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Real estate
Performance determinants of funds
European private equity real
estate funds
Giacomo Morri 209
Department of Corporate Finance and Real Estate,
SDA Bocconi School of Management, Milano, Italy Received 16 April 2020
Revised 7 September 2020
5 February 2021
Ugo Perini 15 February 2021
Bocconi University, Milan, Italy, and Accepted 16 February 2021

Rachele Anconetani
Department of Corporate Finance and Real Estate,
SDA Bocconi School of Management, Milano, Italy

Abstract
Purpose – The paper aims to investigate the performance determinants of European non-listed private
equity real estate funds between 2001 and 2014.
Design/methodology/approach – Using a sample of 363 funds collected from the Inrev database, the
analysis evaluated the impact of fees and other intrinsic characteristics of these funds, such as leverage, size
and duration, on the funds’ performance, intending to enhance the understanding underlying their
relationship.
Findings – The findings show a negative relationship between the return of the funds and redemption fee,
performance fee and management fee. Conversely, marketing fees have a positive effect on performance.
When analyzing the investment style, the results reveal inhomogeneous behaviors of leverage on funds’
performance. This variable has a positive impact on the return in core funds, while there is a negative
relationship in value-added investments. Finally, the emphasis on the global financial crisis shows that the
effects of the independent variables on the performance do not significantly change in different economic
cycles.
Practical implications – The practical implication of the research is to understand whether an investor
can direct its resources in a fund, leveraging on certain intrinsic characteristics that can be observed a priori.
Originality/value – Even if there is a considerable body of literature on determinants of performance in
European non-listed real estate funds, little research has analyzed the role of fees in driving their results.
Besides, this paper takes advantage of observations from different investment styles to emphasize the impact
of higher or lower risk profiles and from the full economic cycle to understand the effects of the crisis period.
Keywords Performance analysis, Non-listed real estate funds, Fees-performance relation,
Management fee, Marketing fee, Performance fee
Paper type Research paper

1. Introduction
The investments in private equity real estate funds or non-listed funds are growing among
professional investors because of a galvanized environment characterized by low-interest rates Journal of European Real Estate
Research
and volatile equity markets. The dynamism and innovations promoted by the professionals Vol. 14 No. 2, 2021
pp. 209-228
within this sector are also reinforcing factors for its development. Consequently, the © Emerald Publishing Limited
1753-9269
investments in this industry have surged during the past decades and boomed in the 2000s. DOI 10.1108/JERER-04-2020-0025
JERER Notwithstanding these promising market conditions, also the positive performance of
14,2 European private equity real estate funds contributed to the moderate expansion of this
industry over the past years. Indeed, the average yearly return of European non-listed real
estate vehicles from 2014 to 2018 has been around 8% (Inrev, 2019).
The growing relevance of this market is the premise for a flourishing uptake in the
number of studies that have investigated the fundamental factors driving the performance
210 of European private equity real estate funds. Often the literature has identified in the
macroeconomic, sectoral and geographical variables the value drivers in the industry. From
an intrinsic viewpoint, also gearing has a prominent role. Nevertheless, limited literature has
yet investigated the role of fees as fundamental drivers of performance, despite the
prosperous research in mutual funds, which this paper would often consider as a benchmark
industry, have already demonstrated the existence of a relationship in that market.
Several mutual fund studies have attempted to determine whether mutual funds can
consistently earn positive risk-adjusted returns. Although these research studies have
documented significant differences in risk-adjusted returns across funds, it became apparent
early on (Sharpe, 1966) that those differences were attributable largely to variances in fund
fees (Gil-Bazo and Ruiz-Verdú, 2009). From a theoretical standpoint, in an efficient market,
fees should be compatible with services provided by the fund and consistently reflect its
portfolio management activities. Accordingly, there should be a positive relationship
between risk-adjusted expected returns and fees (Gil-Bazo and Ruiz-Verdú, 2009). However,
despite the strong theoretical basis, often, authors have demonstrated otherwise,
contravening the efficient market theory, as they found a negative relationship between fees
and performance in the mutual fund industry. Gruber (1996) shows that higher-fees are
associated with inferior rather than superior management and concludes that the investor is
better off buying funds with low expense ratios. Carhart (1997) finds that higher-fee funds
do not perform and lower-fee funds. Sirri and Tufano (1998) find that lower-fee funds and
funds that reduce their fees grow faster, as mutual fund consumers are fee-sensitive.
Concerning market efficiency, private markets are notoriously inefficient, and hence, it
may offer investors opportunities to beat the market (Ling et al., 2018); consistently,
indicators, such as the fees, can behave differently from the hypothesized theory of market
efficiency.
The impact of fee load on performance is not negligible in European non-listed real estate
funds. In Europe, the average total expense ratio (TER) is 1.30% on net asset value (NAV)
and, it differs depending on the style of the fund: the TER is 1.14% on NAV in Core funds
and 1.93% on NAV in value-added funds (Inrev, 2019).
Accordingly, it is reasonable to expect that fees may likely have a negative influence on
non-listed real estate fund performance, as demonstrated by many authors in mutual fund
research. Figure 1 also strengthen this viewpoint. Using the sample [1] subject to analysis,
the average after-fee performance clustered by management fees [2] level does not increase
significantly at the higher level of management fees; in contrast, it seems to follow a
downward trend. Indeed, the average return in funds charging management fees that are
lower or equal to the median (0.885%) is 3.08%, against the 2.20% of the funds that stand
above the median value.
Therefore, the first objective of the paper is to test whether it exists a negative
relationship between the fees charged by a non-listed real estate fund and its performance,
focusing on the European market.
Furthermore, the TER varies depending on the investment style of the vehicle. Therefore,
delving the analysis into the investment style seems to be a logical next step. In particular,
the second hypothesis aims to understand whether the fee-performance relationship
changes based on the investment style of the sampled European non-listed real estate funds. Real estate
The paper would focus on two particular investment styles, namely, core and value-added funds
funds. The difference between the two typologies of funds is the level of risk and expected
return, due to different overall risk levels (operational risk and financial risk).
The final part of the research examines how the independent variables behave in two
main periods, using the outbreak of the global financial crisis (GFC) as the cut-off year
(2001–2007 and 2008–2013) to understand if economic cycles affect the performance of the 211
European real estate funds and the fees dynamics.
From the broader viewpoint, testing these hypotheses would help fill a research gap in
the literature, as most of the studies have not yet focused on the relationship between fees
and performance. Additionally, it has significant empirical implications as demonstrating
this relationship could support investors during their decision process: potentially, they can
direct more effectively investment toward better performing funds, consistently with their
risk appetite.

