In December 2019, the City of Austin Employees’ Retirement System, a US pension plan with around $3 billion in assets, implemented a radical overhaul of its real estate portfolio. At the time, COAERS’ real estate allocation of approximately 10 percent of its total assets was held through a single open-end US core fund. In what seemed a radical move, the board cut that allocation in half and reallocated the liquidated half to a portfolio of real estate investment trusts, effectively moving to a 50:50 private to public real estate investment ratio.
The pension fund’s so-called ‘portfolio completion’ strategy, with its heavy investment in REITs, stands out in an industry where private assets dominate the lion’s share of institutional investment.
Canada-based global benchmarking company CEM Benchmarking has analyzed the investment allocations of more than 200 US defined benefit pension funds – holding nearly $3.9 trillion in combined AUM – in a study published in October. According to the study, in the 21 years to 2018, listed real estate allocations averaged just 0.6 percent of the pension funds’ total assets. In contrast, unlisted real estate had a 3.8 percent allocation on average. This low level of allocation has existed despite listed equity REITs generating the second highest average net returns, of 10.2 percent, across all asset classes. Indeed, only private equity has performed better over the timeframe, at 10.6 percent.
A similar trend has played out in Asia where, on average, between 4 and 9 percent of Asian institutional real estate portfolios are invested in listed real estate, according to industry body ANREV’s Investment Intentions Survey 2020.
For COAERS, the contrarian decision was driven by liquidity, diversification, cost-effectiveness and, more crucially, performance reasons. David Veal, the fund’s chief investment officer, told Washington, DC-based industry body the National Association of Real Estate Investment Trusts in December that it realized it could have performed about 180 basis points better each year over the past 16 years if it had the REIT allocation it has today.
The unprecedented impact of market events unfolding over the past 12 months have given further weight to arguments by institutional investors for a greater exposure to real estate equities today. Karsten Kallevig, special advisor to the chief executive at Norwegian sovereign wealth fund steward Norges Bank Investment Management, said during an interview at PERE’s Europe conference in November: “The listed world is getting more and more important for bigger institutions.” At the same conference, Andrea Orlandi, head of real estate in Europe at the Canada Pension Plan Investment Board, said the public pension plan’s listed real estate program, launched a year and a half ago, had grown rapidly during the pandemic, largely because it “allows us to get over the hump of not being able to visit properties in many cases.”
NBIM and CPPIB are among a growing cohort of investors extolling the virtues of a greater role for listed real estate in a portfolio. Veal told NAREIT the crisis helped COAERS highlight the benefits of having a “liquid, highly customizable allocation to the sector, when you think of the need to adapt the portfolio to changing market conditions.”
Indeed, when private market activity was forced to pause at the start of the pandemic, investors found they could make quick opportunistic trades and take advantage of pricing dislocation, especially in the more covid-resilient property sectors. And against a backdrop of an accommodative monetary policy and a financially healthier REIT environment compared with the last financial crisis, listed real estate, once viewed for its volatility and risk-reward dynamics, has subsequently found itself being re-evaluated, particularly when compared with private core vehicles.
Covid-triggered buying spree
The floodgates may not have opened just yet. But a growing stream of institutional investors have been allocating capital to a range of listed strategies following the coronavirus outbreak.
More than 90 percent of the underlying assets in the open-end core index are in four property sectors: office, apartment, industrial and retail. In contrast, nearly 60 percent of the FTSE-NAREIT All Equity REITs index is represented by sectors outside the mainstream.
Chicago-based manager LaSalle runs a longstanding global real estate securities platform with $4.3 billion in assets under management. Lisa Kaufman, the platform’s global chief executive, says the business saw notably more activity in 2020 than in previous years. The firm signed new accounts, topped-up existing mandates and engaged in heightened request-for-proposal activity. PERE understands from a source familiar with the firm’s business that it raised close to $600 million of new capital in the year for the strategy.
Los Angeles-based CBRE Global Investors, which has $7 billion in real estate securities under management, has had a similar experience. Bernie McNamara, its global head of investor solutions, says the listed part of the firm’s business was in fact the fastest growing of all, on a percentage basis, last year.
