Executive Summary. Since the early 1970s, private commingled real estate funds (CREFs)1 have served as a popular investment vehicle through which institutional investors have allocated capital to the real estate market. Because the institutional investment arena is dominated by pension funds that are either subject to ERISA mandates or merely choose to follow ERISA "prudence,"2 CREF securities have attracted institutional capital because of their ability to maintain diversity, value and stable returns throughout the years. Although still prevalent as a viable asset class, CREFs however have not survived peacefully without demand for alternative market structures and various criticisms initiated by market participants.
This article summarizes and identifies three of the most commonly reoccurring issues, suggested by many industry professionals, to be potential structural flaws with both the CREF market and the CREF vehicle itself. The article further explores an industry reaction to alternative market structure demand; a formalized secondary market for the trading of unregistered real estate securities,3 and analyzes the opinions of industry participants as to the possibility of such a market improving the status quo. During the course of research for this article, thirty industry participants (thirteen fund managers, twelve plan sponsors and various representatives associated with formalized secondary market efforts) were interviewed. The interview results, along with review of industry literature, serve as the basis for identifying additional thoughts that could prove relevant to the successful operation of a formalized secondary market for CREF share trading.
CREF MARKET CONDITIONS; PERCEIVED MARKET INADEQUACIES
Relative to the public equities and bonds market, the private commingled real estate fund market is young and still experiencing developmental criticism from numerous investors. Various past events have led investment professionals to believe that select issues associated with the performance of private commingled real estate funds (CREFs) require attention before the CREF market can continue to develop. Although a consensus has yet to be formed as to the hierarchy of importance of these issues, review of recent industry literature as well as interviews with industry participants reveals that the most commonly reoccurring issues associated with the existing private CREF market and vehicle relate to:
CREF Valuation Methodology
The following paragraphs explain these issues in more detail as they relate to the private real estate securities market and illustrate a demand for direction from industry participants in addressing these issues.
A documented concern with the operation of the private real estate market questions the relative lack of available and accurate information required to make sound investment decisions (as compared to the public investment arena), and the high costs associated with obtaining such. Consequently, many industry professionals have classified the private real estate market as being "inefficient"4 in consideration of the following existing market traits:
high transaction and information gathering costs associated with the acquisition of underlying assets;
lack of available, publicly traded, audited information;
complexity of possible transaction structures-which undermines the ultimate liquidity of underlying assets;
varying state laws for acquisition, finance and operations and the non-homogeneous nature of local markets and assets, which tends to slow down the acquisition process. (Dohrman, 1994)
Why then would the apparent inefficiency of the private real estate market present a concern among industry professionals with regard to CREF investments? In an inefficient market such as real estate, information is …