2. Fee structure in the fund management industry

The fees charged by the management company on funds and investors should reflect the
cost of the services provided. The management company is responsible for investment
management and, typically, uses its adviser’s expertize or a third party (sub-advisor) to
supervise all or part of this function. It arranges for the distribution of shares of the fund,
either directly to investors or by working with intermediaries. Finally, it coordinates other
needed services, such as shareholder servicing through the transfer agent. Profits largely
depend on the fees earned for providing each of these services (Pozen and Hamacher, 2011).
Typically, investors bear several costs when investing in mutual funds, such as distribution
fees, securities transaction costs, investor’s transaction charges, fund services charges,
management fees and performance charges (Pozen and Hamacher, 2011). The paper will not
consider the first four fees classes, as they are not relevant in the real estate fund industry.

2.1 Distribution charges

Investors pay sales loads to acquire or sell fund shares or cover annual distribution and
ongoing service costs. Distribution fees remunerate the intermediaries selling units, and
they account for a minimum proportion of the fund management companies’ earnings. The
goal of distribution fees is to ensure that the distributor recovers his upfront sales costs even
if an investor redeems the investment after a short holding period (Pozen and Hamacher,
2011). If the fund units are sold directly to investors, the management company collects the
entire distribution fee. This case is of funds sold exclusively to institutional investors like
the non-listed real estate vehicles analyzed in this study.

Figure 1.
Annual average after-
fees return clustered
by the level of
management fee
JERER 2.2 Securities transaction fees
14,2 This classification includes the costs funds bear when buying or selling securities, as the
fees paid to a broker to sell or buy stocks and the regulatory expenses for executing a
transaction. In mutual funds, these fees are subtracted from the value of the fund’s units
daily and do not record as an expense in the fund’s financial statements. In contrast, real
estate management companies recognize these fees directly as operating costs of the fund.
212
2.3 Investors transactions charges
These fees apply directly to investors whenever they buy or sell their securities. Usually, the
use of these fees (i.e. the redemption fee) has the objective to discourage frequent trades or
those aimed at benefitting from market timing. These fees are typical for open-ended
vehicles and are paid directly to the fund. As they do not affect the management company,
they are excluded from the scope of the analysis.

2.4 Fund service charges

The fund service charges cover the fund administrative and maintenance services expenses
(for example, shareholders’ communication expenses, prospectus disclosure costs,
registration fees, external professionals’ charges). Typically, the fund recognizes these fees
to the organization that provides the service – either a third party (i.e. the fund auditors), the
management company or one of its subsidiaries.
Some funds may include these charges directly into the management fee. In this case, all
the risks and benefits of managing the fund expenses are transferred to the management
company (Pozen and Hamacher, 2011).

2.5 Management fee

Management fees are charged directly to investors and represent the largest source of
income of the management company. It compensates the management company’s core
business by rewarding the use of its brand name, the risk of setting up the fund and for
organizing the distribution of the fund shares.
The management fee level varies based on the asset the fund is investing in (i.e. stocks
funds have the highest management costs – from 65 to 100 basis points –, followed by fixed
income funds – between 45 and 62 basis points – and money market funds – from 20 to 45
basis points) (Pozen and Hamacher, 2011). The management fee also depends on the assets
under management; when assets exceed a certain threshold level, these fees can be reduced
(Kinnel, 2010).
It exists a proportional relation between the complexity of the asset portfolio and the
level of management fee charged. Therefore, it is not surprising that the management fee
applied by non-listed real estate funds fall in the highest threshold (i.e. it amounts to 85 basis
points in the sampled companies), given the complexities and the several technical analysis
required to manage real estate investments.

2.6 Performance fee

Performance fees reward the return generated by the fund. Their purpose is to incentivize
and remunerate investment managers for producing positive risk-adjusted returns as
typically investment managers apply this charge after achieving a predetermined
performance. Usually, the performance fee is included in the 15%–20% range of the equity
investment. Institutional investors, which are the only target investors for European non-
listed real estate funds, are willing to pay incentive fees if the management company can
return positive alphas, i.e. the residual return over systematic one (Khorana et al., 2008). Real estate
Generally, the performance fee applies only if the NAV is higher than the so-called high- funds
water mark, which is the highest NAV level that a fund has reached in history. Alternately,
it applies the hurdle rate mechanism that recognizes a performance fee if the fund return is
higher than the hurdle rate.
Fees may behave differently depending on the investment style, the structure (i.e. open-
end and closed-end) or countries. Inrev (2019) found that the TER after performance fee is
0.80% on gross asset values (GAV) and 1.14% on NAV on core funds, while it increases to 213
1.19% on GAV and 1.93% on NAV in value-added funds. Therefore, not only the TER is
higher in value-added funds, but there is also a wider gap between GAV-based and NAV-
based TERs compared to core funds, a difference that likely reflects the higher leverage level
that applies to value-added funds. On a structural basis, the TER observed in 82 open-end
funds and 62 closed-end funds was, respectively, 0.66% and 1.23% on GAV and 0.86% and
1.97% on NAV. According to Inrev (2019), this divergence does not reflect the fund’s
structural characteristics, but relates to different investment strategies, as open-end funds
typically adopt core strategies while closed-end funds are more inclined to follow value-
added approaches. Therefore, most of the difference trace back to the investment style. A
similar conclusion also applies to different country strategies. In particular, funds that
concentrate on a single country have lower TERs than those following multi-country
strategies because the core style tends to prevail. Accordingly, in this paper, the analysis
investigates the investment style only, thus excluding any reference to the structure and the
country strategy.

