Direct Real Estate Funds Rebound with 5.81% Average Gain
Semiliquid direct real estate funds posted an average 5.81% return for the year ending June 30, 2026, marking a significant recovery.
The average semiliquid direct real estate fund gained 5.81% for the year ended June 30, 2026. This represents the category's strongest 12-month performance in over three years.
Blackstone Real Estate Income Trust, a $57 billion fund, reported net inflows in the second quarter of 2026. It was the fund's first quarter of net inflows in nearly four years. This resurgence follows a period of severe stress triggered by rapid Federal Reserve interest rate hikes.
Performance Recovery After Rate Shock
Real estate investments were heavily impacted by aggressive rate increases starting in 2022. The effective federal-funds rate rose more than 5 percentage points from early 2022 through September 2023. Higher borrowing costs pressured property values, while long-term leases prevented immediate rent adjustments.
The Morningstar US Real Estate Index, tracking public REITs, fell 33% from January 2022 through October 2023. Both public and unlisted real estate investments have since begun to recover and are making new highs for the current market cycle. Morningstar columnist Dan Lefkovitz highlighted this rebound in public market REITs in August.
Public and private real estate move in the same direction but at different speeds. Public REITs reprice daily, leading to a steeper initial decline but a faster recovery. Private real estate, valued via periodic appraisals, adjusts more gradually. By the end of June 2026, public REITs had ultimately pulled ahead of their private counterparts.
Tax Advantages Boost After-Tax Yield
Total returns are not the only draw for investors. The tax treatment of returns from direct real estate funds provides a significant benefit. Depreciation deductions can offset rental income, allowing much of an investor's cash distribution to be classified as a return of capital.
Return-of-capital distributions are not taxed as ordinary income when received. This makes the yield more attractive on an after-tax basis. Publicly traded REITs also use this treatment, but to a lesser extent due to their longer-lived structures.
For example, about 25% of Vanguard Real Estate ETF's distributions were classified as return of capital in 2025. In contrast, each unlisted REIT in Morningstar's analysis had at least 70% of distributions classified as return of capital. The trade-off is that these distributions reduce the investor's cost basis, deferring taxes until sale, when gains are typically taxed at lower long-term capital gains rates.
The following table, based on Morningstar's data, compares the distribution rates and tax-equivalent rates for selected funds, assuming a 37% ordinary income tax rate.
| Fund Name | Distribution Rate | Tax-Equivalent Distribution Rate |
|---|---|---|
| Fund A | 4.5% | 6.1% |
| Fund B | 5.1% | 7.0% |
| Vanguard Real Estate ETF (VNQ) | 3.8% | 4.5% |
Persistent Liquidity Risks for Some Funds
Despite the broader recovery, some funds are still grappling with liquidity crises. Starwood Real Estate Income Trust, with $7.6 billion in net assets, is a prominent example. Initially, it allowed redemptions up to 2% of net asset value monthly and 5% quarterly.
By May 2024, SREIT had cut its monthly redemption limit to 0.33% of NAV. In April 2026, it halted share repurchases entirely. As of August 2026, the only permitted withdrawals were for death, disability, or accounts under $5,000. This illustrates the liquidity mismatch where investors can request sales, but funds can restrict buybacks.
Other funds have taken different paths. Shareholders of Bluerock Private Real Estate voted in December 2025 to list the fund as a closed-end fund to provide immediate liquidity. The result was a more than 40% drop in share price, which persisted through August 2026.
Morningstar cautions investors to scrutinize a fund's liquidity terms and the manager's history with handling withdrawals. With semiliquid real estate funds, investing is always easier than getting your money back.
