REITs are trying the patience of pension funds.
With a first quarter return of -5.6%, and a calendar 1998 return of -16.6%, as measured by the NAREIT index, owning REITs has become painful for many investors. Some brave funds are adding to their allocations, but many have had enough and are either selling or considering a change in strategy.
The $48.5 billion State Teachers Retirement System of Ohio, Columbus, added $104 million in REITs between June 30 and Feb. 28, bringing the total allocation to $420 million as of the end of February, according to Herb Dyer, executive director.
Five years ago, the pension fund owned no REITs. "We built it up gradually, and have been buying during the downturn," Mr. Dyer said of the internally managed portfolio.
The asset class now represents around 8% to 9% of the system's real estate portfolio, which is 10% of the pension fund, according to Mr. Dyer.
"We use them to fill in holes to keep the portfolio properly diversified. They give us ownership in businesses we don't have directly, such as healthcare."
Despite all of the bargains on the market, the retirement system has stopped buying REITs for now, because it has enough.
Mr. Dyer, like many of his pension fund colleagues, said he is hopeful they will turn around.
And the California Public Employees' Retirement System, Sacramento, has just accumulated its REIT portfolio, now at $500 million, in the last year or so, said Brad Pacheco, a spokesman at the $153 billion fund.
The California fund began buying REITs through its equity unit in September to take advantage of the cheap prices, according to Mr. Pacheco.
Ted Bigman, principal at Morgan Stanley Dean Witter Investment Management, New York, noted pension funds had awarded the firm a number of new separate accounts for REITs in the past two months.
He declined to specify the amount of new business, but pointed out both private and public pension funds have been allocating an average of $40 million to $50 million of their new real estate money to REITs recently.
Dan O'Connor, vice president and REIT portfolio manager at J.P. Morgan Investment Management Inc., New York, said the firm has added $100 million dollars in new REIT business from pension fund clients since the fall, giving it $500 million in REITs under management.
"The fundamentals look good, because so many are selling below their net asset value, while their dividend yields are in the 7% range," Mr. O'Connor said, explaining the increased activity. "Even if REITs don't do any development next year, they would grow internally by an average of 5% over the next year."
Nevertheless, many pension funds are reviewing their approach to REITs after watching them underperform for the past several quarters.
John Lane, chief investment officer at Pennsylvania Public School Employees Retirement System, Harrisburg, was expected to ask the board about changing its REIT strategy at a meeting scheduled for April 16. Mr. Lane didn't elaborate on what changes he has in mind, but said: "We determined our strategy three years ago, and haven't changed it, but the value of our investments has gone down. The idea was to measure it against the Wilshire Real Estate Securities index and to outperform it, which we haven't done. The REITs have been beaten up, although I think they will come back on a selective basis." At the end of February, the $45 billion fund owned $625 million in REITs, divided between internally and externally managed portfolios.
At E.I. du Pont de Nemours & Co. Inc., Wilmington, Del., the REIT strategy is under review, said Brian Abrams, who runs the real estate portfolio. As of Sept. 30, the $30 billion pension fund owned around $100 million in REITs.
Latecomers are sorry
Mike Kirby, principal at Green Street Advisors, Newport Beach, Calif., said pension funds that just began investing in REITs in the last year and a half regret it. "A fair number who got active have not been too happy with returns, although most have stuck with them. There have been a lot of redemptions by retail investors. But the institutional side of the business has held up."
The Public Employees' Retirement Association of Colorado, Denver, which owned around $400 million in REITs as of Sept. 30, is watching the market to determine whether to take advantage of the bargains out there, said Kim Roberts Mosko, director of real estate at the $25 billion fund.
The fund internally manages around $50 million in a passive REIT index portfolio, and has $100 million actively managed with Morgan Stanley. The remaining $250 million is managed by The RREEF Funds, San Francisco. "We transferred assets to RREEF in July when some of our private holdings went public. That became a public portfolio by default," explained Ms. Mosko.
In 1996, the Colorado fund developed a strategic real estate plan to run through 2001. REITs make up 20% of the real estate portfolio, which stands at 8% of the fund, or around $2 billion. Recently, the system has considered increasing its exposure to REITs because they have become so cheap, Ms. Mosko said. "We believe REITs add diversification to our portfolio, so we will be holders and react to the market."
Long-term strategy
Other pension funds such as the $47 billion State of Michigan Department of Treasury Bureau of Investments, Lansing, are holding on to their REITs as part of their long-term investment strategy. "We have no inclination to buy or sell right now, although they (REITs) are probably priced correctly," said Jon Braeutigam, administrator of the pension fund's mortgage and real estate division. "Before they were overvalued," he said. Under Michigan's investment strategy, the pension fund benefits more by owning real estate directly than by owning REITs, he said.
Mr. Braeutigam added that REITs are more volatile than property and his goal is to reduce volatility. As of Jan. 31, the fund owned $350 million in REITs.
While REITs make up just 11% to 12% of Michigan's real estate portfolio, at the Montana Board of Investments, Helena, a $122.6 million REIT portfolio is practically the system's sole real estate investment, with the exception of two office buildings -- one of which houses the pension fund staff, said James Penner, chief investment officer at the $5 billion fund.
The pension fund has owned REITs for the past five years, and managed them internally Mr. Penner said. There hasn't been much activity in the portfolio recently, except for a couple of swaps and sales of those REITs such as healthcare REITs that no longer fit the fund's strategy. Mr. Penner is optimistic and expects that when the growth phase of the stock market has run its course, value investors will return and give REITs a boost.
Abbott Davis, who retired last month as director of real estate at the New York State Teachers' Retirement System, Albany, also believes REITs will rebound. "They have been going through a correction, but we believe they will come back," said Mr. Davis, who noted the $80.1 billion system hasn't bought recently. But in previous years when the share prices were down, the system bought, figuring REITs would go up.
Under Mr. Davis' guidance, the fund accumulated $350 million in directly owned REITs including Liberty Property Trust, Cabot Industrial Trust and Simon Property Group Inc. It also owns a stake in Cornerstone Properties Inc., which it helped launch through a $100 million investment in debentures, which converted into stock after it became public a few years ago. The pension fund owns another $300 million in REITs through advisers, including J.P. Morgan.
At Vassar College, Poughkeepsie, the $6 million REIT portfolio is all invested in AMB Property Group, San Francisco. This resulted from an investment Vassar made in an AMB commingled fund in 1994, said Jay Yoder, director of investments at the $550 million endowment fund. Once AMB went public, its shareholders such as Vassar became owners of a public REIT. But Vassar prefers to own real estate through private commingled funds, because they act more like real estate than REITs do, Mr. Yoder noted. He expects the endowment will phase out its REIT holdings over time.
No change
There has been no change in strategy at the State Board of Administration of Florida, Tallahassee, said Doug Bennett, chief investment officer for real estate at the $90 billion fund. The $250 million in REITs are just a fraction of the fund's $3.4 billion real estate portfolio. "We haven't changed our strategy, or bought during the downturn, because we preferred to take advantage of other opportunities to buy properties directly, such as malls," Mr. Bennett said. The system takes the long-term view, and doesn't trade in and out, he added.
"REITs are an additional vehicle for us, not a preferred one," he said. "Owning them is not like owning property 100% or a piece of Kodak. They are something in-between. But they can be a good vehicle. They can give you access to markets that are hard to get into, and they have an element of liquidity, which is also good, plus access to relationships that might be beneficial."