3. Literature review
The objective of this study is to investigate the determinants of non-listed real estate funds’
performance, with a distinctive focus on the role played by fees charged throughout the life
of privately held funds. Despite there is broad and well-established literature that analyzes
the relationship between performance and the fee structure in mutual funds, the research is
still scarce on non-listed real estate funds. Even though it is a growing academic interest in
investigating the performance drivers in non-listed real estate funds, it exists a theoretical
gap that this study aims to fill by delving into the role of fees and other performance
determinants in private equity real estate funds in Europe.

3.1 Performance driver in non-listed real estate funds

The growing market interest in non-listed real estate funds has attracted increasing
attention in the academic environment. Accordingly, several pieces of research have started
to investigate the performance determinants of these vehicles (Anson and Hudson-Wilson,
2003; Stevenson, 2006; Tomperi, 2010; Baum and Colley, 2011; Baum et al., 2012; Alcock
et al., 2013; Fuerst and Matysiak, 2013; Case, 2015; Fisher and Hartzell, 2016; Delfim and
Hoesli, 2016; Aarts and Baum, 2016; Brounen and Van Der Spek, 2017; Delfim and Hoesli,
2019).
Fuerst and Matysiak (2013), by analyzing the performance of non-listed real estate funds
have found a significant relationship with the sectorial and geographical focus of the
investments, on top of specific macroeconomic and fund-characteristics factors such as size,
gross domestic product, bond and stock market performance. Gearing also plays an
important role, although there is an asymmetric effect depending on whether the fund is
generating gains or losses. Delfim and Hoesli (2016, 2019) have also focused on risk factors
and found significant impacts of macroeconomic elements and stock market returns in
explaining non-listed fund returns. Besides, size, gearing, vehicle structure and fund’s age
JERER affect returns, whereas investment style does not appear to matter. Some authors did not
14,2 found any significant relationship between performance, macroeconomic and fund-specific
factors, a situation that has been attributed to the scarce data available at the time of the
research (Stevenson, 2006).
Several studies also have investigated fund performance persistence to explain how a
fund’s performance connects to past results. Aarts and Baum (2016) found a short-term fund
214 performance persistence across funds managed by the same manager, although these
performances reversed in the long-term. Similarly, Tomperi (2010) has found that non-listed
real estate fund performance positively links to the size and emerging funds, which invest
with managers at an early stage of their life cycle raising a first- or second-time institutional
fund, are more likely to produce higher returns.
Leverage is also an influential factor in describing a fund’s performance. Anson and
Hudson-Wilson (2003) state that the use of leverage should be moderate to optimize non-
listed real estate fund performance. Similarly, Case (2015) and Alcock et al. (2013) have
found that the negative effects of leverage during down-market periods are only partially
recovered during the following upmarket cycles thus, the total impact is negative. Baum and
Colley (2011), Baum et al. (2012) also found a negative relation between leverage and the
fund’s returns in the long-term.
The investment style is often an important variable to determine a fund’s performance.
Examining core, value-added and opportunistic US funds, Shilling and Wurtzebach (2012)
found that the latter two categories outperform core investments when there are favorable
market conditions and the possibility to access low-cost debt. Conversely, Pagliari (2017)
found a relative underperformance of value-added and opportunistic funds compared to core
funds. In contrast, Fisher and Hartzell (2016) concluded that the investment style does not
explain returns.

3.2 Fees and performance

The literature on non-listed real estate funds has only recently started to flourish, and the
relationship between performance and fees seems yet an unexplored area. Therefore, in this
section, the analysis would investigate this relationship focusing on other investment
vehicles such as private equity and mutual funds [3].
In private equity, fees amount to $20bn evenly distributed over time, representing over
6% of equity invested by general partners (Phalippou et al., 2018). In earlier research,
Phalippou and Gottschalg (2009) found that fee is more than 25% of the value invested (6%
per year) – two-thirds of the fee comes from management fees while a third comes from
incentive fees.
In an efficient market, the fees should be positively correlated with the expected before-
fee risk-adjusted returns, and in equilibrium, all funds should earn zero expected after-fee
risk-adjusted returns. Therefore, there must be a linear relationship between the fees and the
fund performance (Gil-Bazo and Ruiz-Verdú, 2009).
In contrast to the market efficiency hypothesis, several academic studies demonstrated a
negative or non-existing relation between fees and fund performance (Gruber, 1996; Carhart,
1997; Ferreira et al., 2013; Garyn-Tal, 2015). Gruber (1996) found that the expense ratio for
the best performing mutual funds increases at a slower pace than that of the worst
performing ones. Moreover, the expenses for top-performing funds do not grow faster than
other funds. Similarly, Carhart (1997) demonstrated a significant negative relationship
between fees and performance in those funds charging a front-end load fee.
Ferreira et al. (2013) found that higher-priced management generates higher gross
returns, but returns are not high enough to cover the fees. Garyn-Tal (2015) finds that within
each investment-style classification, there are no consistent relations between the expenses Real estate
the fund’s charge and the alphas they earn. From a predictive standpoint, Ma et al. (2019) did funds
not find evidence of a relation between portfolio manager compensation and subsequent
fund performance, either gross or net of fees. In contrast, Berk and van Binsbergen (2015)
found that better mutual funds get higher aggregate fees than other funds. In private equity,
Phalippou and Gottschalg (2009) showed that an increase in the management fees, which is
the most relevant in the private equity industry (Phalippou et al., 2018), translates into a 215
1.3% decrease in alpha.
According to Elton et al. (1993), when evaluating a group of mutual funds in the same
asset class, rational investors should avoid picking those charging the higher fees, as these
will systematically underperform other funds.
A study published by Morningstar (2015) confirmed the existence of a negative
relationship between fees and the return of a fund. The findings suggest that the
performance advantage of setting lower fees compounds over time. A possible explanation
is the existence of economies of scale: funds can lower expenses as they collect more assets
offering attractive classes of shares, and gain a competitive advantage over other funds, as
they can potentially invest a larger amount of money on the markets.
Better information quality should relate to higher performance, as it allows for more
efficient investment decisions. However, several studies discussed the potential disclosure
costs borne by informed traders, including mutual funds (Wermers, 2001; Frank et al., 2004;
Verbeek and Wang, 2010) and hedge funds (Shi, 2012) because of front-running costs and
copycat trading activities of other market participants. Agarwal et al. (2015) focusing on a
sample of more informed funds, found that more frequent mandatory portfolio disclosure
improves the stock liquidity but hurts these funds’ ability to capitalize on their information,
reducing their incentives to collect and process information. From a performance standpoint,
Dellva and Olson (1998) have not found any significant relationship between the higher
performances of mutual funds, the amount and the efficient use of information. The reason
is that fund managers share comparable data, but some of them are more effective in
exploiting market timing and in the selection process.
The relationship between the fees and a mutual fund performance may vary based on the
fund’s geographical location (Khorana et al., 2008; Ferreira et al., 2013; Cremers et al., 2016).
According to Khorana et al. (2008), larger funds charge lower fees, as do funds selling cross-
nationally and the relationship between fees and returns is positive. Conversely, there is a
negative correlation in funds in offshore locations or operating in several countries.
According to Ferreira et al. (2013), the correlation between the expense ratio and the net of
fees returns in US open-ended funds was not statistically significant, while in non-US funds,
the relationship was negative. In contrast, Otten and Bams (2002) found that US funds with
higher fees have lower returns, while European funds show a positive correlation between
fees and returns.
The relationship between fees and performance may be affected by the investment style
or the size of the fund. Garyn-Tal (2015) has found a negative relationship between fees and
performance. However, when analyzing different fund categories independently, the author
found no significant relationships between the funds’ charge and the alphas they earn.
Fees can also classify into different categories depending on the underlying service provided,
so their impact on performance may vary. In this perspective, Sirri and Tufano (1998), by
distinguishing the funds between those charging marketing fees and those without it, discovered
that in the first case, there is a positive and statistically significant correlation with the amount of
the resources attracted on the market.
JERER In contrast to recent studies, a few earlier analyzes have found a positive relationship
14,2 between fees and performance. Ippolito (1989) found that the mutual funds that charge the
highest fees also generate the highest returns. Similarly, Grinblatt and Titman (1994) found
that marketing and management costs have a positive relationship with the performance of the
fund. Likewise, Zheng (1999) observed the existence of a positive relationship between fees and
a fund’s return, especially in the presence of high marketing fees as these funds can attract
216 more resources to invest in the market. Finally, Berk (2005) discovered that the fees charged by
a fund are proportional to the extra value generated by an active portfolio manager. The larger
the value a manager can create, the larger are the fee charged to the investors.

