.

In addition to recalibrating fees to be more favorable for investors, NTRs now offer multiple share classes, which give a wider range of investors access to the investment product. These options have created more alignment between advisers and their clients and allowed for deployment of a higher percentage of investors’ funds into assets.

How returns are generated has also changed to everyone’s benefit. Unlike the first iteration of nontraded real estate funds, when share value was determined by offering price, today’s funds use a monthly — or sometimes even daily — NAV to determine share value, allowing investors greater insight into how their investment is doing. Distributions are thus based on a realistic value of the portfolio, and investors have the ability to benefit from asset appreciation.

“Though PNLRs (public nonlisted REITs) are public vehicles, the nontraded nature inherently has similarities to private or direct real estate in the form of historically lower volatility relative to publicly traded REITs,” explains R. Scott Dennis, CEO of Invesco Real Estate. “Most PNLRs today can invest across a range of real estate property sector types, including but not limited to rental housing, supply chain, storage and healthcare, all of which we deem essential to our economy today. They can also invest across geographic locations, unlike most publicly traded REITs, which tend to focus on one particular property sector.”

Any one of these factors can pique an investor’s interest, but one of the most attractive draws is the fact that nonlisted funds give retail investors the opportunity to get closer to the underlying real estate and, thus, benefit from real estate’s characteristics. While listed REITs can provide real estate benefits over the long term, their volatility — REITs were down 22 percent in 2022 and are flat so far this year — can make the ride pretty uncomfortable.

On the other hand, the investors’ potential benefits from owning an interest in a real estate fund are similar to direct ownership of real property. The owners of a real estate fund are entitled to their portion of any potential rental income from the property, their portion of the tax benefits to shelter the rental income (depreciation and interest write-offs from the mortgage), along with their portion of any potential growth or appreciation of the property over the hold period.

“The pass-thru nature of the potential income to the investors also is able to be potentially sheltered via depreciation, 27.5 years for residential and 39 years for commercial, and interest write-offs,” adds Chay Lapin, managing member and co-founder of Cove Capital Investment.

Another benefit, which many investors have become very interested in as of late, is the “sticks and bricks” aspect of a real estate fund. As the term “real assets” implies, the asset is tangible. Values might fall, but having a tangible asset to see and touch gives investors’ confidence there will always be some value, even if it’s less than they hoped.


In addition to the potential benefits, investors need to be aware that, just like all other real estate, real estate funds are illiquid or semi-illiquid investments, and there are no guarantees that the fund will provide cashflow and/or appreciation. Like all real estate investments, real estate funds may be affected by tenant vacancies, declining market values, and potential loss of investment principal.

Although investors recognize there are risks inherent to real estate investing, it is the illiquidity factor that often trips them up. These are assets that are meant to be held long term, yet investors like the comfort of knowing they can sell if they need or want to.

The relatively recent advent of monthly or daily NAV postings has come close to splitting the difference between a fully liquid equity and a fully illiquid real estate asset because sponsors can now price shares accurately for redemption. That doesn’t mean that investors can redeem their shares at any time. Nearly all funds have a limit on redemptions (typically up to 2 percent of the fund’s NAV per month or 5 percent per quarter). If that cap is reached, then requests are typically pro-rated so that all investors requesting redemption receive something.

Until recently, the fact that there was a limit on redemptions was more a theoretical concern than an actual tangible risk. Investors were aware of the cap, but it was rare for it to be breached. Investors might have to pay a penalty for redemption, but they had no problem liquidating shares if need be.

At the beginning of 2023, that theoretical limitation began to look more real. A surge in redemption requests resulted in $12.2 billion in capital outflows back to investors. Because rising interest rates and continued inflation are putting pressure on real estate values, nontraded REITs are starting to lower their NAVs, which is likely to result in more redemption requests. The Blackstone Real Estate Income Trust, the largest NTR in the market, has felt the brunt of the run, with shareholders asking to redeem $4.5 billion in March alone. BREIT allowed about $666 million to be withdrawn, or about 15 percent of what was requested. In the first quarter, BREIT shareholders tried to pull out around $13.5 billion, according to Stanger. Since Nov. 30, the fund has actually paid out about $5 billion, according to Blackstone.

