CHICAGO - Heitman Capital Management dropped its plan to restructure all 18 of its real estate commingled funds into three property-specific private real estate investments trusts after investors overwhelmingly opposed the move.
This is the second time in less than two years that pension funds and endowments have scuttled Heitman's attempt to restructure or roll up properties into private REITs.
The events leading to Heitman's decision featured a mailing to investors of an anonymous memo titled "Heitman/JMB Reorganization, Blatant Self Interest and Greed," an investors-only dissident meeting to strategize about the plan, a "never-seen-that-before" contentious verbal exchange between Heitman Chairman Norman Perlmutter and the firm's clients at the annual investor conference, and threats by some pension funds to complain about the proposal to Heitman's owner, publicly traded United Asset Management, or to other UAM affiliate money managers.
The Boston-based money management holding company had committed $50 million along with Heitman senior management's $10 million commitment to be invested in the REITs. A UAM spokesman said, however, it was Heitman's decision to drop the roll-up, though the announcement was made a day after UAM's board met.
In a statement to clients, Heitman Capital President Charles H. Wurtzebach said: "The client response has been clear. The vast majority of our clients have informally indicated that they would prefer that we not pursue the proposed commingled fund restructuring.
"In recognition of the expressed desire of our clients not to proceed with the proposed restructuring, Heitman has made the decision to discontinue all efforts to refine this proposal."
The proposal, said investors, would not have necessarily provided liquidity they sought, and could have locked them into investments for longer than anticipated.
Heitman's restructuring plan called for the formation of three property-specific REITs - retail, office and apartments - and a disposition fund for properties that didn't meet the criteria of the REITs and for investors that wanted out.
Proposal contained flaws
The 314 investors in commingled funds valued at $2.4 billion were expected to contribute their property interests to the REITs in exchange for shares equal in proportion to the property-type distribution of their existing Heitman funds.
Heitman management believed that the pension funds and endowments wanted a commingled vehicle that aligned the interests of investor and manager through co-investment; provided greater liquidity; and contained an investor-elected board of directors.
The timing was good because public REITs currently trade at a premium between 20% and 30% to net asset value, which could be captured when these REITs went public, said Mr. Wurtzebach.
But Heitman's proposal contained flaws that the public markets would have punished, when and if a public offering were made, critics said.
Among the proposal's most serious structural flaws cited by critics:
The REITs were not vertically integrated. Asset management decisions would continue to be provided by Heitman Capital Management for as much as $140 million and for a term of six years.
Separate account clients of the firm that had co-invested in properties with the commingled funds didn't get a vote in the decision to contribute the properties to REITs.
Opportunity is narrow
Micolyn Yalonis, a real estate consultant with Callan Associates, said she was uncomfortable with Heitman's public markets strategy because the window of opportunity to take advantage of the premium the public market is paying for real estate is narrow.
"How much liquidity would be there is speculative at best," said Ms. Yalonis. "The REITs wouldn't be (entirely) internally managed. They (REIT investors) would discount them down to where they are now."
The premiums at which public REITs are trading is attributable to their managements, said Nori Gerardo Leitz, real estate consultant with Pacific Consulting Alliance.
Ms. Gerardo Leitz took issue with Heitman's attempt to sell its asset management services to the REIT investors when, theoretically, Heitman works at the discretion of the investors, who could choose whom they want as a manager.
"Why should the full value of the management contract go the adviser?" said Ms. Gerardo Leitz. "But for the entering into a contract with the adviser and keeping them in place, they would have no value.
"It is unsettling to the clients that they have been paying fees all these years, and now they would pay an added amount for a management team that has mediocre performance," she said.
According to the annual report for the five Heitman/JMB Group Trusts obtained by Pensions & Investments, funds I, II and V outperformed their benchmark, the Russell-NCREIF Index, since their respective inception, while funds III and IV underperformed.
Three of the four Heitman Endowment and Foundation Realty Funds have underperformed the Russell-NCREIF since inception, according to the annual reports.
It's difficult to say what posed the biggest problem for investors. It's clearer which one most damaged Heitman's reputation: the separate account co-investors, and Mr. Perlmutter's response to them.
According to several accounts, Mr. Perlmutter had an angry exchange at the annual investors' conference with Bruce Moore, a trustee of the $3 billion Orange County Employees Retirement Systems, Santa Ana, Calif., and Scott Franklin, pension finance specialist with the $12 billion pension fund for Shell Oil Co., Houston.
No right to vote
According to Orange County Retirement System Administrator Raymond Fleming, his pension fund has about $100 million invested in separate accounts with Heitman. The investments are in co-investments in 13 properties with the commingled funds that were proposed for roll-up.
Orange County, said Mr. Fleming, didn't have a vote in the roll-up, although its investments would be affected.
Orange County convened a meeting of about 35 investors earlier in the day before the Heitman conference and decided to ask Heitman for a straw poll to determine if investors wanted to proceed with the roll-up or continue managing the funds, as per business plans.
According to various accounts, attendees included representatives from the Iowa Public Employees Retirement System, the endowment for Stanford University and the General Board of Pension and Health Benefits of the United Methodist Church.
The meeting and an opportunity to present its findings at the client meeting was cleared with Heitman, said Mr. Moore.
As Mr. Moore made his call for a straw poll at the client conference later that afternoon, Mr. Perlmutter, who was sitting in the first row, jumped up and snatched the microphone from Mr. Moore.
Several attendees confirmed that Mr. Perlmutter said: "I am shocked that you would have the gall to suggest that. You have absolutely no right to do this.
"You don't even have a right to vote."
At this point, Mr. Franklin of Shell spoke up and said he wanted to hear Mr. Moore's presentation and that his pension fund favored a straw poll. Mr. Perlmutter then turned to Mr. Franklin and said: "We know you. We know you have your own agenda."
Shell has a reputation for aggressively trying to exit its real estate commingled fund investments for redeployment in separate accounts. It is believed that Shell is both a separate account and commingled fund investor with Heitman.
Telephone calls to Mr. Franklin were not returned, but Mr. Moore and others confirmed the exchange.
In a prepared statement, Mr. Perlmutter said of the encounter: "We have had a candid and frank discussion with our clients and will respect their wish to continue with our original plan."
Mr. Moore was conciliatory to Mr. Perlmutter's position: "In fairness to the man, he was under pressure. This was business, not personal."