The hockey stick-shaped growth trajectory in the real estate interval fund space has come to a halt amid current market turbulence. New investment has slowed and similar to other non-traded real estate vehicles, redemption requests for interval funds have accelerated.
Despite storm clouds that started gathering in the second half of 2022, interval funds posted a record year of fundraising in 2022 at $23.5 billion. “It was a good year for fundraising, but redemptions have definitely kicked up,” says Kevin Gannon, chairman and CEO of Robert A. Stanger & Co. Redemptions totaled $6.8 billion for the year, according to Stanger. Gannon expects to see more redemption requests ahead with more volatility in pricing due to the downward pressure on underlying assets within the funds.
Although fundraising slowed to $1.4 billion in January, interval funds are holding up relatively well compared to non-traded REITs. Excluding a $4 billion investment that Blackstone’s BREIT received from the Regents of the University of California, non-traded REITs saw their lowest monthly fundraising since December 2009 at $596 million. Interval funds also are faring better on redemption requests as compared to non-traded REITs, which reported $12.1 billion in redemptions last year, according to Stanger.
Redemption requests aren’t great news for sponsors. However, interval funds were structured to provide more liquidity than some other private vehicles. Real estate interval funds are generally buying traded and untraded real estate, including NCREIF ODCE funds and public REITs. Interval funds don’t have the same liquidity as a stock or mutual fund, but there is liquidity built into the structure for investors.
Interval funds are hitting their quarterly redemption caps, but that also has been the history of the sector. “In good times they raise a lot of money, and in bad times they get hit with redemptions,” says Gannon. Interval funds have caps on redemptions, typically at 2 percent of NAV monthly and 5 percent quarterly, but they don’t gate redemptions. Fund managers need to maintain enough liquidity to accommodate those requests, and so far, they all have done a good job of that, he adds. “What happens in times like this is you realize who manages well in a down market, and who’s able to meet redemptions without hurting NAV,” he says.
The impact of current market volatility varies widely depending on the individual assets within specific interval funds. Some asset classes have held up better than others. Infrastructure, for example, has been more resilient to some of the slowing in the economy, whereas real estate funds with higher exposure to office properties are seeing more pricing volatility and higher redemption requests. “Interval funds are merely the structure. The underlying asset classes really delineate the volatility in capital impairment, which is why you see redemptions in these more sector-specific funds such as office, where there is a greater degree of refinance risk,” says Michael Underhill, president of the Alternative & Direct Investment Securities Association and chief investment officer at Capital Innovations, a financial services firm.
Growing retail channel
Slowing momentum in fundraising is a shift from what has been strong growth trend fueled by retail investors. The interval fund structure has been around for several years. “What you’re seeing with the democratization of alternatives is that interval funds are providing greater access to infrastructure, real estate and private equity that have traditionally been reserved for institutional investors,” says Underhill. That appeal among non-accredited investors seeking private alternatives is really starting to take hold and show up in the fundraising numbers, he adds.
According to Stanger, fundraising jumped from $3.2 billion in 2017 to $18.8 billion in 2021. Unlike other private investment vehicles, interval funds are open to non-accredited investors with minimum investment amounts that range between $2,500 and $25,000. Investors like the yield that interval funds deliver, which tend to be a little bit higher than some other alternative securities. “Performance has generally been pretty good. Oftentimes, they focus on credit and real estate, and debt and fixed income is a good marriage of investments that produce a higher yield than equities do. So, that’s where the dollars are being raised lately,” says Gannon.
According to Stanger, the annualized return for the 11 real estate interval funds it tracks over the three-year period through the end of 2022 averaged 6.06 percent (without load). The one-year return for 2022 alone (without load) totaled 1.8 percent. Although that number seems nominal, it stacks up well in the recent environment, which has been tough on both stocks and bonds. In comparison, the FTSE Nareit All Equity REIT Index posted total returns down 25 percent in 2022.
Attractive market for managers
Whereas Blackstone’s BREIT dominates fundraising in the non-traded REIT sector, fundraising in the interval fund space is spread across several large players. Cliffwater was the clear leader in fundraising last year with $7.0 billion in fundraising, followed by Bluerock Fund Advisor at $3.8 billion and Pacific Investment Management Company at $2.3 billion. Other sponsors, including Apollo, Carlyle, Variant and CION Ares, all had capital raises that were over or near the $1 billion mark, according to Stanger. “I think that’s good. It’s not healthy to have 60 percent concentration in one deal,” says Gannon.
It's no surprise that interval funds are attracting attention from large private equity managers, adds Underhill. Defined benefit pension fund capital is a shrinking part of the investment universe, whereas the private wealth side of the business—the mass affluent—is a growing segment of the market. “The large managers have extended their brand into the mass affluent space, and even mid-size and boutique managers with track records have done quite well in raising money and providing access to unique and innovative products via interval funds,” says Underhill.
Investment managers often find an easier pathway into the interval space. “You have a little easier time telling your story, and you’re not dealing with a 900-pound gorilla like Blackstone that sucks up all the oxygen. It’s also a niche sector with different strategies,” adds Gannon. PIMCO was among the latest firms to introduce a new real estate interval fund last December with its Flexible Real Estate Income Fund (REFLX).
Positive outlook for long-term growth
Despite near-term challenges, industry participants see significant growth opportunities for the sector over the longer term as investment managers focus more on retail investors. Although the brass ring for many advisors and capital raisers is still that high-net-worth or accredited investor, that group is a small portion of the market at roughly 10 to 11 percent of the U.S. population. The majority of investors in the U.S. are non-accredited, or what advisors often refer to as “mass affluent”, notes Underhill. “Interval funds really seem to be filling a larger role for that mass affluent investor that is trying to reach their investment goals and their retirement objectives,” he adds.
“This is just the tip of the iceberg in terms of fundraising. I think you will see a lot more fundraising in this space in the future, because people like it,” agrees Gannon. “It’s a way to get your exposure to private investments as well as public securities and you’ve got managers that are trying to thread the needle on both and get you a better return.”