Key Takeaways
- • Private real estate funds averaged 7% IRR from 2011–2021, dramatically underperforming buyout funds (14.5%) and venture capital funds (10.9%) across a dataset of 2,738 liquidated PE funds, according to University of Wisconsin researchers Da Li and Timothy Riddiough.
- • Real estate managers experience severe performance deterioration across fund generations: Fund I averaged 14% IRR, while Fund V and Fund VI declined to 8.1% and 4% respectively—a pattern absent in buyout and VC strategies, which maintained consistent performance across fund cycles.
- • Underperforming real estate managers survive and continue raising capital at higher rates than their buyout and VC counterparts, violating the conventional "survival of the fittest" narrative that typically governs private equity fundraising dynamics.
- • Performance collapse in real estate accelerates significantly after Fund IV, suggesting systemic structural issues rather than isolated manager skill gaps, with researchers unable to definitively isolate causation from available data.
- • Institutional investors' failure to hold real estate managers accountable for underperformance is cited as a contributing factor to the persistence of poorly-performing strategies in the real estate asset class.
Summary
New research from the University of Wisconsin, Madison reveals a persistent underperformance crisis in private real estate that contradicts fundamental industry assumptions about manager accountability and capital allocation discipline. Analyzing over 2,738 liquidated private equity funds across real estate, buyout, and venture capital strategies from 2011 to 2021, researchers Da Li and Timothy Riddiough documented that private real estate funds delivered an average internal rate of return of just 7%—substantially trailing buyout funds at 14.5% and venture capital funds at 10.9%.
The data exposes a troubling structural dysfunction unique to real estate: performance degradation across successive fund launches. First-time real estate funds (Fund I) averaged 14% IRR, a respectable figure that deteriorates sharply through subsequent offerings. By Fund V and Fund VI, average returns collapsed to 8.1% and 4% respectively. Critically, buyout and VC funds exhibited relatively stable performance across fund generations, suggesting that real estate faces distinct operational or market-structural challenges rather than a universal industry problem.
The researchers attribute part of this performance gap to insufficient institutional investor discipline. While the conventional private equity narrative assumes that only managers with strong track records survive to raise subsequent funds, real estate violates this principle: underperforming managers in this asset class continue accessing capital and launching new funds at elevated rates compared to their buyout and VC peers. This survival pattern indicates that investor accountability mechanisms—typically the mechanism enforcing "survival of the fittest" dynamics—are weaker or less effectively applied in real estate fundraising processes.
The paper does not definitively establish causation for real estate's underperformance. However, the pronounced acceleration in performance decline after Fund IV suggests systemic factors beyond individual manager skill, potentially including fee structures, diseconomies of scale, or market dynamics that become more pronounced as fund sizes expand. The research underscores a critical gap between institutional investor commitments to performance-based capital allocation and actual fundraising behavior in private real estate.
The data exposes a troubling structural dysfunction unique to real estate: performance degradation across successive fund launches. First-time real estate funds (Fund I) averaged 14% IRR, a respectable figure that deteriorates sharply through subsequent offerings. By Fund V and Fund VI, average returns collapsed to 8.1% and 4% respectively. Critically, buyout and VC funds exhibited relatively stable performance across fund generations, suggesting that real estate faces distinct operational or market-structural challenges rather than a universal industry problem.
The researchers attribute part of this performance gap to insufficient institutional investor discipline. While the conventional private equity narrative assumes that only managers with strong track records survive to raise subsequent funds, real estate violates this principle: underperforming managers in this asset class continue accessing capital and launching new funds at elevated rates compared to their buyout and VC peers. This survival pattern indicates that investor accountability mechanisms—typically the mechanism enforcing "survival of the fittest" dynamics—are weaker or less effectively applied in real estate fundraising processes.
The paper does not definitively establish causation for real estate's underperformance. However, the pronounced acceleration in performance decline after Fund IV suggests systemic factors beyond individual manager skill, potentially including fee structures, diseconomies of scale, or market dynamics that become more pronounced as fund sizes expand. The research underscores a critical gap between institutional investor commitments to performance-based capital allocation and actual fundraising behavior in private real estate.
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