public securities group i | 3q 2018 | real estate .../media/... · on the overall allocation to...

FOR INSTITUTIONAL USE ONLY.

Exploring the Synergy of Combining Public and Private Real Estate

PUBLIC SECURITIES GROUPI | 3Q 2018 | REAL ESTATE

Institutions have many choices for gaining exposure to real estate, ranging from relatively illiquid options through direct investment and private funds, to more liquid public funds and public securities individually. In our view, a hybrid approach that combines private and public real estate—each with distinct business models based on their liquidity profiles, investment time frames and operational strategies—can lead to a unique long-term investment synergy. At the same time, we believe that some meaningful structural benefits can be achieved through this combination.

1


Why Add Public Real Estate Securities to a Private Portfolio? Exploring the Investment Synergy: 1989-2017

There are also structural characteristics based on the investment time frame, liquidity profile, the number of assets owned and operational control. The relatively low correlation suggests to us that adding public real estate securities to a private real estate portfolio can lead to more meaningful diversification benefits than a private-only or public-only allocation, possibly with greater portfolio efficiency. Exhibits 1 and 2 explore these factors using the historical returns of public and private real estate indexes.

A D D I N G P U B L I C S E C U R I T I E S S E R V E D T O E N H A N C E P O R T F O L I O E F F I C I E N C Y

While the long-term returns of public real estate securities and private funds have been similar, their correlation over the life of the FTSE NAREIT Developed Index and Cambridge Real Estate Index has been a moderate 0.29. To some extent, we attribute this relationship to the different management objectives of private-fund and public-company business models.

OUR RESEARCH SHOWS THAT COMBINING PRIVATE REAL ESTATE FUNDS WITH PUBLIC REAL ESTATE SECURITIES CAN SERVE TO ENHANCE PORTFOLIO EFFICIENCY. BASED ON OUR STUDY OF HISTORICAL INDEX RETURNS OVER THE LIFE OF THE FTSE EPRA/NAREIT DEVELOPED INDEX (1989 THROUGH 2017), A PORTFOLIO ALLOCATED EQUALLY TO PRIVATE AND PUBLIC REAL ESTATE PROVIDED A MORE EFFICIENT PORTFOLIO OUTCOME, WITH HIGHER RISK-ADJUSTED RETURNS (ADJUSTED FOR DIFFERENCES IN REPORTING METHODOLOGIES AND FREQUENCIES). IN PART, WE ATTRIBUTE THESE RESULTS TO THE LOW CORRELATIONS OF THE TWO VEHICLE TYPES OVER THE PERIOD.

As of December 31, 2017. Source: Cambridge, FTSE and Brookfield. Data include backtested performance and is shown for illustrative purposes only. Please see Hypothetical Performance Disclosure at the end of this paper. See disclosures for index definitions.

E X H I B I T 1 : P U B L I C A N D P R I VAT E R E A L E S TAT E H AV E G E N E R AT E D S I M I L A R L O N G -T E R M A N N U A L I Z E D R E T U R N S , B U T CO R R E L AT I O N S H AV E B E E N M O D E R AT E . Geometric Returns: 1989-2017

W H Y A D D P U B L I C S E C U R I T I E S T O A P R I V A T E R E A L E S T A T E P O R T F O L I O ?

Exploring the Historical Investment Synergy 2

Exploring the Structural and Practical Benefits 4

Our Closing Perspective 6

Cambridge RealEstate Index

FTSE EPRA NAREITDeveloped Index

8.09%7.61%% of Periods

Public Outperformed% of Periods

Private Outperformed

Calendar Quarters 55.36 44.64

Calendar Years 46.43 53.57

CORRELATION

0.29

EXPLORING THE SYNERGY OF COMBINING PUBLIC AND PRIVATE REAL ESTATE 2


R O L L I N G 5 - A N D 1 0 - Y E A R R E T U R N S P O I N T T O T H E S I M I L A R L O N G - T E R M V O L A T I L I T Y O F P U B L I C A N D P R I V A T E R E A L E S T A T E

Below in Exhibit 2 we take a long-term look at the risk/reward characteristic of public and private real estate on the basis of historical long-term rolling returns. Notably, the standard deviation of 10-year rolling returns are actually higher on this basis for the Cambridge Real Estate Index (private funds) than for the FTSE/NAREIT Developed Index (public securities).

