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Special Report real estate managers

Quest for steady income helps push worldwide assets up 8.7%

Bradley Baker said debt placates investors afraid of a downturn.

Assets under management of the largest real estate managers continued along a path of steady growth, pushed by investors search for steady income, with worldwide assets up 8.7% to $1.32 trillion for the year ended June 30, compared with 5.5% growth a year earlier.

There were reversals of fortunes in a few of the categories tracked by Pensions & Investments' annual survey of real estate managers. Worldwide real estate investment trust assets managed by the largest managers dropped by 10.7% to $416.3 billion after last year's growth spurt of 15.4%. Hybrid debt was the only other sector to lose assets in the 12 months ended June 30, although from a lower base, down 13% to $9 billion compared to a 14.5% increase in last year's report.

Not all the reversals were negative. Worldwide timber assets were up 1.3% to $31.8 billion, compared to a 2.4% drop in the year-earlier period. Worldwide farmland assets grew by 10.2% to $18.7 billion, compared to a 12% drop in worldwide farmland assets a year ago.

MetLife Investment Management lead the list of managers of worldwide real estate with assets up 4.7% to $105.8 billion.

"Our growth in AUM reflects an increasing number of customers across the commercial real estate strategies we offer, including our​ real estate debt and real estate equity platforms," said Robert Merck, senior managing director and global head of real estate and agriculture at MetLife Investment Management. "Overall growth in our platform has been driven by new investments, and while we continue to attract new customers and assets, the denominator effect has moderated our overall rate of growth."

The denominator effect occurs when a decline in a pension fund's total assets causes target allocations to illiquid alternative investments to rise to or above their targets, curtailing their ability to make new commitments.

Real estate equity assets managed for U.S. tax-exempt clients increased 2.1% to $416.6 billion, continuing the steady climb since 2010. Last year, real estate U.S. tax-exempt assets grew nearly 5%.

Strong strategies

Two of the strongest sectors of assets managed for U.S. tax-exempt institutions were debt strategies, albeit from lower bases. Mezzanine climbed 31.4% to $6.2 billion and loans were up 19.7% to $1.7 billion. Mortgage assets also increased by 7.2% to $65.5 billion. Meanwhile, hybrid debt managed for U.S. tax-exempt clients fell by 7.3% to $5.7 billion.

Last year, mezzanine was up 24.4%, loans were up 12.4%, and mortgage assets were up 4.2%.

Real estate managers are gaining assets in real estate debt strategies they expect could protect investors' portfolios in a downturn.

"There is concern about where we are in the (real estate) cycle after seven strong years," said Bradley Baker, managing director and chairman of the real asset research committee in the Pittsburgh office of Wilshire Consulting, the investment consulting and OCIO business of Wilshire Associates. "There's a debate about where the next correction will be."

These concerns are motivating some investors to commit increasing amounts of capital to real estate debt strategies, he said.

It's not a wholesale move of their real estate equity allocations into real estate debt, but clients that have exceeded their real estate equity target allocations have been rebalancing into real estate debt strategies, Mr. Baker said.

Investors still see value in real estate equity even though returns have moderated, he said.

For the year ended June 30, the National Council of Real Estate Investment Fiduciaries' NCREIF Property index returned 6.97%, down from the 10.64% return for the 12 months ended June 30, 2016. Return from the income component of the index was 4.69% and 2.20% appreciation. This year's NCREIF Property index return was well below the annualized average total return over the past five years of 10.49% and just above the annualized total return for the past decade of 6.42%.

The relative yield of private real estate — ranging from 4% to 6% — looks attractive when investors compare real estate to the yield of other asset classes, Mr. Baker said.

The slide in REIT assets is partially due to lower returns. The total return on the FTSE NAREIT All REITs index, which includes equity and mortgage REITs, for the year ended June 30 was 1.38%. The total return on the FTSE NAREIT All Equity REITs index over the survey period was 0.22%, according to data provided by the Washington-based National Association of Real Estate Investment Trusts.

The previous year, the total return of the FTSE NAREIT All REITs index was 22.68% and the total return of the FTSE NAREIT All Equity REITs index was up 24.04%, NAREIT data shows.

