Discover why smaller real estate funds may outperform mega-funds like Blackstone. Analysis of performance data shows boutique operators delivering superior returns through agility and mid-market focus.
When institutional investors write $100 million checks to real estate funds, they often gravitate toward household names like Blackstone. It’s a natural instinct – these firms manage hundreds of billions in assets and have decades of track record. But what if this conventional wisdom is wrong?
The David vs. Goliath Performance Story
Recent academic research is challenging the assumption that bigger is better in real estate investing. A study conducted by Origin Investments of private equity real estate funds shows smaller funds outperforming larger ones over the past decade, with the performance gap being both significant and persistent.
Using Preqin data, Origin compared the relative performance of funds with less than $200 million in assets under management against that of funds with more than $1 billion under management. The results were striking: while the data shows meaningful outperformance by smaller funds, the exact figures require careful analysis of multiple datasets to verify.
However, the broader research paints a concerning picture for large real estate funds overall. Real estate funds generated a mean size-weighted internal rate of return (IRR) of 7.0% and a direct alpha of –4.6% (based on liquidated funds with vintage dates through 2011), inferior to both buyout funds (IRR of 14.5%, direct alpha of 4.6%) and venture capital funds.
Why Size Becomes a Liability
The Deployment Problem
Large funds face what we call the “deployment imperative.” Blackstone is the world’s largest alternative asset manager, with more than $1 trillion in AUM, creating enormous pressure to put capital to work quickly. When you need to deploy billions annually, you can’t afford to wait for the perfect deal.
This creates several challenges:
Scale Constraints: A $25 million apartment building that might generate excellent returns simply doesn’t move the needle for a billion-dollar fund. The transaction costs and management overhead aren’t justified by the impact on overall portfolio performance.
Competition Premium: Large funds often compete directly against each other for the same trophy assets, driving up prices. The reason for the discrepancy in performance may be due to strategic drift and chasing over-priced deals in primary real estate markets.
Geographic Limitations: Mega-funds typically focus on primary markets like New York, San Francisco, and Los Angeles, where they can deploy significant capital. This leaves secondary and tertiary markets – often with better risk-adjusted returns – to smaller operators.
The Agility Advantage
Smaller funds operate with fundamentally different advantages:
Niche Expertise: A $150 million fund can specialize in a specific property type or geographic region, developing deep expertise that large generalist funds can’t match.
Decision Speed: With fewer layers of bureaucracy, smaller funds can move quickly on opportunities. While a large fund requires committee approvals and extensive due diligence processes, a boutique operator might close a deal in weeks.
Relationship Access: For those investors with the financial resources to be classified as “accredited investors”, namely having $1 million in the bank and/or a steady annual income of $200,000, then a private equity fund might offer a means of accessing a diversified portfolio of real estate. Smaller operators often have stronger relationships with local brokers, property managers, and other deal sources.
The Mid-Market Sweet Spot
The most compelling argument for smaller funds lies in the mid-market opportunity. Properties valued between $10-100 million often receive less attention from institutional buyers, creating pricing inefficiencies that skilled operators can exploit.
This segment offers several advantages:
- Less Competition: Fewer qualified buyers mean better negotiating position
- Value-Add Potential: Smaller properties often have operational improvements that can significantly impact returns
- Local Market Knowledge: Success depends more on understanding local dynamics than having massive scale
The Research Reality Check
While the case for smaller funds is compelling, investors should approach these claims with appropriate skepticism. Recent studies that evaluated closed-end real estate private equity fund performance concluded that the value proposition has, on average, been lacking.
The academic research shows concerning trends across the entire real estate fund industry:
- Closed-end funds in general generated negative alpha for investors, often did not outperform leveraged core strategies or REITs, and had significantly higher fees than alternative investment vehicles
- The best performing fund type in terms of the IRR are secondaries (18.82%), whereas the worst performing are expansion/late stage funds (9.09%). In terms of multiples of invested capital, the best performing fund type are buyouts (1.73x), while the worst performing type is represented by real estate funds (1.44x)
Due Diligence Is Everything
The performance variation within small funds is enormous. For individual closed-end real estate funds, the range of performance outcomes can be very broad. For example, the since-inception pooled IRR of the 504 U.S. closed-end real estate funds with vintages between 2008 and 2020 from the Burgiss Manager Universe dataset was 11.27% at the aggregate level, but for the 95th percentile it was 24.2% and for the 5th percentile -19.0%.
This means that while the best small funds may significantly outperform large funds, the worst can be catastrophic. Success requires identifying operators with:
- Proven Track Record: Look for teams that have successfully navigated multiple market cycles
- Transparent Reporting: Avoid funds that don’t provide regular, detailed performance updates
- Aligned Interests: Ensure management has significant personal capital invested alongside yours
- Operational Expertise: Real estate is ultimately about operations – focus on teams that can actually improve properties
The Personal Touch Factor
Perhaps the most underappreciated advantage of smaller funds is accessibility. When you invest with a boutique operator, you’re not just account number 47,291. You can actually reach the decision-makers, understand their strategy in detail, and get regular updates on your investments.
Blackstone’s team of nearly 900 real estate professionals across 12 offices operates as one globally integrated business. While this scale provides advantages, it also means individual investors often interact with junior staff rather than the key decision-makers.
The Verdict
The evidence suggests that carefully selected small real estate funds can outperform their larger counterparts, but this comes with significantly higher risks and the need for much more rigorous due diligence. The key is finding operators who combine deep market expertise, operational capabilities, and aligned interests.
For investors willing to do the homework, smaller funds offer the potential for superior returns through access to overlooked opportunities, faster decision-making, and more focused strategies. But remember: in real estate investing, there’s no substitute for thorough due diligence and understanding exactly what you’re buying.
The giants of the industry will always have their place, but the smart money increasingly recognizes that sometimes, smaller really is better.
This analysis is based on academic research and industry data. Past performance does not guarantee future results. Real estate investments involve significant risks and should only be considered by accredited investors as part of a diversified portfolio.