H I S T O R I C A L L Y , A D D I N G P U B L I C S E C U R I T I E S T O A P R I V A T E P O R T F O L I O I M P R O V E D R I S K - A D J U S T E D R E T U R N S

Historically, the return profiles of public and private real estate have been similar in magnitude; however, the relative volatility of these investment types, at any given point in time, can appear quite dissimilar. The primary reason is that different methodologies are used to measure the performance of public real estate securities portfolios and private funds.

While the returns of public securities are marked-to-market on public exchanges, private-market investments are generally based on quarterly appraisals of the underlying assets. Using this methodology, the valuations of private real estate over a given period represent a moving weighted average of actual, but unobserved returns over recent history. As a result, there is an inherent lage that tends to bias volatility downward, making it difficult to compare public and private market returns on an “apples-to- apples” basis. To account for this distortion, we use a recognized de-smoothing process, based on the work of MIT David Geltner published in the September 1991 issue of the Journal of Real Estate Finance and Economics. Through this process, we believe that the volatilities of private assets are adjusted for the reporting biases of appraisal-based valuations, and thus the private-market return series are much more comparable to those of public market assets. See the Appendix for a more technical explanation of de-smoothing.

E X H I B I T 2 : S I M I L A R L O N G -T E R M V O L AT I L I T Y (12 / 3 1/ 8 9 -12 / 3 1/17 )

Source: Bloomberg and Cambridge Associates as of 12/31/17. Data reflect the performance of the Cambridge Real Estate Index (Private Funds) and the FTSE EPRA/NAREIT Developed Index (Public Securities) over the period 12/31/89-12/31/17. The data in this exhibit includes backtested performance and is shown for illustrative purposes only. Please see Hypothetical Performance Disclosure at the end of this paper. See disclosures for index definitions.

Rolling 10-Year Returns (%) Rolling 5-Year Returns (%)

Private Funds Public Securities Private Funds Public Securities

Average Annualized Total Return 8.94 8.48 8.95 9.01

Minimum Annualized Total Return 2.01 2.23 -6.93 -5.28

Maximum Annualized Total Return 16.91 12.81 25.04 26.79

Standard Deviation 4.18 3.09 7.71 7.98

Maximum Total Return–Minimum Total Return 14.90 10.58 31.97 32.07



E X H I B I T 3 : H I G H E R S H A R P E R AT I O S F O R A P R I VAT E / P U B L I C CO M B I N AT I O N Sharpe Ratio: 1989 – 2017

As of December 31, 2017. Source: Bloomberg and Cambridge Associates. The data in this exhibit includes backtested performance and is shown for illustrative purposes only. Please see Hypothetical Performance Disclosure at the end of this paper. A de-smoothing filter has been applied to account for timing differences in the reporting methodologies or public and private returns. See disclosures for index definitions.

Cambridge RealEstate Index

50% Public/50%Private Combination

FTSE EPRA/NAREITDeveloped Index

0.290.33

0.24

IN OUR STUDY, THE RISK-ADJUSTED PERFORMANCE OF THE COMBINED PUBLIC AND PRIVATE INDEXES WAS MORE FAVORABLE THAN EITHER OF ITS PUBLIC OR PRIVATE COMPONENTS.

SECTION SUMMARY To summarize the historical investment synergy of combining public and private real estate, the two vehicle types generated similar long-term returns, but with relatively low correlations and similar volatilities (when adjusted for the different reporting methodologies of the two vehicle types). The combination also provided higher risk-adjusted returns over the same study period, from 1989-2017. In our view, these historical results illustrate the benefits of combining public and private real estate investments.

Why Add Public Real Estate Securities to a Private Portfolio? Exploring the Structural and Practical Benefits

The immediate commercial real estate exposure that public securities can provide solves an age-old challenge for the closed-end private fund investor. Over the mature stages of a private fund, proceeds distributed from asset sales can be redeployed into public real estate securities to immediately regain commercial real estate exposure.

P U B L I C S E C U R I T I E S C A N A D D I M M E D I A T E E X P O S U R E T O C O M M E R C I A L R E A L E S T A T E

During the two-to-three-year ramp up of many private funds, committed but uncalled capital is often held in reserves or short-term cash instruments. Over a multi- year horizon, this can create a significant cash drag on the overall allocation to private real estate assets.

