Hungry for diversification, 401(k) sponsors are slowly starting to give plan participants the ability to invest in real estate.
Real estate investing has not yet gained widespread acceptance among 401(k) plan participants, largely because too many people remember the real estate bust of the 1980s, experts say. Major mutual fund companies are adding real estate funds at a rapid clip and all claim to see significant interest in them among defined contribution plans.
Among plan sponsors adding real estate in recent months is Autodesk Inc., San Rafael, Calif., which added the Vanguard REIT Index Portfolio to its $72 million 401(k) plan in November.
Kathy Guthormsen, benefits and risk manager at Autodesk, said the REIT fund was added along with the Vanguard Small Cap Index Fund to further diversify the fund's offerings. She said the funds were added after a periodic review of asset classes in the plan. The investment committee was seeking to complete the risk/return characteristics of the fund.
Because the funds are relatively new, she said, the asset total in the REIT and small-cap index funds are small but have attracted the same amount of assets and interest from participants. The additions brought the Autodesk investment options to 13.
Vanguard Group, Malvern, Pa., started the REIT index fund in 1996 and, a spokesman said, "has several (401(k)) clients using the REIT index fund as part of their plans."
Vanguard officials could not provide information about other 401(k) plan assets in the fund, which totals about $1.6 billion.
New funds launched
Seeing what they say is growing interest in real estate investing, American Century Investments, T. Rowe Price, INVESCO and Alliance Capital Management have added real estate funds available to both institutional and retail clients.
And Boston-based State Street Global Advisors -- which dropped real estate from its defined contribution fund offerings after the market collapse in the late 1980s and early 1990s -- is considering the addition of real estate funds within the next 12 months, a spokeswoman said.
Morgan Stanley Asset Management, New York, has had an institutional real estate fund since 1996. And, said Ruth Hughes-Guden, principal and head of the Morgan Stanley defined contribution business, interest in the fund is starting to grow.
Interest in REIT funds seems to be more active among small and midsized plans.
William A. Schneider, principal at DiMeo Schneider & Associates, Chicago, said his firm has about 20 middle-market companies using REIT funds in their 401(k) plans as a diversification tool.
"It is an asset class with low correlation with other investments and, from a pure modern portfolio theory standpoint, makes sense," Mr. Schneider said. "This is one area where large plans haven't led the way; this is probably the reverse."
The Carroll Co., Dallas, added the American Century Real Estate Fund to its investment offerings this year in its $2.4 million 401(k) plan.
Peter Laurea, controller, said the fund was added to the investment mix to provide participants with additional diversification and long-term return potential as well as a hedge against inflation. "We added the fund primarily for diversification purposes," he said.
"We don't expect our participants to put everything into the real estate fund but we wanted to include it for those looking for diversification and for the return potential. We offer funds ranging from money market to aggressive growth funds and felt this would fit well in our plan," Mr. Laurea said.
The American Century fund was introduced in June and is subadvised by RREEF Real Estate Securities Advisers LP, Chicago.
Most of the new real estate funds invest in REITs, which invest in income-producing properties and real estate such as shopping centers, office buildings, apartment complexes, warehouses and hotels, or real estate related loans.
Chris Lucas, director of REIT research at Coopers & Lybrand, Washington, said REIT funds have a place in many 401(k) plans as an income-producing investment and as a way for plans to diversify market exposure.
Consolidation in the real estate industry following the market collapse "has created enough quality companies to now provide opportunities for investors to participate in a way they could never before," he said.
Real estate companies "are more liquid and managements now have more depth . . . there is a real comfort level now with investors which has developed since that time (1993)," Mr. Lucas said.
REIT funds are "in some cases . . . better for tax-exempt investors than for taxable since you can receive the income without having to pay taxes," he said.
Lipper Analytical Services, New York, tracks 78 real estate mutual funds that returned an average of 33.39% in 1997, 60.1% for the two years and 84% for the three years ended Dec. 31. The number of real estate funds tracked by the firm has increased to the current 78 from only 42 in 1995, a Lipper spokeswoman said.
"We are starting to see more interest in real estate," said Stacy Schaus, defined contribution consultant at Hewitt Associates, Lincolnshire, Ill. "We have a couple of plans that have it now. You may start to see a bit more as a good diversifier for defined contribution plans. But what we are seeing most is that as clients add a (mutual fund) window, that opens up many options and that's where you are most likely to see real estate."
Morgan Stanley's Ms. Hughes-Guden said the maturing of the defined contribution arena has led plans to diversify their investment offerings and become "more defined-benefit-like" in their investment structure.
"The next step in that process is including investments such as emerging markets and real estate," she said.
And as memories of the sour real estate market of the 1980s begin to fade, plans are starting to test the real estate waters, she said.
The Morgan Stanley Institutional U.S. Real Estate Fund has assets of about $360 million.
Edmund Martinez, vice president and senior investment manager at Merrill Lynch Group Employee Services, Plainsboro, N.J., said Merrill does not offer its own REIT fund but offers several such funds through its alliance network. He said in the past year there have been inquiries regarding Merrill's ability to offer such investments and "we do offer it in a few of our plans. . . . We are starting to see it.
"When you look at it, the real estate class probably makes a lot of sense because of its low correlation."
Officials at T. Rowe Price constructed a comparison of twin portfolios with the traditional 60% stocks and 40% bonds; and another with 60% stocks, 20% bonds and 20% in REIT funds for the 20-year period ended Dec. 31. They found investors could receive essentially the same average return, 15.4% vs 15.3%, with substantially lower risk as measured by standard deviation.
"I've heard a lot of discussion about the use of REIT funds in the defined contribution market," said Shlomo Benartzi, professor of accounting at the University of California at Los Angeles and recognized behavioral finance expert. "And the REIT people are trying to get their product into 401(k) plans."
Mr. Benartzi said REIT funds might be an appropriate investment for some participants but the typical plan participant might already have a high real estate equity investment.
"On the one side, people are saying why is defined contribution money being invested differently from defined benefit plans when the typical defined benefit plan has real estate. They say let's have real estate in defined contribution plans. But the participant already has lots of equity in real estate -- they own a house."