Both private and public markets offer access to real estate investments — but according to new research, one may be more effective than the other.

In a new study published in the Journal of Portfolio Management’s real estate issue, authors Thomas Arnold, David Ling, and Andy Naranjo found that, when compared side-by-side, real estate investment trusts outperformed U.S. closed-end private equity real estate, or PERE, funds by 165 basis points annually.

The study was based on a sample of 375 PERE funds, which the researchers compared against an index of listed REITs and an index of private real estate funds. In order to accurately evaluate performance, the authors took a “horse race” approach, matching each PERE fund’s realized return with the return that would have been earned by investors in the indexes over the same investment horizon. 

“It’s an apples-to-apples comparison,” said Arnold, the former global head of real estate at the Abu Dhabi Investment Authority. “And, on average, you would be better off investing in the public markets, and the outperformance is material.” 

On a global scale, REITs outperformed a sample of 255 international PERE funds by an average of 194 basis points, according to the study. 

And when public market risk like risk, leverage, illiquidity, and uncertainty were factored in, REITs came out even stronger. When the sample was adjusted for risk, the proportion of PERE funds that outperformed the REIT index declined by eight percentage points, while the share of funds that underperformed rose by eight percentage points. As risk increased, the authors found that the performance disparity between PERE returns and the REIT index grew wider. 

In the paper, the researchers recognized that there are advantages of public markets over private, including leverage and liquidity. In the public markets, equity analysts act as checks on companies against over-leveraging. But, this level of oversight doesn’t exist in the private markets, Arnold said. On average, there is higher leverage in closed-end private funds, which means they harbor more debt.

Liquidity is also an issue in the private markets. While investors and managers can enter and exit deals as they choose in the public markets, they have less flexibility when investing in private real estate funds.

“With the public markets, you can call your broker and invest today, if you want to,” Arnold said. “And if you decide to sell in six months, you can sell it. You may not like the pricing, but at least there’s liquidity, which is not at all the case in the private markets.”

Arnold noted that the results don’t necessarily mean that private funds can’t outperform public ones. But he said limited partners should be more strategic in their real estate allocations. 

“If you had a crystal ball and could find a top-quartile private fund manager, you’d be pretty happy,” he said. “But if you’re playing the odds, you’d be better off with a higher allocation to the public markets.” 

In the future, Arnold said he expects investors to make larger real estate allocations to the public markets. He also said he thinks investors will increasingly push back against current fee structures in the private space. 

“The environment has changed dramatically, but the fee structures look a lot like they did 25 years ago,” Arnold said. “It will be slow to change, but I think investors will begin to push back.”