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Special Report

Real estate manager asset growth hits speed bump

Eric Adler affirmed that PGIM is continuing its policy of buying and selling properties in equal fashion.

Worldwide increase much more modest than previous year

(updated with correction)

Growth slowed dramatically for the larg-est real estate investment managers in the year ended June 30, with worldwide assets rising only 5.5% vs. the 14.8% of a year earlier.

REIT assets leaped 15.4% in the period, vastly outpacing the overall growth, Pensions & Investments' annual survey of real estate managers shows.

The jump in real estate investment trust assets, more than double the year-earlier increase, was one of a very few bright spots in the survey period. Most strategies show much slower growth.

The 5.5% growth rate for worldwide real estate assets in the survey period is the lowest since 2010, when assets fell 4.3%, Pensions & Investments' annual survey shows.

Real estate equity assets managed for U.S. tax-exempt clients grew 5% to $409.4 billion, down from last year's 8.4% pace.

Debt strategies for U.S. institutional tax-exempt clients exhibited stronger growth, albeit from lower bases, with mezzanine up 24.4% to $4.8 billion, hybrid debt up 14.5% to $6.2 billion, loans up 12.4% to $1.4 billion, and mortgage assets up 4.2% to $61 billion.

But even among many of those hot debt strategies, the largest managers saw growth rates in those categories slip. In the year-prior survey, mezzanine investments had grown 39.5% and mortgages, 45.2%.

The U.S. still appeared to be a desirable location spot for real estate investment in the year ended June 30. Total worldwide assets invested outside the U.S. were basically flat, rising a mere 0.8% to $329.8 billion, while assets invested in the U.S. for foreign clients grew 27.7% to $93.6 billion.

That is not to say U.S. tax-exempt investors left their real estate dollars at home. U.S. institutional assets invested outside the U.S. rose 5.8% to $29.8 billion.

Growth also slowed in other areas of real estate managers' businesses.

Real estate assets managed for defined contribution plans was up 5.6% to $17.3 billion, vs. 15.5% in the year-earlier survey.

Farmland also grew 5.6% to $13.2 billion, compared with nearly 17% among U.S. institutional tax-exempt investors last year. And timber lost ground with assets managed, down 2.4% to $18.7 billion, compared with last year's 10% growth.

“When I look at the year leading to June 30, there was continued slow private market appreciation of real estate,” said Cedrik Lachance, director of U.S. REIT research at Newport Beach, Calif.-based Green Street Advisors LLC, a real estate research firm. The return is lower “but there's been tremendous property price growth since 2010.”

Much of the growth in assets was due to property appreciation. For the year ended June 30, the NCREIF Property index returned 10.64%. The 5.56% return from appreciation was higher than the income return of 4.88%. Indeed, income return has been trending down since 2010 because property values have been outpacing income, NCREIF analysis shows.

However, the returns are lower than the year-earlier period, when the NCREIF Property index return was 12.98%.

The growth in REITs also was propelled by return. The total return of the FTSE NAREIT All REITs index, which includes equity and mortgage REITs, was 22.68%, while the total return of the FTSE NAREITs All Equity REITs index, which excludes mortgages, was up 24.04%, according to data provided by the Washington-based National Association of Real Estate Investment Trusts.

“The private markets appreciated and the public markets took it even higher,” Mr. Lachance said.

However, REIT assets under management — $466.2 billion as of June 30 —still account for only a small slice — 38% — of the total $1.22 trillion managed by the 88 managers in P&I's universe.

Largest do better

The largest real estate managers fared a bit better during the survey period. The 50-largest real estate managers of U.S. institutional tax-exempt assets under management grew at a faster clip than the entire group, up 10.7% to $480.3 billion, representing 93% of the total. U.S. institutional tax-exempt AUM of the top 10 managers grew 11.5% to $291 billion, with the top 10 managers accounting for 56.5% of total U.S. institutional tax-exempt assets.

PGIM, the asset management arm of Prudential Financial Inc. formerly called Prudential Investment Management, once again leads P&I's rankings as the largest manager of worldwide institutional real estate assets with $101.4 billion, up 3% from last year. MetLife Investment held its second position, gaining 12% to $101.1 billion. TH Real Estate, the real estate division of TIAA Global Asset Management, was third with worldwide assets of $94.4 billion, also up 12%.

Not included in the rankings again this year is Blackstone Group LP, New York, which tracks its data in a different way from P&I's method. But Blackstone executives did provide some information. As of June 30, Blackstone real estate's worldwide AUM — defined as equity value net of leverage and unused capital commitments — totaled $103 billion. One third of the capital is from U.S. institutional investors.

TH Real Estate retained the top spot on the ranking of U.S. institutional tax-exempt assets with $64.8 billion, up 15%. PGIM was second, up 4% to $50.4 billion, and J.P. Morgan Asset Management (JPM) was again in the third spot with U.S. institutional tax-exempt assets with $45 billion.