4. Data
For the present analysis, we used Inrev data [4]. The database is composed of 363 European
non-listed real estate funds and includes observations for the period between 2001 and 2014.
The period has been selected consistently with the real estate vehicles investment interval
and sufficiently long to exclude potential survivorship bias. Indeed, the sample considers
funds that survived the financial crisis, funds that stopped the business and, finally, entities
that started their operations in the aftermath of the crisis. However, the analysis excluded
those funds that changed the fees policy in the analyzed period to guarantee consistency.
The initial database is an unbalanced data panel consisting of 2,540 observations. Panel
data provide information on individual behavior (in this case, the annual after-fee return of
the 363 funds included in our database), both across individuals and over time. Therefore,
they have both cross-sectional and time-series dimensions. The main benefit of using panel
data is that it enables to control for individual heterogeneity at the fund level. For each fund,
the observations collected depends on its duration. However, given the relatively short time
horizon, there are no concerns about non-stationarity issues (Baltagi, 2013).
In the context of identifying the performance drivers in European non-listed real estate
funds, one of the main objectives is to test whether fees have a significant role in
determining the performance of a fund. Accordingly, in this paper, the analysis introduces
five variables, each representing one of the fee categories that, typically, are charged by non-
listed real estate funds such as load fees, redemption fees, management fees, performance
fees and marketing fees. The management and performance fees are expressed in a
percentage of the NAV.
Load fees remunerate both the fund placement and subscription services and ensure that
the management company recovers the upfront sales costs in the hypothesis that an investor
redeems the holdings after a short period (Pozen and Hamacher, 2011). On the contrary,
redemption fees belong to the shareholder transaction fees class, which includes the charges
that a fund applies to discourage specific investment transactions. In particular, the
redemption fee aims at disincentivizing frequent trades, targeted at achieving the benefits of
market timing.
Management fees refer to all the operational costs faced by a fund during its day-to-day
activities, including property management expense, legal and audit costs and it typically
represents the most important source of income for the fund management. Generally, their
value is proportional to the complexity of the fund portfolio. Consequently, considering the
structured characteristics of real estate investment and the preliminary technical analysis
they require, the average value of management fees in the sample is 85 basis points.
Marketing fees remunerate the fund advertising activities, and its objective is to attract
new investors in the market. Finally, the performance fee (or incentive fees) are fees charged
by investment advisors or managers, after a predetermined investment performance has
been attained (Inrev).
 The duration is the life of funds in years, while the leverage, defined as one minus the Real estate
ratio of NAV over GAV, is the proxy of the level of debt used by a fund. Macro is a dummy funds
variable that controls for macroeconomic factors by identifying years with shocks and takes
the value of “1” in the correspondence of the crisis event. The objective of this indicator is to
investigate whether the burst of the GFC has affected the relationship between the
performance of a non-listed real estate fund with selected independent variables. Finally, the
size is the GAV of the funds.
Table 1 provides an overview of the variables used in the analysis and the descriptive 217
statistics of the funds included in our database.

