Pension fund investors in two closed-end commingled funds sank The RREEF Funds' attempt to start a new private real estate investment trust by transferring five regional shopping centers from the two commingled funds.
Heitman/JMB Advisory Corp., meanwhile, is marketing a new private REIT seeded with three shopping centers from one of its closed-end commingled funds, despite opposition by at least two investors in that fund.
The process of transferring properties from one or more funds and placing them into a new vehicle is known as a roll-up. The technique was used frequently in 1993 and 1994, when many developers combined limited partnerships into a REIT and took them public. At the same time, pension executives increasingly are favoring private REITs over group trusts, believing REITs have greater liquidity and corporate governance.
Rolling up existing group trusts into a private REIT was viewed as part of that evolution. But the process has not proceeded smoothly. Both RREEF and Heitman have worked on their roll-ups for almost two years.
In an Oct. 31 letter to clients, San Francisco-based RREEF said it would abandon its efforts to create the RREEF Retail REIT, which was to have been seeded with regional malls from the RREEF USA II and USA III commingled funds. The investors in USA II and III were to receive shares in the new vehicle, or they could have cashed out. RREEF would then buy additional shopping centers for the REIT.
USA II was supposed to terminate at the end of 1994 and has been extended. USA III is scheduled to terminate in 1996.
RREEF executives said a lack of interest by new institutional investors - particularly non-U.S. investors - and plan sponsors' high allocation to retail properties led to the decision to abandon the roll-up.
"Also," a letter to clients stated, "we found some who believed that investment in regional malls is more attractive using the public market vehicles available.
"While we disagree with this idea, some potential investors and their consultants are allocating their retail money to public regional mall REITs."
Investors in the RREEF closed-end funds include the pension funds of Hughes Aircraft Co., Chevron Corp., AT&T Co., Lockheed Corp. (now Lockheed Martin Corp.), International Paper Co., Shell Oil Co., McDonnell Douglas Corp. and Chrysler Corp.
Public fund investors include the State Universities' Retirement System of Illinois and the Connecticut Trust Funds.
Most pension fund officials declined to comment, but other real estate professionals spoke - not for attribution - about the drawbacks of RREEF's proposal.
Telephone calls to RREEF were not returned, although RREEF Senior Vice President Stephen Steppe provided Pensions & Investments with the client letter.
One pension investor said its staff was disappointed the proposal didn't go forward because RREEF provided an attractive cash-out option. Transaction costs from selling the properties in order to return money would have been avoided, thus providing a better return, the investor said.
Staying in the funds until termination might cause the net asset value to erode because the funds are overweighted in retail properties and "there are many clouds over the retail industry today," the pension investor said.
RREEF conceded as much in its letter.
"A major premise behind the RREEF Retail REIT idea was that today is not a good time to sell regional malls," the letter stated. "Capitalization rates are higher today than they have been in years."
One real estate professional suggested RREEF's attempt to roll up the properties into another vehicle was a way for the manager to retain the assets and to continue to generate fees.
It is an oft-repeated allegation made by pension executives against their real estate managers. Goldman, Sachs & Co., New York, earlier this month released a report titled "The Coming Evolution of the Investment Management Industry," which said in part: "Managing money is not the true business of the money management industry. Rather it is gathering and retaining assets."
A pension fund consultant opposed the plan because altering the vehicle transferred the decision-making authority from RREEF to the investor. The REIT would be open-ended and infinite, leaving it up to the investor to decide when to sell its shares; the closed-end structure left the sell decision to RREEF, the investor said.
Meanwhile, Chicago-based Heitman/JMB already has begun to market Heitman Mall Investors. But Nori Gerardo, a consultant with Pension Consulting Alliance, Portland, Ore., said her clients have not approved of the transfer of their interest in Heitman V into the new vehicle.
While Ms. Gerardo would not identify the clients, real estate professionals said Ms. Gerardo's clients invested with Heitman/JMB include the Sacramento County Employees' Retirement System and the Sisters of Mercy, Regional Community of Detroit Inc.
Heitman V is a diversified property fund that will transfer three malls to HMI; another mall will be contributed by a Heitman/JMB separate account client.
According to Heitman/JMB Managing Director Dan Epstein, Ms. Gerardo and her clients are the only investors opposing the roll-up. Mr. Epstein declined to go into detail about how many investors approved the plan.
The opposition of Ms. Gerardo's clients "does not mean the abandonment of the process," said Mr. Epstein.
"It is highly unlikely that we will be unable to work this out," he said. "I think (PCA client concerns) can be solved at the client level."
Ms. Gerardo said her clients have reservations about transferring their interest from a closed-end, finite-life vehicle to an open-end infinite vehicle. They also are concerned about the absence of a cash-out option before the roll-up.
"There is no guarantee of liquidity, and there is a change in the relationship with Heitman from an ERISA fiduciary to a non-ERISA relationship in HMI," said Ms. Gerardo.
"To the best of my knowledge, they haven't offered them (the clients) an opportunity to cash out," said Ms. Gerardo.
Mr. Epstein said investors can liquidate their investments after the conversion.
Ms. Gerardo also questioned the analysis of the malls performed by the independent fiduciary because it done was in 1994. "The market for regional malls has changed during that time period," she said.
Chadwick, Saylor & Co. Inc., Los Angeles, served as the independent fiduciary.
Ms. Gerardo said there also are concerns about the proposed governance of HMI, although she declined to elaborate.