Jack Gay, Charlotte, N.C.-based managing director and global head of commercial real estate debt at TH Real Estate, attributed his firm's increase to continued low interest rates, which drove investors' search for additional yield. “It's been a long real estate cycle,” Mr. Gay said. “The real estate cycle is certainly aging and so investors are conscious about where values are.”

On the equity side, PGIM continued the trend it began last year — selling as many properties as it has been buying, noted Eric Adler, CEO of PGIM Real Estate. “Last year was balanced between net buying and net selling. It's the same this year,” Mr. Adler said. “It's interesting the amount of money wanting to go after large stabilized core assets.”

There have been a number of core deals, especially in the U.S., he said. However, he added that transaction activity in the U.K. stalled after British citizens voted to leave the European Union in June. “Money was waiting for the Brexit vote, which they thought would go the other way. Brexit threw everyone for a loop,” Mr. Adler said.

Before the June 23 vote, Asian investors investing outside Asia had divided their investment between the U.S. and Europe. Following the vote, Asian investors are going with the U.S. “Even with the economic and political uncertainty in the U.S., the U.S. feels better for Asian investors than Europe,” Mr. Adler explained.

Joseph K. Azelby, managing director and CEO, global real assets, in the New York office of J.P. Morgan Asset Management attributed his firm's growth to investor flows and performance.

While inflows and outflows were fairly close, some of JPMAM's larger clients reduced their positions in J.P. Morgan Asset Management's large open-end core commingled funds as a rebalancing move, he said.

J.P. Morgan tops this year's ranking of the 10 largest managers of open-end funds for U.S. institutional tax-exempt investors, with assets up 8% to $35.9 billion. UBS Global Real Estate was in the second spot with open-end fund assets up 5.4% to $23.8 billion and TH Real Estate was in third with $20.2 billion. TH Real Estate did not report open-end fund assets last year.

“The growth was due to a combination of inflows and appreciation as well,” Mr. Azelby explained. “We saw everything from the traditional pension funds still adding to their core real estate allocations and we still see investors that are relatively new to the real estate space coming into our real estate funds.”

JPMAM has also had some success with very targeted real estate strategies the firm offers to larger, more sophisticated investors, he added.

Demand for income

Mezzanine assets managed on behalf of U.S. institutional tax-exempt clients spiked during the survey period as a result of investors' search for yield, managers said.

“Lower global interest rates and aging populations that have a need for income are all creating a natural demand for income-oriented investments that mezzanine and mortgages can provide,” said David Durning, CEO of PGIM Real Estate Finance, PGIM's credit business.

PGIM's mortgage assets rose 5% to $16.1 billion, but its mezzanine assets dropped 31%, to $285 million, because of a reorganization of the firm's mezzanine business, Mr. Durning said.

“Our mezzanine activity is relatively small. The group sits between PGIM Real Estate and our organization,” he noted.

“We have a new person and we are putting together a new (mezzanine) strategy,” Mr. Durning said.

During the survey period, PGIM hired Stephen Bailey to head the mezzanine team, which is a joint strategy of PGIM's real estate equity and real estate debt businesses, he explained.

Mr. Bailey had run the high-yield business at Chicago-based real estate money management firm Heitman.

In light of the mature real estate investment cycle, high real estate prices and talk of an interest rate increase, investors are seeking higher yielding core-plus strategies, Mr. Durning said.

However, investors do not wish to take on as much risk by investing in development projects and higher loan-to-value mortgages as they did at the height of the last real estate cycle, he said.

This is driving investment in certain type of mezzanine and other real estate debt strategies, he said.

TH Real Estate leads this year's list of mezzanine managers with assets up 121% to $2 billion. Rounding out the top three managers of mezzanine assets for US. institutional tax-exempt assets were Brookfield Asset Management, with assets dipping 9% to $545 million, and Principal Real Estate with $448 million, up 25%.

TH Real Estate's growth came from new separate accounts for mezzanine strategies, TH Real Estate's Mr. Gay said.

Mezzanine assets also rose in part because during the survey period TH Real Estate deployed new mezzanine capital from an existing separate account with the Korean Teachers Credit Union and the firm has increased the size of the separate account and extended the investment period, Mr. Gay said.

Those wins also helped place TH Real Estate in second place among managers of separate accounts for U.S. institutional tax-exempt clients. TH Real Estate has $41.8 billion invested through separate accounts, behind PGIM, with $45.9 billion. Neither firm reported separate account assets last year.

Overall U.S. institutional, tax-exempt mortgage assets grew 4.2% to $61 billion, with the 10 largest managers of mortgages accounting for 92% of the total. n

This article originally appeared in the October 3, 2016 print issue as, "Asset growth hits a speed bump".