Real estate is a legitimate alternative asset class, offering a way to diversify portfolios heavily weighted in stocks and bonds.
However, it comes with a significant caveat: it is inherently illiquid, as anyone who has tried to sell a home in a tough environment can attest.
For decades, real estate firms have marketed Open-End Real Estate funds that promise to mitigate the illiquidity issue of owning private real estate by offering quarterly redemptions.
But let’s be clear – such liquidity is often an illusion. It disappears during tough times. When distress hits, redemptions from these funds resemble a run on the bank: everyone wants to exit at the same time, and consequently, no one can.
Consider the recent troubles of the Starwood fund, highlighted in last week’s Wall Street Journal.
Or look at the redemption issues faced by one of the largest funds managed by Blackstone last year. While Blackstone skillfully navigated out of that predicament, there’s no assurance that similar problems won’t arise again if the real estate market remains sluggish.
The sluggishness of the market is causing investors to withhold or withdraw their money. McKinsey reports (see source below) that open-end funds suffered “$13 billion in net outflows in 2023, reversing the trend of positive net inflows throughout the 2010s”
If you like the risk, return, and diversification potential of private real estate, by all means, consider it. But, entering with the belief that you’re investing in a liquid (open-end) fund is simply ignoring a fundamental reality.
Source of Recent Cash Flow Data: McKinsey Global Private Markets Review 2024 available here