Why active management matters in private real estate

CEO argues period of easy gains has ended, and that analysis of portfolio composition is more important in today's environment

Why active management matters in private real estate

Even as unprecedent events over the past two years have coalesced into an extreme acid test for investors, alternative strategies and private investments have been a bright spot – if you know where to look.  

“Certainly, the economy has become much more uncertain over the last year,” John Courtliff, CEO and partner at ICM Asset Management, told Wealth Professional.  

Courtliff pointed to how the aggressive upward movement in interest rates over the last 12 months, which has created a shockwave of economic uncertainty as well as a challenging valuation environment for assets across the board. He says investors broadly are still trying to process how rising rates have impacted the value of their existing assets and the fair value to pay to acquire new investments or assets.  

Music royalties hitting the right notes  

Against that backdrop, ICM’s portfolio of investments has performed well over the past year, Courtliff says, though the underpinning reasons for each success differs.  

He cites the firm’s private asset music royalty fund, which has been “incredibly successful” over the last 36 months as institutional investors and the broader investment community are just now tuning into the space. Earlier this month, investors saw the launch of the MUSQ Global Music Industry Index (MUSQIX), which captures multiple facets of the music ecosystem including music streaming, music content and distribution, live music events and ticketing, satellite and broadcast radio, and music equipment and technology.  

“We've been in this space for a number of years now. Increased investor demand has outweighed the impact of rising rates over the last 12 months,” he says. “Our music royalty fund generated a mid- to high teens return last year.”  

A focus on real estate – the right markets & asset types matter

The firm also has multiple real estate strategies. Around 2018, Courtliff says ICM concluded that the twenty-plus-year trend of cap rate compression that fuelled strong beta across the real estate universe – not counting the Financial Crisis of 2008 – had run its course. The investment implication: just buying assets and waiting for the returns to come in is no longer a viable strategy.  

“Rather than just buying and holding property, we’re seeking to generate returns through active management strategies that can include value enhancement on a property through renovation, repositioning, or even through to development,” he says. “That's been rewarded over the last number of years, right through the first half of last year.”  

During that time, ICM sold off a number of industrial development projects within its largest real estate fund portfolio. They fetched values far above what they were being carried at within the portfolio, which Courtliff says gave them room to write down some other existing investments they felt were at risk as interest rates began to rise.

“We generated outstanding results for investors in 2022 that were truly the product of dispositions, as well as what we feel to be a properly priced portfolio in today's environment,” he says. “The return from our real estate fund has been in the 20% range, gross of tax, and in the high teens on a net of tax basis.”  

ICM also has a self-storage fund, which Courtliff says has continued to garner significant interest as storage assets trade at values equal to or greater than in the second half of 2022. He sees a conviction among investors that storage assets will continue to shine in times of economic uncertainty, as well as persistent strength in the secular demand for storage.  

Market over-correction doesn’t mean no rate impact  

Following the carnage in public markets last year, investors are increasingly considering alternative investments for their portfolios. In the case of private real estate, what Courtliff has seen is hardly a “fools rush in” phenomenon, but rather one where investors are looking with critical eyes and asking whether the valuations managers are currently reporting are fair and reasonable.  

“With public markets having reacted so fiercely, it's drawn a lot of very high-profile landlords, property owners, and investors out to say this is an overcorrection by the market. And they may be right,” he says. “But to say that there's no impact, which some of them have, is not something we agree with.”  

Given the substantial movement in interest rates during 2022, Courtliff suggests that it’s impossible to argue they’ve had no effect on stabilized income-producing real estate asset values, though he stressed that some property types have been more affected than others.  

The case for investing in office properties, for example, is currently facing an existential crisis in the wake of the Covid-driven broad adoption of remote work. Multifamily assets, meanwhile, were priced so aggressively in early 2022 that Courtliff and his team don’t see a whole lot of upward opportunity for rental rate growth from the already-expensive levels individual renters have already been struggling with.  

“I think investors are right to question the carrying values of private real estate managers. But not all managers and not all funds are created equal,” he says. “It's important that investors understand the differences between one manager and the next, one strategy and the next, and different portfolio compositions.”