BOTH PUBLIC AND PRIVATE REAL ESTATE PROVIDE ACCESS TO A LARGE UNIVERSE OF POTENTIAL INVESTMENTS. HOWEVER, WE CAN POINT TO SEVERAL UNIQUE FEATURES FOUND IN PUBLIC REAL ESTATE SECURITIES THAT CAN ADD VALUE TO A PRIVATE REAL ESTATE PORTFOLIO, FROM BOTH A STRUCTURAL AND PRACTICAL PERSPECTIVE.

Annualized Returns

Standard Deviation

FTSE EPRA/NAREIT Developed Index 7.61 19.48

Cambridge Real Estate Index 8.09 17.75

50% Public/50% Private Combination 7.96 14.91



A D D I N G P U B L I C S E C U R I T I E S C A N B R O A D E N T H E S O U R C E S O F P O R T F O L I O R E T U R N

As illustrated by historical performance data compiled by Cambridge Associates, the performance of private real estate funds has varied greatly across vintage years. As shown in Exhibit 4, median annual returns have

A D D I N G P U B L I C S E C U R I T I E S M A Y D R I V E E X C E S S R E T U R N P O T E N T I A L

The liquidity of a public securities allocation may allow for the potential to add additional alpha through dynamic allocation across real estate sectors and geographies, as well as through active securities selection. At the security level, active managers use their industry

ranged from 0% to more than 20% for funds created from 1994 through 2016. Adding public securities—which have shown moderate correlations to private funds— can serve to diversify these sources of return over a greater number of assets, with greater geographic and sector diversification.

expertise in these markets to assess relative valuations, market trends, macro risk factors, and economic and policy developments, and they shift allocations in an effort to capitalize on public market dislocations. While not always the case, history shows that public real estate securities can trade at attractive discounts to net asset value, as shown in Exhibit 5 below.

E X H I B I T 4 : M E D I A N H I S T O R I C A L A N N U A L R E T U R N S O F P R I V A T E R E A L E S T A T E F U N D M A N A G E R S

As of December 31, 2017. Source: Cambridge Associates. Performance is shown for illustrative purposes only and does not predict or depict the performance of any investment. Based on data compiled from 980 real estate funds (including opportunistic and valued-added funds) formed between 1993 and 2016. Data is provided AS-IS and at no cost to Brookfield.

Net

IRR

Sinc

e In

cept

ion

(%)

Vintage Year

Net to Limited Partners IRR

40

30

20

10

0

-10

-20

Median

E X H I B I T 5 : H I S T O R I C A L G L O B A L P R E M I U M S / D I S CO U N T S T O N AV

-50

-40

-30%

-20%

-10%

0%

10%

20%

30%

Jun-18Jun-15Jun-14Jun-11Jun-09Jun-07Jun-05Jun-03Jun-01Jun-99Jun-97Jun-95Jun-93Jun-91Jan-90

HISTORICAL AVERAGE-9.7%

CURRENT-12.3%

Global Premium (Discount) to NAV Historical Average

As of June 30, 2018. Represents data beginning January 1990. Source: UBS Global Real Estate research; Brookfield Investment Management research and estimates.



The potential for active managers of listed real estate portfolios to provide alpha is supported by data compiled by eVestment on 58 managers over the period spanning calendar years 2004-2017. Over this period, the performance of public real estate portfolios varied meaningfully over time, evidenced by the 229 basis-point annual average spread between the top-and-bottom quartile managers, gross of fees. Exhibit 6 highlights the excess return over fund benchmarks for top-quartile managers on a one-, three- and five-year basis ended

December 31, 2017. Note that global REIT managers outperformed global equity managers in all of these periods, while U.S. REIT managers matched global equity managers on a one-year basis, and outperformed on a three- and five-year basis. In addition, over the five-year period, both global and U.S. REIT managers delivered meaningfully higher excess returns compared with their global equity counterparts, by an average of 90 basis points on an annualized basis.

SECTION SUMMARY We believe that adding public securities to a private real estate portfolio can provide several practical and structural benefits—more immediate exposure to commercial real estate during a private fund ramp up period, greater diversification by property type, geography and vintage year and potential alpha generation through dynamic asset allocation and active securities selection.