Much of the demand has come from investors looking for tactical ways to capitalize on market dislocation. Public markets are often where distress first shows up, with daily mark-to-market valuations making listed real estate an early indicator of what might happen in private markets later.
“The Dow was falling 2,000 points a day in late March,” recalls Steve Sakwa, senior equity research analyst covering REITs for the investment banking advisory firm Evercore. “It felt like the world was ending in those last eight to 10 days. We had some big drawdowns on stock prices and there were some good opportunities. But you had to move quickly to take advantage. Some private equity folks like Blackstone also stepped in to buy publicly traded REITs.”
“It happened early and big in the public market,” agrees Kaufman. “When we look at fair value of our stocks, we are seeing among the biggest discounts to our estimated fair value in a very long time, perhaps in our history.”
International investors also jumped on the buying bandwagon. In the throes of the outbreak, Korea’s Public Officials Benefit Association approved a $200 million investment in US REITs and selected two real estate advisors to build out its portfolio. Donghun Jang, the pension fund’s chief investment officer, says he saw the pandemic as a “very unique event” for investing in REITs. Around 10 percent of POBA’s real estate portfolio, with $4.4 billion of AUM as of year-end 2020, is invested in listed real estate while the rest is in private assets. “I thought the situation could be resolved with a vaccine in the future, so we needed to take advantage of the market dislocation,” he says. In addition, there were not many transactions in the private market so we could not realize or invest freely as we could have in REITs.”
The equities opportunity is not over either. Although the market has seen a rally since then, there is still scope for opportunistic trades, PERE hears. “To a degree, that pricing dislocation and buying opportunity still exists, if you compare global REIT performance year-to-date to what the S&P 500 has done,” McNamara told PERE in late December. “Global REITs are still down 10 percent and the S&P 500 is still up 15 percent. So, there is still a gap there and interest from a pricing and value perspective.”
In December, for example, France-focused manager ICAMAP launched an absolute return-focused opportunistic listed real estate fund. The vehicle, structured as an open-end fund with an initial €200 million target, is targeting 15 percent returns by buying listed European property companies without a benchmark. As the firm highlighted in its fund announcement, a selection of companies still trade at high yields and “unjustifiably large discounts” to their net asset value of up to 60 percent.
(Un)appeal of core funds
The open-end structures that have been marketed over the past 20 years purported to offer the best of both worlds – liquidity and less volatility – Alan Supple, JPMorgan Asset Management
The growing attraction of listed real estate is also the result, in part, of institutional frustrations with the illiquidity involved in private market investing generally. These frustrations have become more pronounced in the pandemic era, market practitioners say.
“The open-end structures that have been marketed over the past 20 years purported to offer the best of both worlds – liquidity and less volatility,” says Alan Supple, head of global real estate securities at bank platform JPMorgan Asset Management. “But in periods of extreme market stress, one may have to sell the underlying asset to realize liquidity. In many cases, that is not an appealing prospect for the manager.”
The undisclosed open-end core fund holding of COAERS’ original real estate allocation, for example, has been gated for the foreseeable future, Veil highlighted in the NAREIT interview.
Last March, the UK also saw a wave of suspensions of open-end property funds by managers such as Columbia Threadneedle, BMO Global Asset Management and Aviva Investors as the country dealt with the ramifications of its exit from the EU. German open-end funds had famously slammed their gates following a wave of redemption requests in the aftermath of the global financial crisis of 2008.
We have heard from institutional investors that are frustrated because they see where real estate trends are going and would like to reallocate accordingly. But they cannot get money out of their private funds – John Worth, NAREIT.
“We have heard from institutional investors that are frustrated because they see where real estate trends are going and would like to reallocate accordingly,” says John Worth, executive vice-president for research and investor outreach at NAREIT. “But they cannot get money out of their private funds. It does not matter if you are ahead of a trend when you cannot put your money to work. It is not appealing to have to sit in a queue for 12-18 months before your money is called, and right now there are four-year redemption queues as well. Investors are asking why they cannot execute when they want to in real estate, which is possible in any other asset class.”