Variable Mean SD Min Max

Load fee
Overall 0.5346 0.4989 0.0000 1.0000
Between 0.4923
Within 0.0845
Management fee
Overall 0.0085 0.0067 0.0000 0.0710
Between 0.0056
Within 0.0020
Redemption fee
Overall 0.7835 0.4120 0.0000 1.0000
Between 0.4275
Within 0.0243
Marketing fee
Overall 0.5579 0.4967 0.0000 1.0000
Between 0.4960
Within 0.0446
Performance fee
Overall 0.1853 0.0636 0.0000 0.4000
Between 0.0555
Within 0.0303
Duration
Overall 12.74 8.5635 3 100
Between 8.5635
Within 0.0000
Leverage
Overall 0.3795 0.2374
0.5327 0.9991
Between 0.2194
Within 0.0906
Total return (After-fee % NAV)
Overall 0.0190 0.1667
0.9847 0.9400
Between 0.0793
Within 0.1517
Size
Overall 587,649,000 94,627,807 56,308,229 904,028,416
Between 72,889,678
Within 18,392,729 Table 1.
Data characteristics
Note: Data refers to 2,540 observations (2,540 observations)
JERER On average, the duration of the funds is 12.74 years, with a standard deviation of about
14,2 8.5 years. It is worth noting that the maximum value is 100 years, but this exceptional result
only refers to a single fund case.
The leverage has an average of 38%, with a between-variation of 22%. Within value-
added funds, the average leverage value is 50%, but it reduces to 32% in core vehicles.
Considering the approach this paper followed to calculate the leverage, there are a few
218 cases in which this variable assumes values that are lower than zero, suggesting that in
certain cases the cash position is higher than the amount of liabilities held by the fund.
The average size of the funds in the data set is around e588m, with a standard deviation
of e94m.
From the performance fees viewpoint, the average value is 18.52%, with a maximum of
40% and an overall standard deviation of 6.3%. The between standard deviation amounts
to 5.54%, meaning that most of the performance fee variation depends on structural
differences between funds rather than the intrinsic features of the vehicle. A similar
conclusion is valid for management expenses charged by the funds in the analyzed sample.
The load fee, the redemption charges and the marketing costs are included in the
model in the form of dummy variables, namely, the value “1” means that a fund is
charging that fee, “0” otherwise. Accordingly, the descriptive statistics that relate to
these three latter variables are indicators of frequency and defines the percentage of
funds in the sample that do charge the specific fee. In this perspective, more than half of
the funds require investors to pay marketing and load fees and, respectively, weighting
about 56.0% and 53.5% of the sample, while an absolute majority of them (78.3%)
apply a redemption fee.
Finally, turning to the dependent variable, the total annual after-fee return, calculated in
percentage of NAV, amounts to 1.9% (in line with an average return of 1.94% of the Inrev
index observed in the period 2001–2014) against an overall standard deviation of 16.67%.
The variable is particularly volatile, as expressed by the maximum (94%) and minimum
values (
99%).

5. Methodology
Based on a multilevel collection of data, the units of observations fall into groups. The first
level is represented by single observations for each fund, while the second level is identified
by each fund.
The linear regression model considered in our analysis takes the following form:

Yij ¼ B1 þ B2 X2ij þ . . . þ Bp Xpij þ eij

where:
Yij: annual logarithmic after-fee return of fundi at time j;
B1: intercept of the model;
X2ij: management fee of fundj at time t;
X3ij: performance fee of fundj at time t;
X4ij: leverage of fundj at time t;
X5ij: duration of fundj, which is the same for j observations of fundj;
X6ij: a dummy variable for load fee (equals to 1 if fundj applies it at time t);
X6ij: a dummy variable for marketing fee (equals to 1 if fundj applies it at time t);
 X6ij: a dummy variable for redemption fee (equals to 1 if fundj applies it at time t); Real estate
X7ij: size of fundj at time t, measured in terms of GAV of fundj; funds
X8ij: a macro variable that takes the value 1 if the observation has been collected in a
year characterized by a macro shock (2000 and 2008–2010); and
eij: a residual error term.

It may be unrealistic to assume that the returns of the same fund are independent given the 219
observed covariates (Xs variables). In other words, residuals eij and ei’j’ are independent. It is,
therefore, possible to split the total residual into two error components:

eij : uj þ sij

Substituting for eij yields a linear random intercept model, which will be used to carry out
the analysis.
The linear random intercept model takes the following form:

Yij ¼ B1 þ B2 X2ij þ . . .: þ Bp Xpij þ uj þ sij


¼ B1 þ uj þ B2 X2ij þ . . .: þ Bp Xpij þ sij

Now, the model can be interpreted as a regression with a fund-specific intercept uj that then
can be considered a “random parameter” not estimated together with the fixed parameters
B1 . . . Bp, rather than its variance v1 is estimated together with the variance v2 of sij.
The Level 2 residual (equivalent to the random intercept) uj is a fund-specific error term that
remains constant across the different yearly observations for each fund. While the Level 1 error
term sij is specific of every single yearly observation and varies for each observationi, as well as
fundsj. uj is independent among funds, while sij is independent over funds and each yearly
observation of the covariates. uj is inserted into the model to represent the joint effects of
unobserved heterogeneity and omitted mother characteristics. If uj is negative, the total residuals
for fundj will tend to be negative, leading to lower-than-predicted returns. If uj is positive, the total
residuals for fundj will tend to be positive, leading to higher-than-forecasted returns. As uj is
shared by all responses for the same fund, it creates within-fund dependence among sij.
Based on the assumptions of the model, it is possible to conclude that both uj and sij are
uncorrelated with the Xs variable. It is then crucial to test whether the findings of our model
satisfy this hypothesis.
Turning to the hypothesis about the distribution of the error term components, we
assume that:

