SPECIAL REPORT: Keeping it real

In the tight-knit world of private real estate, it is not unusual for professionals to frequently bump into the same people. For TIAA real estate executive Chris McGibbon, however, a visit to a US institutional investor often meant unexpectedly encountering some of his own colleagues.

“We were constantly running in each other,” McGibbon, head of Americas real estate at the New York-based financial organization, recalled. “We’d be coming out of a real estate meeting and Jose [Minaya, then TIAA’s head of private markets asset management] would be waiting in the lobby.”

At many of these institutions, the same investment professionals often covered real estate, agriculture, timber, energy and infrastructure, McGibbon explained: “The TIAA teams were at times duplicating efforts.”

This overlap helped to drive TIAA’s decision, announced last month, to create a global real assets division, which essentially involved folding its real estate unit into a group that already included agriculture, timber, energy and infrastructure. The launch of the new division – which will be overseen by Minaya as group head – also coincided with the restructuring of its real estate team, which will see the departures of its global head, Tom Garbutt, and chief investment officer, Phil McAndrews.

The creation of TIAA’s real assets group came on the heels of asset management goliath BlackRock’s update in January that it was forming a unified real assets platform incorporating its real estate and infrastructure businesses. To head up the new platform, the New York-based asset manager appointed Jim Barry, who also will remain the company’s head of infrastructure.

Convergence of asset classes

TIAA and BlackRock are the two most recent examples of institutions that have been reorganizing multiple asset classes under one real assets umbrella. “We’re definitely hearing more and more on the convergence of the asset classes,” said Doug Weill, managing partner of Hodes Weill & Associates, the New York-based real estate advisory firm that releases an annual report on institutional real estate allocations in partnership with Cornell University. “Increasingly, we’re seeing them merged.”

Among the institutions with unified real assets groups are managers such as JP Morgan Asset Management (JPMAM); Deutsche Asset Management (AM), AXA Investment Management – Real Assets; and Macquarie Infrastructure and Real Assets; and on the institutional investor side, the US pension plans California Public Employees’ Retirement System; Teacher Retirement System of Texas; and the Virginia Retirement System.

“It makes sense to look at these assets, because they have similar investment characteristics, as a single asset class,” said Joe Azelby, group head of real assets at JPMAM, which first began investing in the space in 1970. Those characteristics include more income generation than bonds; equity-like returns without the volatility of the equities market; low correlation to stocks and bonds; and low correlation to each other. Such attributes are likely to compel institutional investors to increase their real assets allocations from an average of 10 percent today to 25 percent over the long term, he said.

According to Azelby, real assets is evolving in the same way as the fixed-income and equities markets – typically the two largest components of institutional investors’ portfolios – with multiple sub-groups with each asset class. “I think real assets are going to be the third major asset class,” he said.

Investment characteristics aside, real assets are also being viewed as a collective group because of manager consolidation among some institutional investors. Some large institutions have been culling their base of managers, and opting to put their dollars with managers with expertise across a number of different capabilities, added Azelby. “That’s a trend that we’re trying to position ourselves for,” he said. “We’re hearing from large investors that they really don’t want 50 relationships, they’d prefer to have five relationships with people who can do more things for them.”

Not every institutional investor, however, agrees with the need to have one unified real assets group, nor with the concept that all of the underlying asset classes within real assets are very similar. Indeed, it is a concept that is primarily favored by larger capital providers. While the New Mexico State Investment Council (NMSIC) has the same director overseeing investments for real estate and real return – which includes timber, infrastructure, energy, farmland and some financial assets, the state endowment intends to keep the two divisions separate.

“We fundamentally see real estate as a different investment than we do real assets,” said Vince Smith, chief investment officer at NMSIC. “There’s some similarities, but we see a difference with how it acts within the portfolio, and the return streams that we see. Real estate is much more closely tied to gross domestic product growth and the success of corporations. One of the big reasons to invest in real assets is to get diversification from corporate risk, or stocks and bonds.”

Also, NMSIC generally prefers to invest in a niche manager rather than a broadly diversified manager. For Smith, it can be easier to implement an allocation strategy with the former as compared with the latter: “If I say we’re going to be 30 percent timber within our real assets bucket, I want to find managers to fill that 30 percent, not have a manager tell me whether 30 percent is right or not.”

Group structure

Broadly diversified managers have gone about structuring their real assets groups in different ways. “Unlike bringing a bunch of different groups together into a single business unit, we’ve always been a single business unit that has evolved from a real estate platform to a real assets platform,” said Azelby.

Similarly, Deutsche AM began investing in real estate more than 40 years ago and then expanded into infrastructure in the early 1990s. “We used our very strong footprint in real estate to grow our infrastructure business,” recalled Pierre Cherki, the company’s head of alternatives and real assets. “Our European direct infrastructure business really grew out of the platform that we had in real estate in Europe.” However, following the global financial crisis, in 2012, the company decided to rebrand its alternatives business, then known as RREEF, as Deutsche Asset & Wealth Management, and began managing its individual real assets businesses under the same umbrella.

