Chapter 20 | Investment Return Profiles


A commonly asked job interview question for business school students is, “If you had $100 million, how and where would you invest?” While there is not a “right” answer to the question (i.e., there is no “right way” to invest in real estate), there are well-reasoned responses that can be informed by two key studies on investment vehicles and property risk.


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There are key qualitative differences between alternative real estate investment vehicles, such as levels of liquidity, leverage, and reporting and operating control.  Linneman Associates simulated institutional investor returns for a $100 million investment over a 7-year horizon in Unlevered Core (proxied by NCREIF), Core Plus, REITs (proxied by NAREIT), and Value-add funds, each under 4 different market scenarios.  Without losing sight of the qualitative nuances specific to each vehicle, the 16 scenarios are compared quantitatively.

In the simulated Base market case (2% annual NOI growth and an 8% residual cap rate), pre-promote IRRs were 10.5% for Core, 16.3% for Core Plus, 13.0% for REITs and 20.0% for Value-add.  The Core option performed worst in terms of both IRR and equity multiple in all scenarios except for in the Disaster case, where Core Plus performed the worst, falling victim to its higher debt service and higher management fees.  The Value-add vehicle performed the best on both IRR and equity multiple bases in all four market scenarios, even when measuring the limited partner’s post-promote returns at various preferred return hurdle rates.

The analysis notes that interim performance measurement is only useful for the most conservative strategies, as more opportunistic strategies are difficult to evaluate prior to a full liquidation of investments.  However, while the Value-add fund generally presents the best risk-reward balance, it requires that successful stabilization is in fact achieved and that the investor is willing to risk capital loss in exchange for greater upside.

A second study performed by Linneman Associates looked at how “at risk” different property investments are to an economic downturn.  The study used an 8-year hold period for 3 hypothetical multifamily investments:  a class A property with a low yield and high NOI growth in a Gateway market (“Gateway A”); a class A property with a mid-range yield and medium NOI growth in a secondary market (“Secondary A”); and a class B property with a high yield, but low NOI growth, in a tertiary market (“Tertiary B”).

Assuming cash flow margins of 83% of NOI across all investments (reflecting on-going cap ex), the study revealed that, absent NOI growth (i.e., the simulated downturn), higher leverage does not always translate into higher IRRs and equity multiples.  Evaluating returns across property types, the Tertiary B property outperforms Gateway A and Secondary A properties over the longer hold.  That is, in both economies, the highest equity IRRs are generated by the Tertiary B property, regardless of leverage or economy.  Similarly, the Tertiary B property also generates the highest percentage share of return from operating cash flows, reducing its risk by making it less dependent on value appreciation.  This is due to the higher going-in yield generating high cash-on-cash returns, particularly at higher leverage.  In contrast, when comparing properties under similar economic conditions, the least attractive scenario generating the lowest comparable returns is the highly leveraged Gateway A investment, particularly in a Realistic case, where you bet on high growth which fails to occur.


These are the types of questions you’ll be able to answer after studying the full chapter.

1. What are the four main institutional real estate investment vehicles, and which one did the Linneman Associates study conclude generally provides the best risk-reward balance?

2. What are some of the qualitative differences between the four main institutional investment vehicles?

3. Under what market conditions would higher leverage not necessarily translate to a higher investment IRR?

Audio Interviews

A benefit of a long-term holding period (2:59)


Answering the $100 million-dollar question (3:28)

Key Terms

To view the definition, click or press on the term. Repeat to hide the definition.

The fund sponsor entity’s share of excess profit above the preferred return, with which no cash investment is associated. Also known as “sweat equity.”

A private equity fund distribution provision that allows for the sponsor to be caught up to the same rate of return as the Limited Partners.

Chapter Headings

  • Study #1: Investment Vehicle and Limited Partner Performance
  • Qualitative Differences
  • The Set-Up
  • Market Scenario Comparisons
  • The Impact of Sponsor Promotes
  • Sensitivity Analyses
  • Study #1 Conclusion
  • Study #2: Property Risk and Opportunity

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