The top three REIT managers held onto their positions. BlackRock (BLK) Inc. (BLK) led the list with total assets up less than 1% to $116 billion in the survey period. Vanguard Group Inc.'s REIT assets were relatively flat as well at $64.4 billion and third place Cohen & Steers Inc. saw assets down 4.9% to $38.3 billion.

Jon Cheigh, New York-based executive vice president and global portfolio manager of Cohen & Steers, said in an emailed statement that the firm was not immune to market forces challenging the industry during the survey period.

REIT returns dropped during the period, which impacted REIT assets, Mr. Cheigh said. What's more, there is increased manager competition.

"Among active managers, we continue to witness significant dispersion in returns. As competition increases throughout the industry, and as institutional investors grow ever more sensitive to the fees they pay for services, we believe those managers that consistently deliver alpha should have the opportunity to gain market share," Mr. Cheigh said.

Tax-exempt growth slows

The 50 largest real estate managers of U.S. institutional tax-exempt assets under management, representing 93% of the total, saw growth slow to 5.8% to $502.3 billion, from 10.7% growth shown in last year's survey. U.S. institutional tax-exempt AUM of the top 10 managers grew 5.8% to $307.9 billion, with the top 10 managers accounting for 58.1% of total U.S. institutional tax-exempt assets.

MetLife Investment Management jumped into first position this year as the largest manager of worldwide real estate assets, switching with PGIM, the asset management arm of Prudential Financial Inc., which fell to second position with worldwide assets gaining 3% to $104.4 billion. Nuveen, formerly TIAA Global Asset Management, held onto its third-place spot with worldwide real estate assets up 5.4% to $99.5 billion. TH Real Estate is Nuveen's real estate investment management affiliate.

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's worldwide real estate AUM — defined as equity value net of leverage and unused capital commitments — totaled $104 billion, up 1% from last year.

The top three managers of U.S. tax-exempt assets held onto their positions from last year. Nuveen retained its lead on the list of managers of U.S. tax-exempt assets with an 11.9% increase to $72.5 billion; PGIM was second with assets up 1.5% to $51.2 billion; and J.P. Morgan Asset Management (JPM) was in third with assets up 2.7% to $46.3 billion.

In the six months ended June 30, PGIM had the most growth in international assets, said Eric Adler, London-based CEO of PGIM Real Estate.

"We've been big in Mexico … and Asia continues to grow," Mr. Adler said. "It's big enough to move the needle."

For instance, international assets managed for PGIM's U.S. tax-exempt clients jumped 44.8% to $1.4 billion during the survey period.

Meanwhile, certain areas in Asia became less correlated with the rest of Asia. For example, Tokyo and Sydney real estate became more competitive, while properties in Brisbane, Australia, rose in value as the region begins to recover from being hard hit by the global oil glut, he said.

"Europe and the U.S. were flatter. We were buying as much as we were selling," Mr. Adler said.

More interest from Asia

Asian investors are increasingly investing in U.S. real estate, Mr. Adler said.

In the six months ended June 30, a growing proportion of capital to be invested in U.S. real estate is from non-U.S. investors, he added.

PGIM again tops the list of real estate firms managing U.S. assets for foreign clients, with assets up 19% to $15.2 billion. Brookfield Asset Management was in the second spot with assets up 29.5% to $11.3 billion, while Bentall Kennedy LP was third with assets up 330% to $8.6 billion. While Bentall Kennedy has pushed to attract foreign investors, a large portion of the increase was due to a difference in reporting.

Anton Pil, managing partner of J.P. Morgan Asset Management (JPM)'s global alternatives business, said desire for core real estate picked up quite significantly in 2017.

"Investors recognize that we are late in the U.S. cycle and the (Federal Reserve) is thinking about removing liquidity from the financial system, which has driven clients into safer, cash-flowing investments that they view as more stable," Mr. Pil said. "At this point in the cycle, you don't want to buy land and start from scratch if you don't know what the world will look like in three to four years from now."

Investors are also still looking for a fixed-income alternative to provide them stable income and some level of inflation protection, especially since the yield of other fixed-income alternatives such as high-yield bonds have fallen, Mr. Pil said. "That trend may accelerate in the next 12 to 18 months," he added.