BREIT might be dominating the headlines because of its size, but it by no means is the only nontraded fund to be experiencing an outflow of capital. Other active funds, such as those sponsored by Starwood, KKR and RREEF, have also reached monthly caps.

The level of withdrawal requests is likely to remain high because of growing investor concern around real estate trends broadly, according to Keefe, Bruyette & Woods analysts. Investors finding more attractive sectors to deploy money could also keep redemption requests elevated, the analysts wrote in a guidance note.

While the redemptions are concerning, industry leaders argue that the system put in place to allow limited redemptions is working as planned and should give investors confidence in the stability of the fund. With limits in place, there can be no devastating runs on capital, as there was with Silicon Valley Bank, and the resulting panic spiral.

In addition to managing the amount of redemptions met, the funds have built in liquidity sleeves, as well as capital that is invested in more liquid securities that they can tap into so they don’t have to resort to selling real estate assets in a down market.

“We keep a certain amount of the fund in liquid investments, which is intended to be available for redemption requests, but real estate is not something you want to buy and sell quickly. As such, investors who want to exit inside the first 12 months are subject to a 5 percent early repurchase deduction,” explains John McCarthy, CEO of Starwood Real Estate Income Trust. “However, given that those investors have been receiving monthly distributions, and NAV might have increased in the months since they entered the fund, they may not necessarily lose money. But they do know going in that they should be looking at this as a longer-term investment.”

Kevin Gannon, CEO and chairman of Robert A. Stanger and Co., believes that REIT liquidity sleeves are sufficient to carry REITs through 2023 and possibly into 2024 without having to liquidate assets. If fundraising can get back to the $1 billion monthly pace that it saw at the end of 2022, that alone would cover a big chunk of redemptions.

“The industry has successfully met redemptions up to the 2 percent monthly and 5 percent quarterly caps to date, with sufficient liquidity sleeves on the balance sheets to fund redemptions without tapping real estate asset sales, and we expect to see the same in 2023,” Gannon said.

In addition to liquidity sleeves, some funds provide their own secondary markets to pair shareholders that want to get out with those that want to get in.

“We’ve structured our funds so that they are transferable securities,” explains Lapin.  “Over the years we’ve gained a lot of investors that love to buy secondary transactions, and we try to facilitate that.”


Although having a variety of choices is a good thing, it also presents investors and their advisers with a challenge: What do we look for in choosing a fund?

As with any investment, investors should be choosing a fund that adds value to their portfolio. NTR funds are nuanced and can provide diversification, income or growth, depending on what an investor’s portfolio needs.

Unlike many investments, however, vintage years play a large role in a NTR fund’s performance.

“In our opinion, the longer-term view of public and private real estate is that they tend to deliver similar returns over time, but the path of those returns tends to be bumpier for public real estate due its correlation to the equity market,” explains Dennis. “For this reason, vintage investment periods and the length of hold periods can be important considerations when making allocation decisions between public or private real estate.”

“Investors should also look at the launch period of a nontraded REIT,” Dennis continues. “The world has changed significantly since the pandemic and so has the real estate landscape. Asset managers that decided to launch a nontraded REIT after the pandemic will have a different property and geography mix than those that launched pre-pandemic to take advantage of the ‘new’ real estate world that we currently find ourselves in.”

The world has definitely changed. Fifteen years ago, nontraded real estate funds were a no-go zone. Two years ago, investors couldn’t get into them fast enough. Today, we might be seeing a reversion to the mean. These are still attractive investments for investors with a long-term outlook and a need for an alternative investment that can provide diversification, income and growth, as well as a possible hedge against inflation, but they are not bulletproof. As with all real estate investments, the key is to choose wisely, work with a manager you trust, and assume you are in it for the long term. Investors who do that are likely to find NTRs to be an attractive addition to their portfolio.


Sheila Hopkins is a freelance writer in Auburn, Ala.

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