Our Closing Perspective

Our paper also pointed to some of the structural characteristics of public real estate securities that can provide practical benefits to a private real estate portfolio. For example, investing committed but uncalled private fund capital in public real estate securities can result in earlier commercial real estate exposure than a private-only fund with a multi-year ramp up period. Adding public securities can also provide more diversified exposure across vintage years, property types and geographies, while potentially adding alpha through dynamic asset allocation and active securities selection. As mature private fund investments are liquidated, investors can immediately regain exposure to commercial real estate by investing distributed sales proceeds into public real estate securities.

This paper has explored the potential investment synergy, as well as some structural and practical benefits, of adding public real estate securities to a private real estate fund allocation. In our view, the similar long-term total returns of these vehicle types, which have exhibited low correlations with one another, suggest that greater portfolio efficiency may be achieved through a combined approach to both vehicle types, compared with a private-only or public-only portfolio. This was the case over the time frame of our study from 1989 – 2017. Another finding of our study was that a combined public/private portfolio generated more favorable risk-adjusted returns than either a private-only or public-only portfolio when returns were adjusted for differences in reporting methodologies.

E X H I B I T 6 : AV E R A G E E XC E S S G R O S S R E T U R N A S O F D E C E M B E R 2 0 17

Perc

ent

-0.5%

0.0%

0.5%

1.0%

1.5%

2.0%

5-Year3-Year1-Year

1.6%

1.3% 1.3%

0.7% 0.8%

0.4%

0.7% 0.7%

-0.2%

Global REIT Managers

U.S. REIT Managers

Global Equity Managers

As of December 31, 2017. Source: eVestment and Brookfield.



A P P E N D I XAbout the De-smoothing of Private Market Returns: While the returns of public securities are marked-to-market on public exchanges, private-market investments are generally based on quarterly appraisals of the underlying assets. Using this methodology, the valuations of private real estate over a given period represents a moving weighted average of actual, but unobserved returns over recent history. This creates an inherent lag in reporting returns that tends to bias volatility downward, making it difficult to compare public and private market returns on an “apples-to-apples” basis. To account for this distortion, we use recognized de-smoothing process, based on the work of MIT Professor David Geltner published in the September 1991 Issue of the Journal of Real Estate Finance and Economics.

According to Mr. Geltner, the slow pace at which private-fund managers respond to changes in market value of the underlying assets results in a smoothing of returns over time; the theory being that the net asset value (NAV) of a private fund at any given point in time actually reflects both i) data observations in the then-current valuation, along with ii) a portion of data observations from the previous time period. Since the quarterly returns exhibit autocorrelation, the widespread method of annualizing quarterly data by multiplying by the square root of 4 understates risk. To calculate a more accurate measure of volatility, you can first adjust the quarterly return series by removing the first order autocorrelation. Volatility calculated on this adjusted return series gives a more accurate measure of the underlying risk.

D I S C L O S U R E SBrookfield Investment Management Inc. “(the “Firm”) is a wholly owned subsidiary of Brookfield Asset Management Inc. Opinions expressed herein are current opinions of the Firm, including its subsidiaries and affiliates, and are subject to change without notice. The Firm, including its subsidiaries and affiliates, assumes no responsibility to update such information or to notify client of any changes. Any outlooks, forecasts or portfolio weightings presented herein are as of the date appearing on this material only and are also subject to change without notice. Past performance is not indicative of future performance and the value of investments and the income derived from those investments can fluctuate. Future returns are not guaranteed and a loss of principal may occur. The information in this publication is not, and is not intended as investment advice, an indication of trading intent or holdings or the prediction of investment performance. Views and information expressed herein are subject to change at any time. The Firm disclaims any responsibility to update such views and/or information. This information is deemed to be from reliable sources; however, the Firm does not warrant its completeness or accuracy. This publication is not intended to, and does not constitute an offer or solicitation to sell or a solicitation of an offer to buy any security, product, investment advice or service (nor shall any security, product, investment advice or service be offered or sold) in any jurisdiction in which the Firm is not licensed to conduct business, and/or an offer, solicitation, purchase or sale would be unavailable or unlawful.

