The Role of Financial Leverage in the Performance of Core, Value-add and Opportunistic Private Equity Real Estate Funds

We study a unique data set in order to examine the performance of a sample of 169 global private equity real estate investment funds across the core, value-add and opportunistic investment style categories over the most recent property cycle (2001-2011). We employ a multi-factor asset pricing model to measure the impact on the funds’ total excess returns of the underlying real estate market, managerial skill measured by Jensen’s alpha, leverage and, for the first time, managerial skill as it relates to timing leverage decisions to anticipated future market trends. We find evidence consistent with the hypotheses that i) fund performance is almost directly proportional to the return on the underlying real estate market, ii) there is evidence for systematic underperformance as measured by Jensen’s alpha, possibly related to market frictions, iii) leverage cannot be viewed as a long-term strategy to enhance performance, and iv) timing leverage choices to the expected future market environment does not appear to add significantly to fund excess returns.