Tapping the new economy
Listed and private real estate markets have also evolved in vastly different ways over the years. The public-vs-private debate today is more about the “old economy” versus the “new economy,” as Patrick Kanters, head of real assets at APG Asset Management, noted at PERE’s November conference.
Take the NFI-ODCE index, for example. More than 90 percent of the underlying assets in the open-end core index are in four property sectors: office, apartment, industrial and retail. In contrast, nearly 60 percent of the FTSE-NAREIT All Equity REITs index is represented by sectors outside the mainstream. “Listed real estate has been ahead of the game in terms of innovating,” says Worth.
With the pandemic creating a setback for mainstream sectors such as office and retail, investors are also turning to listed real estate as part of a long-term strategy to scale their exposure in sectors supported by secular, demographic growth trends. These include student housing, healthcare, life sciences, single-family rental, medical office and cold storage. Jarrett Vitulli, senior managing director at investment banking advisory firm Evercore, says the typical private investor has about 20 percent exposure to non-traditional asset classes.
There are also a limited range of closed-end private funds specifically targeting these operationally intensive sectors. “Investors have been pushed into being more flexible in how they invest to get the exposure they want,” he says.
For Vitulli, directly buying real estate equities is not necessarily the answer. He is seeing more institutional investors forming partnerships with public REITs, rather than buying REIT stock. These partnerships have a seven- to 10-year average hold period, like a typical core fund.
“You are not going to get the same public volatility that you will get in a stock, but will end up with a more bespoke, discreet JV around a pool of assets,” he says. “At the same time, you will have better alignment, better governance, and better control over the investment strategy than a traditional commingled fund.”
Last February, for example, JPMorgan Asset Management’s Strategic Property Fund, an open-end core US vehicle, reportedly formed a joint venture with American Homes 4 Rent, a California-based REIT, to invest in single-family homes, a sector seeing strong demand due to the suburban migration trend in the wake of the pandemic.
In Asia, the listed new economy trend is also taking off, albeit gradually, creating successful fundraising outcomes for the first movers along the way. In December, pan-Asia logistics manager ESR listed the ESR Kendall Square REIT, Korea’s first logistics REIT.
Following its global offering, the REIT has a portfolio with $1.3 billion in total asset value and a $650 million market capitalization. Jeffrey Perlman, ESR chairman and also the head of Asia-Pacific real estate and head of South-East Asia at Warburg Pincus, tells PERE the initial public offering received an overwhelmingly positive response from both international and domestic investors, even though the roadshow was done virtually amid the pandemic.
The Korean REIT listing came more than a year after parent ESR was listed in Hong Kong, the latter listing raising $1.8 billion. That was the third-largest IPO in the city that year.
“In Asia, you do not have that much listed new economy real estate, so investors will naturally gravitate towards the limited options,” says Perlman. “There is only one listed data-center REIT in Asia, for example, and it trades at a huge premium to NAV.
“As the largest APAC-focused logistics real estate platform, the ESR stock has jumped more than 60 percent over our debut [price] on the stock exchange of Hong Kong.”
The biggest reason investors have been wary of increasing their listed exposure is its inherent volatility. Private real estate, because of lagged returns, is thought to have lower measured volatility.
Across all asset classes, including fixed-income, alternatives, and equities, listed equity REITs and unlisted real estate had the fourth and sixth most volatile net returns, with volatilities of 19.2 percent and 18 percent, respectively
However, the study by CEM Benchmarking found that listed equity REITs and unlisted real estate actually have comparable volatilities, after adjusting for reporting lags. Across all asset classes, including fixed-income, alternatives, and equities, listed equity REITs and unlisted real estate had the fourth and sixth most volatile net returns, with volatilities of 19.2 percent and 18 percent, respectively.
“The people on the forefront of investing in real estate understand that that is an illusion,” NAREIT’s Worth says about the perceived volatility of listed markets. “True volatility of real estate – whether in a listed or private form – is the same. It is the same underlying asset.”
REITs have also become more financially resilient over the years. During the global financial crisis, there was a massive sell-off by institutional investors in the public markets because there was a liquidity crunch and companies with overleveraged balance sheets triggered a fear of wholesale liquidations.
