Core charm

Institutional investors say they are willing to trade lower returns for less risk. However, is the current push for core full of hidden risk?

“We are living in an era of less,” the Urban Land Institute and PricewaterhouseCoopers declared this week.

A shrunken US economy, less demand, reduced credit availability and fewer development prospects has forced all real estate fund managers to adapt their investment models not only to an era of lower returns, but also an appetite for less risk-taking.

This week, the scale of that attraction to core was revealed in full. According to ULI and PwC’s Emerging Trends 2011 report, almost 43 percent of equity targeting the US was eyeing core and core-plus investments, compared to 25 percent for opportunistic deals and 21.8 percent for value-added.

With more than $700 billion of private equity, pension fund and foreign investment equity eyeing US real estate markets this year alone, core is showing it has plenty of charm.

For institutional investors, the appeal is understandable. After valuation declines of up to 50 percent, investors looking to deploy capital in the final quarter of 2010 and 2011 are finding the perceived safety of cash-flowing assets much more attractive than the less certain returns of higher-risk value-added and opportunistic strategies. After all “life is too short”, as one US pension plan executive told ULI and PwC. “I get paid as much for achieving solid 8 percent returns through core as making bigger returns on opportunistic strategies without the higher risk of losing my job if I bomb,” the executive said.

Of course, as investor demand for core increases so does fund manager activity in the space.

This week, Goldman Sachs Asset Management launched a new core real estate business, hiring ING Clarion’s number two Jeff Barclay to lead the operation. Hines and Antarctica Real Estate Capital also closed one of the largest core deals of the year this week, buying 11 landmark offices from the State of California in a $2.33 billion, 20-year sale-leaseback deal. For Irvine, California-based Antarctica, an emerging markets real estate investor over the past four years, the transaction marks its foray into the US.

The convergence to core, however, is raising concerns among some quarters of the industry.

With economic – and real estate – growth expected to be muted over the next few years, can the low cap rates and high prices being seen at some auctions for core assets actually be justified? Or is the relative return of real estate today, over and above money market and other fixed income alternatives, a good risk-adjusted play?

For Hodes Weill & Associates, the answer is patience. Writing a white paper on the issue this week, the New York-based firm said, over a full cycle, a plan sponsor’s real estate assets should be weighted to core. However, bearing in mind the competition and risks currently inherent in the core sector any portfolio realignment should be done over the next three to five years, instead of immediately.