Magazine article Real Estate Issues

Institutions Re-Examine Real Estate

Magazine article Real Estate Issues

Institutions Re-Examine Real Estate

Article excerpt

As we near the end of 1995, real estate is reemerging as a viable investment product for institutional investors. Many were so badly burnt over the last five years that real estate is still a dirty word. But others have recognized that real estate, like most investments, is cyclical and that pricing probably went past its peak on the high side and now has probably dropped below a normal ebb on the low side. Many opportunistic funds have been structured to take advantage of this market opportunity, and institutions are participating in various areas, from direct equity to debt. This article will look at three major institutional players: pension plans, life insurance companies and banks. All have been affected by real estate and are responding to the changing market in different ways.

The total value of United States real estate, estimated at about $3.08 trillion, is divided approximately $1.86 trillion or 60% to non-institutional owners comprised mostly of government and private concerns. The balance, or $1.22 trillion, is considered institutional real estate and represents about 40% of the total. The institutional segment is further divided between debt and equity. The debt component is about $992.53 billion and the equity is $231.55 billion.

As indicated in Figure 1, the two largest players in the equity area are pension funds (43.4%) and life companies (21.6%). Combined, they represent 65% of the market. And the largest investors in the debt market are commercial banks with 39.4% market share. It wasn't until the late 1970s that pension funds started investing in real estate in a meaningful way. One of the strong arguments to invest in real estate was that it provided a good diversification to stocks and bonds which accounts for the bulk of invested pension dollars. Life companies have invested in both equity and debt for a number of years; recent regulatory changes have affected their investment strategy and many are becoming net sellers. Commercial banks were stung by many bad loans and, consequently, had growing REO (Real Estate Owned) portfolios which hurt earnings. Many banks have been restructured and others have merged or acquired other banks to expand market presence and create greater efficiencies.

Pension Funds

Pension Funds represent one of the fastest growing pools of capital in the United States. As shown, pension funds assets are projected to double from 1987 to 1997, or grow from $1.5 trillion to $3.2 trillion. Over this period, the mix of assets has changed and is expected to continue changing.

The major change has been a reduction in domestic bonds from 35.3% in 1984 to 24.9% estimated in 1997. International stocks/bonds, or those emerging markets, picked up most of the excess growing from 3.7% in 1989 to 13.8% estimated in 1997. Equity real estate, as we all know, has not fared well in recent years. Due primarily to value declines, equity real estate has dropped from 5.2% of pension assets to about 3.2% in 1994. The good news is that by 1997 this asset class is expected to grow by about 1% or $32 billion.

The Russell-NCREIF Property Index reported positive returns for all four quarters of 1994, and it ended the year with a healthy 6.73% annual return. The first quarter of 1995 has continued the trend with a positive 2.0% return.

As of 1994, about 43% of all pension funds invested in equity real estate. This was down slightly (about 2%) from 1993. During 1995, corporate and public funds are expected to increase their equity real estate slightly, but endowments and foundations should grow by about 7%. Pension funds are moving back into the market, but they are using their experiences of the 1980s to ask the right questions and understand the risks prior to committing. Many funds are deciding whether an average fund's real estate allocation of 3.2% is worth the time and effort, since an allocation of approximately 10% is necessary to achieve any diversification benefits. …

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