Between 2009 and 2020, REITs ended up raising $460 billion in common equity and, when the pandemic began, the overall leverage ratios were at or near the lowest on record, according to NAREIT’s 2021 REIT Outlook paper. The macroeconomic backdrop in the ongoing crisis was also vastly different, with low 10-year treasuries, accommodating credit spreads and abundant access to capital.
“If a fund’s CIO was comfortable with the underlying assets and felt that the companies could weather the storm because they were in a healthier position, there wasn’t such a willingness to sell,” says Supple.
Between 2009 and 2020, REITs ended up raising $460 billion in common equity and, when the pandemic began, the overall leverage ratios were at or near the lowest on record, according to NAREIT’s 2021 REIT Outlook paper.
The relative performance of different property sectors in 2020 has also helped in shifting investors’ mindsets. Although office, retail and lodging/resort REITs recorded significant declines, data center REITs – wrapped around more popular digital real estate – posted a total return of 17.2 percent.
“There is a change in investor perception of volatility as well as risk,” says LaSalle’s Kaufman. “Traditional sectors used to be considered lower risk than some of the newer economy sectors, which were newer entrants in the market. That perception, that began to shift a few years ago, has accelerated with the pandemic.”
Finding the right ratio
The listed real estate market has been steadily growing over the years, through more IPOs by private managers across the world. Markets such as India are witnessing a newfound interest in REIT launches, driven by the successful debut listing by Blackstone when it raised $689 million for the Embassy Office Parks REIT in 2019. Last May, Chinese regulators kicked off a pilot infrastructure REIT program, which, if successful, could become a $300 billion to $735 billion market within a decade, according to a report by market intelligence provider S&P Global.
Asset managers are also increasing their listed portfolios by acquiring stakes in REITs. ESR, for example, owns a strategic stake in Australian property investor and REIT manager Centuria alongside its own Korean REIT.
There is consensus among industry experts that listed real estate will become a greater part of an institutional real estate portfolio. An outstanding question is by how much. Is there an ideal ratio of listed and unlisted real estate for delivering the best risk-adjusted returns?
“For us, there’s no perfect ratio,” says Perlman. “As we get our assets completed and stabilized, we can sell them into our core funds or into listed REITs. We think both are very good vehicles, but just for different investors with different needs.”
Another Asian real estate manager, ARA Asset Management, for example, currently has 65 percent of its gross assets under management – amounting to S$110 billion ($83 billion; €68 billion) as of June 30, 2020 – in public real estate, including stakes in fellow managers Kenedix and Cromwell Property Group. The remainder is held in private assets. Chua Yang Liang, the firm’s head of group research and strategy, does not think “there is a hard rule of how much you should have in REITs vs private funds,” either. “It really depends on the individual business, each local market and the different growth cycle of the economy,” he says.
Meanwhile, for investors, the current allocation to listed real estate is so disparate across different portfolios that it is hard to arrive at an ideal percentage, according to industry observers. A person familiar with US pension fund allocations told PERE that Florida State Board of Administration, for example, has an 11 percent REIT allocation out of its total real estate, while Texas County & District Retirement Plans has as much as 40 percent invested in REITs.
Reaching a universally acceptable allocation also requires investors to reach a consensus on where listed real estate should sit in a portfolio. As Supple points out, investors have [historically] “struggled to classify real estate securities within their framework. It wasn’t quite real estate. But it wasn’t quite equities.”
Indeed, there are some pension funds where REITs are part of the equities portfolio. Others include them in their real estate portfolio while using their equities team expertise. After the US public pension fund CalSTRS decided to allocate $500 million to REITs in late 2019, for example, it moved an equity strategist to the real estate division to strengthen the listed real estate investing program, according to a person familiar with the development.
For listed real estate to stand on an equal footing with private real estate, however, it will ultimately require a systematic shift in investing approaches. “The REIT market cap back in 1991 was less than $10 billion. Today it is more than a trillion dollars,” says Worth. “There is ample room for even the largest institutional investors to get their real estate exposure. But they have built systems, culture and a process around private real estate. And it will take time for REITs to get shelf space in that world.”
With additional reporting by Christie Ou