Although TIAA and BlackRock reorganized their real assets sub-groups in a similar way to Deutsche AM, their leadership choices were a departure from those of their predecessors. After all, JPMAM, Deutsche AM, AXA IM – Real Assets and MIRA, all opted to name the head of their largest underlying asset class to preside over the overall real assets group. TIAA and BlackRock did not, even though real estate also represents by far the largest percentage of the assets under management (AUM) of their own real assets businesses.

Some real assets executives, however, downplayed the connection between the areas of expertise of TIAA and BlackRock’s new real assets heads and the areas of focus for the companies’ real assets businesses. “I would suspect that is somewhat idiosyncratic,” said Azelby. “I wouldn’t draw any conclusions from that.”

At Deutsche AM, having the head of the largest product group heading the broader real assets platform “was the natural evolution,” said Cherki. Ultimately, however, he said the underlying asset class in which the real assets group head has expertise is a secondary issue. “I fundamentally don’t think it’s really important,” he said. “You need someone at the head that can take a broader view and can work with clients across the product range of whatever you put under real assets.”

He did not, moreover, think that a real assets group head would skew investment decisions for the platform to favor the asset class where that person had expertise. “Human nature is that you tend to turn back to where you have your investment expertise,” he acknowledged. “And if I take my case, clearly if I get to the details of an investment, I can contribute more on the real estate side than I can contribute on the infrastructure side, but that’s not really where I spend my time. I spend my time with clients and making sure that we allocate resources in the best possible way.”

Real estate’s role

However, as the real assets industry has evolved, so has real estate’s position within the space – while it remains the largest component of most real assets portfolios, the asset class no longer may be the principal engine for growth.
Real estate is overwhelmingly expected to continue to be the largest asset class within real assets. According to a BlackRock report released in November, 96 percent of investors had allocated capital to real estate, compared with 66 percent for infrastructure and 29 percent for commodities. About half of the institutions in each category expected to further increase allocations over the next 18 months, the report said.

Other real assets sub-groups, however, are poised to grow at a more robust pace. “In absolute numbers, real estate will continue to dominate,” said Azelby. “But on the infrastructure side and in other real assets, I would suspect on a percentage basis, those growth rates will be much higher, because they’re operating off a smaller base and in a very different stage of the adoption curve.”

Over the past decade, “the degree of institutionalization across the spectrum has really increased,” said Smith. “We’ve been able to find managers to do just about any of the sub-asset classes that we want. These assets aren’t institutionalized quite to the point that real estate is, but it wouldn’t shock me for these assets to catch up to how institutionalized real estate is today.”

Indeed, “managers are hearing from institutions that they may have capital for real assets overall, but weighing more to infrastructure today than in commercial real estate,” Weill observed. Yet he did not see other real assets sub-groups stealing dollars from real estate. “It’s going to be additive.”

But while growth rates may be higher in an asset class such as infrastructure as compared to real estate, the acceptance of the former is not likely to be as widespread as it is in the latter, Cherki pointed out. “Infrastructure is still an up-and-coming asset class, where many investors are not exposed at all, it will take them time to understand how they get that exposure,” he said.

Infrastructure, after all, is more difficult for institutional investors to access, given that investments in the space require much larger ticket sizes – typically in the hundreds of millions or billions of dollars – than in real estate, where buyers can purchase a property for much smaller amounts. For this reason, Cherki anticipates that “infrastructure certainly will continue to grow, but will remain a comfortable number two” to real estate. Indeed, he expects that the underlying allocations in Deutsche AM’s real assets portfolio to remain about the same in five years. “I do expect real estate to be about 50 percent of the portfolio,” he said. “When I look at capital allocation, I do expect that to be broadly similar to what we have today.”

McGibbon, meanwhile, still expects real estate to be a major area of growth for TIAA. “Real estate will still take the lead in terms of growth from a dollar perspective,” he said. “While we already have a large global real estate franchise, there are plenty of parts of the world where we’d like to expand.”

For example, “in the US, we’d like to launch two or three more products annually and move further out on the risk spectrum into value add or opportunistic.” Additionally, the company plans to build up its real estate business in Asia, where it currently has only about a couple of billion dollars in AUM. “We also will look at really filling out our Asia Pacific offerings,” said McGibbon. “We have a small presence there, but that could be the lion’s share of the real estate growth.”

Real assets as an asset class will continue to have its skeptics, including one consultant who said: “It’s clearly the flavor of the month. I’m not sure whether we’ll still have real assets divisions 10 years from now.” Azelby, however, expects many more real assets groups to be created in the years to come: “I think it’ll accelerate because the rationale has become more obvious.”