H Y P O T H E T I C A L P E R F O R M A N C E The information and data included in this publication constitute hypothetical and/or back-tested information, and do not represent the investment performance of any actual investor account, investment product or strategy. The hypothetical and/or back-tested simulated results are net of estimated advisory fees and transaction costs for private index returns and gross of fees and transaction costs for public index returns; all dividends are assumed to be reinvested. Although the information and data in this publication provide background information and data relevant to considering prior events and risks, past hypothetical or back-tested performance is not a guarantee of future returns. It is possible that the markets will perform better or worse than shown in the hypothetical and back-tested simulation results; that the actual results of an investor who invests in the manner these simulations suggest will be better or worse than the simulations; and that an investor may lose money by investing in the manner the simulations suggest. Although the information contained herein has been obtained from sources believed to be reliable, its accuracy and completeness cannot be guaranteed. While the simulation results reflect rigorous application of the methodology selected, the hypothetical and back-tested simulation results have certain limitations and should not be considered indicative of future results. In particular, they do not reflect actual trading in an account or fund, so there is no guarantee that an actual account or fund would have achieved the hypothetical or back-tested results shown. There may be material factors relevant to any such comparison such as differences in the volatility, and regulatory and legal restrictions between the indexes shown and a Brookfield investment strategy. Past performance is not indicative of future returns.

Performance shown in this report prior to the launch dates of the index

below is backtested by the index provider: FTSE EPRA/NAREIT Developed Index, inception date 2/1/2005; The FTSE Nareit All Equity REITs Index, 3/6/2006.

F O R W A R D – L O O K I N G S T A T E M E N T S Information herein contains, includes or is based upon forward-looking statements within the meaning of the federal securities laws, specifically Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements include all statements, other than statements of historical fact, that address future activities, events, or developments, including without limitation, business or investment strategy or measures to implement strategy, competitive strengths, goals, expansion and growth of our business, plans, prospects and references to future our success. You can identify these statements by the fact that they do not relate strictly to historical or current facts. Words such as “anticipate,” “estimate,” “expect,” “project,” “intend,” “plan,” “believe,” and other similar words are intended to identify these forward-looking statements. Forward-looking statements can be affected by inaccurate assumptions or by known or unknown risks and uncertainties. Many such factors will be important in determining our actual future results or outcomes. Consequently, no forward-looking statement can be guaranteed. Our actual results or outcomes may vary materially. Given these uncertainties, you should not place undue reliance on these forward-looking statements.

I N D E X P R O V I D E R D I S C L A I M E RBrookfield Investment Management Inc. does not own or participate in the construction, or day-to-day management of the indices referenced in this document. The index information provided is for your information only and does not imply or predict that a Brookfield Investment Management Inc. product will achieve similar results. This information is subject to change without notice.

The public-market indexes referenced in this document do not reflect any fees, expenses, sales charges, or taxes, while the private market indexes are shown after the deduction of fees and expenses. It is not possible to invest directly in an index. The index sponsors permit use of their indices and related data on an "As Is" basis, makes no warranties regarding same, does not guarantee the suitability, quality, accuracy, timeliness, and/ or completeness of their index or any data included in, related to, or derived therefrom, assumes no liability in connection with the use of the foregoing. The index sponsors have no liability for any direct, indirect, special, incidental, punitive, consequential, or other damages (including loss profits). The index sponsors do not sponsor, endorse, or recommend Brookfield Investment Management Inc. or any of its products or services.

I N D E X D E F I N I T I O N SThe Bloomberg Barclays Capital Global Aggregate Index is a flagship measure of global investment grade debt from 24 local currency markets. This multi-currency benchmark includes treasury, government-related, corporate and securitized fixed-rate bonds from both developed and emerging markets issuers.

The Cambridge Associates Real Estate Index, which is compiled by Cambridge Associates, is based primarily on data reported by general partners in partnership financial statements and narratives to their limited partners. As of December 31, 2017, this benchmark dataset was based on information provided by 980 real estate funds formed between 1986 through 2016.

The FTSE Nareit All Equity REITs Index is a free-float adjusted, market capitalization-weighted index of U.S. equity REITs. Constituents of the index include all tax-qualified REITs with more than 50 percent of total assets in qualifying real estate assets other than mortgages secured by real property.

The FTSE EPRA/NAREIT Developed Index is a capitalization-weighted total-return index, which consists of publicly traded equity REITs and listed property companies from developed markets.

The MSCI World Index is a free float-adjusted market-capitalization-weighted index that is designed to measure the equity market performance of developed markets

E N D N O T E Si. The Public Securities Group, or Brookfield Investment Management,

is a wholly owned subsidiary of Brookfield Asset Management.

C O N T A C T U Sbrookfield.com | [email protected]© 2018 Brookfield Investment Management Inc.


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