uj Nð0; v1 Þ
e

sij Nð0; v2 Þ
e
6. Results and findings
6.1 Fee level and performance
The first research question investigates how the fees charged by a non-listed real estate
fund, together with its duration, size and leverage, affect the performance of the fund.
A likelihood ratio test for the hypothesis H0: v1 = 0 (that uj = 0 or that there exists no
random intercept in the model) is performed, suggesting that the hypothesis is rejected with
JERER a p-value of 0.00001. Therefore, as will be confirmed by the results of the tests, the use of a
14,2 random intercept model and a multilevel model is appropriate, as further confirmed by the
fact that rho is statistically different from zero.
Between-effects (Level 2) and within-effects (Level 1) regressions and Hausman’s test
have been performed to define the appropriate specification for the model. The analysis
showed statistically significant results, indicating that the fixed-effects model that only uses
220 within information should substitute the random intercept model. However, the use of a
fixed-effects model would not allow for the estimation of the coefficient of Xs variables that
vary only between clusters. Indeed, if there exist covariates that have the same within and
between effects, we obtain valuable estimates of these coefficients by using both between
and within-cluster information. This reason explains why the paper adopts a random
intercept model, and inserts cluster mean for those covariates showing relevant differences
among between and within effects. The paper considers cluster-means for performance fees
and leverage covariates. Indeed, when mn_Performance Fee and mn_Leverage are included
in the random intercept, the Hausman’s test is no longer significant at the 5% level.
Finally, a variance inflation factor (VIF) test has been performed to check for
multicollinearity issues. However, as none of the variables have a critical VIF value, the
issue does not seem to impact the results significantly.
Table 2 describes the model after performing all the statistical tests. The regression
includes nine plus two independent variables and one dependent variable, indicated by the
log total return. Redemption fees, performance fees, management fees and macro negatively
affect the return of a fund. Conversely, marketing fees, leverage, size and duration have a
slightly positive effect on a fund’s log total return. The load fee still not significant at a 10%
confidence level. Performance fee and leverage represent the fixed effect estimation of the X
coefficient, while mn_Performance Fee and mn_Leverage represent the between-cluster
coefficients.
Rho is statistically different from zero, confirming the suitability of a multilevel
regression model. Moreover, the normality check on Levels-1 and
2 residuals show that the
hypothesis of the normal distribution is valid.
The findings of the research demonstrate the first hypothesis, thus confirming the
existence of a negative relationship between the fees and returns in the European non-listed
real estate funds. Besides, these results are in line with those described in earlier studies in
the mutual fund industry.
Management fees, redemption fees and performance fees have all a negative impact on
the performance. However, the magnitude of the negative relationships varies considerably
for each of these fee clusters. The only exception to this line of reasoning comes from the
marketing fees, which are the only expenses producing a positive effect on the return.
However, despite colliding with the initial expectation, this result is still justified in the
academic literature (Sirri and Tufano, 1998; Grinblatt and Titman, 1994; Zheng, 1999).
Several reasons support this negative relationship between the fees and the performance.
First, the fees reflect the costs of operating the fund. Accordingly, the higher these expenses,
the higher the return a fund needs to generate to compete with other investment vehicles.
Hypothetically, should all the funds produce the same before-costs return, the best
performer is the one charging the lowest fees. Furthermore, the presence of economies of
scale can impact the larger funds by lowering their operating costs. Those funds may
deliver better performance and persistence, should the size be a relevant indicator of past
performance. Finally, the presence of skilled managers can contribute to lower fees as they
carry out better investment decisions and are more efficient in managing the operations of
the fund.
 Dependent variable: log total return
Real estate
funds
Constant 0.0122*** (0.0021)
Management fee
0.0019*** (0.0007)
Performance fee
0.0957** (0.0086)
Mn_Performance fee
0.0013** (0.0008)
Load fee 0.0098 (0.0045)
Redemption fee
0.0016* (0.0009) 221
Marketing fee 0.0095*** (0.0009)
Duration 0.0089*** (0.0024)
Leverage
0.0055*** (0.0018)
Mn_Leverage
0.0168*** (0.0219)
Size 0.0003*** (0.0000)
Macro
0.0979***

0.0194
Observations (Level 1) 2,540
Observations (Level 2) 363
R2 – total 0.2808
R2 – Level 1 0.0109
R2 – Level 2 0.4542
Residual std. Error_u 0.0371
Residual std. Error_s 0.1984
Table 2.
Rho 0.0298 Output of regression
after performing the
Notes: (Standard error); *significant at 10% level, **significant at 5% level and ***significant at 1% level statistical tests

It is worth noting that the negative relationship between before-fee returns and fees can also
depend on the so-called strategic fee. A definition introduced for money market mutual
funds by Christoffersen and Musto (2002). The authors, by analyzing the empirical studies
on mutual fund flows (Sirri and Tufano, 1998) and studying survey data on mutual fund
investors’ behaviors (Capon et al., 1996; Alexander et al., 1998) concluded that mutual fund
investors have different sensitivity to performance. They observed that funds with a
bad record of accomplishment have less performance-sensitive clients, as high performance-
sensitive investors would have exited those funds following bad returns. Accordingly, funds
with a greater proportion of performance-insensitive investors can charge higher expenses,
as the reduction of after-fee performance caused by an increase in fees, will not translate into
a large outflow of money: funds with bad historical performance will find it optimal to
charge high fees to their investors.
The redemption fee coefficient is slightly negative at the 10% threshold. Accordingly, a
unit increase in the redemption fee would reduce the log return by 0.158%, ceteris paribus.
This result partly contrasts with previous studies on mutual funds that demonstrated a
positive relationship between fund performance and redemption. However, the results do
not conflict with the initial hypothesis, once highlighted the structural differences between a
mutual and a non-listed real estate fund. Typically, the objective of the back-end load in an
equity mutual fund is to discourage redemptions, namely, by making redemptions
expensive, a mutual fund dissuades investors from redeeming their shares, so it can invest
the resources in a riskier portfolio to enhance performance. However, the turnover in equity
mutual funds is usually high, given that they are open-ended funds. On the other hand, non-
listed real estate vehicles are mainly closed-end funds and characterized by a very low
investment turnover. Therefore, in non-listed real estate vehicles, it is likely that the
JERER redemption fees hurt a fund’s performance, as it loosens the capability to act as deterrents to
14,2 turnover compared to equity mutual funds.
Performance fees have the highest negative impact on the return of European non-listed
real estate funds. However, considering that the average amount of performance fees is
18.52%, much higher than any other fee percentages, this fact explains most of the
phenomenon. The research results also demonstrate that marketing expenditures have
222 positive impacts on the return of the funds. In line with previous studies, this event
illustrates how marketing fees allow attracting more inflows on the market, which, in their
turn, translate into a competitive advantage for large funds compared to smaller ones (Sirri
and Tufano, 1998; Zheng, 1999). Access to non-listed real estate funds is permitted only to
institutional investors, so it is arguable whether investments in marketing activities affect
this category in the same way they do for the retail investors in the mutual funds industry.
Additionally, the research has considered the impact of duration, leverage and fund size
to provide a broader perspective on the variables that drive the performance in European
non-listed real estate funds.
Regarding the first element, the intuition underlying the positive relationship between
duration and return is that, given the high degree of the complexity characterizing real
estate investments, a longer duration grants the manager more time to better manage the
fund, in particular, considering the high real estate transaction costs. Likewise, leverage
impacts the performance of non-listed real estate funds in a slightly positive relationship.
This finding is indeed consistent with the idea that leverage can enhance the return of a
fund, despite it is crucial to use it with discretion.
Finally, concerning the fund’s size, the findings show that with a unit increase in size, the
log return would increase by 0.03%, ceteris paribus. As suggested by Chou and Hardin
(2014), the existence of extra performance in large funds partly depends on the economies of
scale. Indeed, as they reduce the costs per unit, the economies of scale would enhance the
fund’s return. Additionally, large funds possibly have access to more financial resources,
enabling them to afford and employ better portfolio managers and invest in high-quality
research (Lin and Yung, 2004). Besides, there are pieces of evidence that a larger asset
portfolio corresponds to higher benefits from diversification. Therefore, a greater
diversification might positively affect the return of a fund. Finally, it is likely to expect the
impact of potential barriers to entry. In particular, the largest funds can invest in larger
assets (i.e. trophy building), for which there are fewer potential bidders, therefore in a less
liquid segment with a higher expected return.

