Real Estate Risk and Hedge Fund Returns

Abstract

Extant literature has focused on the performance of hedge funds that invest in a wide range of investment strategies; however, an explicit analysis of funds that follow a real estate investment strategy is lacking. In this paper, we fill this void and explore a new dimension of hedge funds’ investment strategy relating to their exposure to the real estate market. We augment existing literature by introducing a real estate source of variation to proxy for investments in the securitized and direct real estate markets. Using fund level data from 1994 to 2011 from a major hedge fund data vendor, we identify 1,230 hedge funds as having significant exposure to the direct and securitized real estate market. We document that funds with significant real estate exposure have lower incentive fees, longer redemption periods, and higher high water mark levels. Additionally, hedge funds that have significant exposure to real estate are predominantly classified as fund of hedge funds implying a diversification strategy through real estate investments. Finally, we test for the economic impact across funds with varying levels of real estate exposure, and show that funds with significant real estate exposure significantly underperform funds that do not have real estate exposure.