NEW YORK - Bankers Trust Co. has created a group of real estate indexes that will enable investors to use over-the-counter vehicles to gain or shed real estate equity investment exposure without having to buy or sell any actual property.
The indexes, which seek to capture the returns of real estate, are created using a theoretical long position in real estate stocks combined with a theoretical short position in stock market index futures. The goal of the indexes is to capture the real estate portion of the return in publicly traded real estate investment trusts and other real estate stocks without taking on the stock market risk embedded in those securities, said Dennis G. Montecillo, vice president with Bankers Trust.
In turn, Bankers Trust could use the returns generated by the indexes as a basis for various OTC transactions, such as the swapping of real estate returns for some other return, or for structured notes with an interest rate linked to real estate returns.
Bankers' research shows its indexes performing as well as, or better than, the traditional measure of real estate returns, the Russell-NCREIF Property Index.
And with the indexes, Bankers Trust says its OTC real estate-linked transactions would allow investors to make asset allocation decisions in real estate quicker and cheaper than actual investing would, Mr. Montecillo said. Plus, institutions that don't have enough assets to invest in real estate directly, and aren't attracted to commingled vehicles might want to consider using OTC transactions as a means to invest in real estate long term, he said.
Mr. Montecillo noted a major difference between OTC deals that would use Bankers' indexes and previous OTC real estate deals, which often used the non-investible Russell-NCREIF index, is that Bankers can hedge its side of the trade by actually going short real estate stocks and long stock market index futures. Without the ability to hedge itself, Bankers Trust would have to offer real estate-linked OTC transactions that involve finding someone to take on the risk that goes with the opposite side of the trade, or Bankers would have to take on the risk itself.
Without seeing the details of the indexes, plan sponsors and consultants greeted the concept positively, but with reservations about its usefulness for long-term investment and the liquidity of the strategy.
Investment officers for the Illinois Teachers' Retirement System, Springfield, said an OTC strategy might be worthwhile for strategic asset allocations, but for a fund their size, using OTC transactions to gain permanent real estate returns probably wouldn't make sense.
Matthew Evans, investment officer in real estate and alternative investments for Illinois Teachers, said the fund's staff had explored the possibility of using short positions in REITs to strategically lessen the fund's real estate exposure, but decided REITs contained too much stock market exposure. Bankers' strategy might get around that, he said.
Mr. Evans said that for capturing the long-term returns of real estate, the Illinois Teachers fund would be better off making the actual investments, noting investors get paid a premium for taking on the illiquidity of real estate. The Illinois Teachers' system has about 15% of its $12 billion in assets invested in real estate.
Mr. Montecillo acknowledges there are shortcomings with the Russell-NCREIF index, and said Bankers' indexes don't attempt to match the index.
Instead, Bankers is trying to capture the returns from real estate that are reflected in publicly traded stocks, and in the process provide similar or better returns than NCREIF reflects.
According to the investment bank's research, just 16% of REITs' returns reflect the actual returns of real estate - the rest is stock market-related. Bankers indexes would seek to isolate that "pure real estate" return, Mr. Montecillo said.
Scott Lummer, a managing director in the consulting services group of Ibbotson Associates, Chicago, said the overall concept sounds good, but he's not sure adequate demand can be found on both sides of real estate-linked OTC arrangements being made.
Mr. Lummer said Ibbotson's consultants have found OTC transactions work best, and are cheapest, when there is adequate demand on both sides of the deal.