6.2 Core and value-added funds

Following the same methodology adopted in the previous section [5], we divided the sample
according to fund investment style to test whether the findings discovered in Section 6.1
holds in two subcategories, core and value-added funds. Accordingly, the overarching
objective is to test the second research hypothesis by understanding how the fee-
performance relationship changes between different investment styles.
In this section, the paper dedicates particular attention to the role of leverage, which is
one of the significant variables that contribute to creating different investment style
clusters. Indeed, core and value-added funds in the sample show different debt levels, which
amount to 32% in the first case and 50% in value-added funds. Therefore, it is a
fundamental requirement to understand whether leverage plays a distinct role when
examining categories with different financial structures and investment styles.
The analysis is carried out separately for core and value-added funds, and the results are
summarized in Table 3.
 In both core and value-added funds, the results of performance fees, management fees Real estate
and macro variables are in line with those highlighted in the previous section, showing a funds
negative relationship with the dependent variable. Likewise, marketing fees and size are
significant and confirmed their slightly positive impact on the fund’s performance. On the
contrary, the redemption fee indicator, which was significant at a 10% threshold in the full
sample, lost its significance at the two-subcategory levels. Therefore, the investment style is
not a significant predictor in evaluating the differences in performance for these indicators.
This finding is in line with the study of Fisher and Hartzell (2016). 223
It is worth noting that the negative impact of performance fees on performance is slightly
worse in value-added funds than in core funds. Therefore, if higher fees funds should be a
deterrent to attract investments from wise investors, this finding corroborates when it
comes to value-added funds. These results, which reflect the different investment styles, are
consistent with the second research hypothesis expectations. Noticeably, value-added funds
follow more aggressive investment strategies; thus, they charge higher performance fees as
an adequate reward for the higher risk taken on.
The leverage indicator behaves differently depending on the investment style of the
fund. In the core sample, the leverage has a slightly positive effect on performance, while in
the value-added cluster, it shows a clear negative impact on returns (Table 3). Considering
that the investment style links to different risk profiles, it is not surprising that leverage has
different roles depending on the underlying investment style (Fuerst and Matysiak, 2013).
The different leverage behaviors observed in the two samples are consistent with
previous studies. Shilling and Wurtzebach (2012) found that the impact of leverage on a
fund performance depends on the investment style of the vehicle itself. Furthermore, Fuerst
and Marcato (2009) demonstrated that leverage improves the performance of core open-
ended funds. Indeed, excessive use of debt, like in value-added vehicles, may harm a fund
performance by making the cost structure too rigid (Anson and Hudson-Wilson, 2003).

6.3 The impact of global financial crisis: 2001–2007 versus 2008–2013

Furthermore, the paper investigates the impact of the GFC on the funds returns.
Accordingly, the analysis distinguishes between two periods, 2001–2007 (AnteGFC) and

Core investment Value-added Whole universe

Dependent variable: Dependent variable: Dependent variable:
Independent variables log total return log total return log total return

Constant 0.01294*** (0.0204) 0.0225*** (0.0109) 0.0122*** (0.0021)

Management fee
0.0216** (0.0099)
0.0202* (0.0079)
0.0019*** (0.0007)
Performance fee
0.00029*** (0.0001)
0.0058*** (0.0029)
0.0957** (0.0086)
Load fee
0.0011 (0.0082) 0.0019 (0.0001) 0.0098 (0.0045)
Redemption fee 0.0003 (0.0002)
0.0007 (0.0003)
0.0016* (0.0009)
Marketing fee 0.0007*** (0.0005) 0.00004** (0.0000) 0.0095*** (0.0009)
Duration 0.0008** (0.0001) 0.0007** (0.0001) 0.0089*** (0.0024)
Leverage 0.0065*** (0.0005)
0.0072*** (0.0002)
0.0055*** (0.0018)
Size 0.0002*** (0.0006) 0.0008** (0.0004) 0.0003*** (0.0000)
Macro
0.0382** (0.0094)
0.0285*** (0.0092)
0.0979***
0.0194
R2 – total 0.1923 0.1692 0.2808
R2 – Level 1 0.0112 0.0087 0.0109
Table 3.
R2 – Level 2 0.3825 0.3871 0.4542 Output of the
regression after
Notes: p-value; *significant at 10% level, **significant at 5% level and ***significant at 1% level performing tests
JERER 2008–2013 (PostGFC). Table 4 shows the results of the analysis that has been carried out for
14,2 two different periods separately.
For both periods, the redemption fee and load fee are not significant at a 10% confidence
level. Besides, the results show a negative impact on the return for performance fee and
management fee, leverage, marketing fee, size, while duration has a slightly positive effect
on the log total return of a fund. It appears that the relationship between the independent
224 variables and the performance of a fund did not substantially change during the GFC.
However, in PostGFC, size seems a less relevant factor in determining a fund’s positive
performance, reflecting the greater flexibility enjoyed by small-size funds (Ferreira et al.,
2013). Indeed, Ferreira et al. (2013) demonstrated that smaller funds generally are managed
better and can provide investors with more accurate explanations of their investment
strategies than larger ones do. In highly volatile markets, large funds may no longer have
economies of scale; but, the lost flexibility – due to a bigger asset base – may be offset by
their capability to generate greater operating efficiencies.
A further interpretation of the findings observed in Table 4 is that the GFC has dramatically
reduced the number of potentially profitable investments, changing the approach used by
institutional investors in their investment selection. Indeed, before the GFC, large funds
attracted most of the investments given the cost advantage they offered and the relatively large
availability of profitable investment opportunities. However, during the GFC, the inflows
registered by large funds have decreased as institutional investors started to dedicate more
time analyzing potential investments; consequently, this generated a slowdown in the returns.
Finally, it is worth noting the distinct intercepts between the two sub-periods and the
significantly higher value of the one in AnteGFC, reflecting a different average yearly return
in the two sub-periods (8.4% during the AnteGFC and 4.9% in PostGFC).

7. Conclusions
The European private equity real estate funds have gained increasing attention among
investors and, yet, the academic literature coverage has been relatively moderate.
Accordingly, the paper’s objective was to investigate the performance drivers in a sample of
363 European non-listed real estate funds both in a broader perspective and tailor-made

2001–2007 2008–2014 Whole universe

Dependent variable: Dependent variable: Dependent variable:
Independent variables log total return log total return log total return

Constant 0.02274*** (0.0209) 0.01428** (0.0131) 0.0122*** (0.0021)

Management fee
0.0176** (0.0089)
0.0186** (0.0081)
0.0019*** (0.0007)
Performance fee
0.0003*** (0.0001)
0.0057*** (0.0029)
0.0957** (0.0086)
Load fee
0.0014 (0.0081) 0.0027 (0.0001) 0.0098 (0.0045)
Redemption fee 0.0002 (0.0002)
0.0006 (0.0003)
0.0016* (0.0009)
Marketing fee 0.0008** (0.0004) 0.00004* (0.0001) 0.0095*** (0.0009)
Duration 0.0006** (0.0001) 0.0007** (0.0001) 0.0089*** (0.0024)
Leverage 0.0050** (0.0014) 0.0019*** (0.0012)
0.0055*** (0.0018)
Table 4. Size 0.0009*** (0.0001) 0.0004*** (0.0003) 0.0003*** (0.0000)
R2 – total 0.2139 0.1951 0.2808
Output of the R2 – Level 1 0.0100 0.0118 0.0109
regression after R2 – Level 2 0.3871 0.3799 0.4542
performing statistical
tests Notes: p-value; *significant at 10% level, **significant at 5% level and ***significant at 1% level
scenarios and highlight the impact of different investment styles or time intervals with a Real estate
focus on the effects of the GFC. funds
In the first section, the paper identified several variables to be significant fund
performance predictors. Despite the findings on leverage, size and duration confirmed those
of previous research studies, this paper also found different fee categories to be significant
predictors, adding a relevant contribution to the existing literature on European non-listed
real estate funds. In particular, it found redemption fees, performance fees and management
fees to have a negative relationship with fund performance, while marketing fees have
225
positive impacts on the returns. On the contrary, load fees do not show any statistical
significance. These results have an empirical implication, as they help investors to direct the
investments toward more efficient funds, capable of providing returns that can be more in
line with the risk appetite of each individual.
Additionally, in all subsequent sample classifications, by investment styles and by time
intervals, the findings observed at the full sample level are still confirmed. Therefore, the
relationship between fees and a fund performance tends to be consistent in different
scenarios of analysis, irrespectively of the fund risk orientations or the economic cycle.
However, although the positive or negative direction of the relationship holds at sub-sample
levels, the values of the coefficients are different. In particular, their impacts on returns
appear to be more profound, especially in the aftermath of the financial crisis.
From the investment-style perspective, leverage has a significant role. Indeed,
depending on their risk profile, funds may have different financial structures. In
particular, value-added funds generally use more leverage than core ones do, consistent
with their higher risk profile. Therefore, it is not surprising that the different financial
structure of the two types of funds would affect their respective performance
differently. If for core funds, the relationship between leverage and returns is positive,
as in a low-debt scenario the use of debt delivers well-known advantages (as widely
explained by the literature), in value-added funds, which already have high debt
exposure, incurring in more debt would make its cost structure excessively rigid, and
increase the risk of default.
From a practical viewpoint, these results are supportive and can provide investors with
guidelines on how to optimize their investment choices and in line with their risk appetite. If
there are no substantial differences in the relationship between fees and performance
according to the investment style, with the only exception of the performance fees, within
the same asset-class, higher fees would generally translate into lower a fund’s performance.
Thus, in line with previous studies, investors, especially in the aftermath of the GFC, should
invest their resources in vehicles that charge lower fees. Inrev could potentially leverage
these findings to create awareness on both fund managers and investors’ perspectives on the
major drivers that, potentially, could foster a fund’s performance.

Notes
1. For readability purposes, Figure 1 excludes four outliers that have management fees above 3.5%.
2. Most of the income of a management company of a fund comes from the management fees.
3. Non-listed real estate funds have unique characteristics compared to mutual funds. They are
marketed only to institutional investors. Furthermore, their investment decision is preceded by
direct contact with the management company, so marketing activities may be different from
those used for mutual fund marketing campaigns. Finally, real estate assets are less liquid than
other financial assets (i.e. equity and foreign exchange instruments).
JERER 4. The European Association for Investors in Non-Listed Real Estate Vehicles. The authors are
14,2 grateful to Inrev for providing blind data for this research. All results and comments are the sole
responsibility of the authors.
5. For readability purposes, this section will describe only the results that answer the second
research question.

226
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Corresponding author
Giacomo Morri can be contacted at: giacomo.morri@sdabocconi.it

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