Real estate equity assets up despite demanding market

Real estate equity managers overcame challenging fundamentals and high real estate prices to gain the most assets under management last year among firms investing in alternative investments other than hedge funds, with internally managed U.S. institutional tax-exempt assets rising by $24.5 billion, or 15%, from 2002.

Real estate equity assets under internal management for U.S. institutional tax-exempt clients rose to $191.6 billion as of year-end 2003, from $167 billion the year before.

High-yield bond managers also enjoyed a boom year, with assets rising $21 billion, or 24%, to $109 billion, according to Pensions & Investments' annual survey of money managers. (All figures cited in this story, unless otherwise specified, reflect U.S. institutional tax-exempt assets under internal management as of year-end 2003.)

Assets under management in many of the other alternative asset classes either stayed the same or increased in the current report. Real estate investment trust assets were up 38% to $43.6 billion from $31.4 billion. TIAA-CREF and Deutsche Asset Management, both of New York, once again held the top two spots, with $7 billion and $5.6 billion, respectively.

Private securities — private equity and privately placed bonds — rose 12% to a combined $67.2 billion, from $59.8 billion. Privately placed bonds jumped 18% to $41 billion, from $35 billion; private equity rose 4.5% to $25.8 billion, from $24.7 billion. However, venture capital assets under management declined 12% to $16.2 billion from $18.5 billion, among respondents to the P&I survey.

The leading real estate equity managers based on internally managed U.S. institutional tax-exempt assets remained much the same as in 2002, with the exception of Morgan Stanley Real Estate, New York, which took the top slot with $16.9 billion in U.S. tax-exempt assets, partly through its acquisition of Lend Lease Real Estate's equity assets last year. Morgan Stanley Real Estate received $10 billion in total assets from its Nov. 4 purchase of Lend Lease, said Andrew Walton, MSRE spokesman. (Lend Lease reported $11.3 billion in real estate equity in the year-end 2002 survey, ranking it second for real estate equity assets; Morgan Stanley Real Estate did not participate in that survey.)

INVESCO moved up to fifth in the real estate equity rankings, with $8.9 billion under management, including $1.6 billion in international investments, from eighth place billion in 2002.

The firm jump-started its European expansion through acquisition and increased its assets under management last year when it bought 75.1% of Hypo-und Vereinsbank, Munich, constituting €3.3 billion ($3.9 billion) in U.S. and Europe-based real estate from European-based investors, said Max Swango, global partner, who is director of client services for the Dallas-based INVESCO Real Estate unit.

In 2001, INVESCO also had acquired Parkes & Co., a London-based real estate investment manager with $700 million in real estate assets under management, Mr. Swango said.

"In order to be a major real estate manager you have to have a global presence," Mr. Swango said. "Europe was the next step." Mr. Swango said he does not expect INVESCO will be buying more business.

Also, INVESCO Real Estate stopped offering additional separate accounts to focus on commingled funds, Mr. Swango said. Although they fell out of favor during the real estate depression in the 1980s, Mr. Swango said there is a trend back toward commingled funds, because of the diversification benefits.

In addition to the growth in U.S. and international equity real estate, INVESCO also reported $1 billion under management in REITs, up from $442 million. Part of that increase was due to the market's overall performance last year, when REITs traded at a 20% premium, Mr. Swango said. The National Association of Real Estate Investment Trusts Composite index shows a return of 38.47% on a total return basis for calendar 2003, according to data from the Washington trade group.

J.P. Morgan Fleming Asset Management, New York, ranked fourth on the listing with $10 billion in real estate equity assets under management, up 8.6% from its $9.2 billion at year-end 2002.

Last year, institutional investors, particularly pension funds, continued to increase their allocations to real estate, said Joseph K. Azelby, managing director and global head of J.P. Morgan Fleming Real Estate, New York. The firm had a lot of success buying real estate in private transactions with partners they had worked with previously, rather than going through the bidding process that pitted money managers against highly leveraged individual investors.

"We stayed very disciplined. We focused on the fundamentals, things like replacement costs," Mr. Azelby said. "We've been very active in retail, which has served us well."

Overall, Mr. Azelby sees a rosy picture for real estate, with just a few clouds.

"Real estate is a mainstream asset class," Mr. Azelby said. "More pension funds and institutions will have meaningful allocations to real estate and it will be very, very good for business."

However, the market is adjusting to billions of dollars of new institutional money that poured into real estate equity.

"Whether there is a backlog depends on what happens to the other buyers and interest rates," Mr. Azelby said. "All successful managers will have a backlog of capital to work through."

Some real estate managers saw the high prices in 2003 as a selling opportunity. "I think for many of the investors we represent, we viewed 2003 as an attractive time to harvest gains and at the same time re-investing the capital in segments of the market where we think there is value," Maury R. Tognarelli, president and chief executive officer of Heitman Real Estate Investment Management, Chicago.

As a result, Heitman's real estate equity assets under management dipped to $5.9 billion from $6 billion, Mr. Tognarelli said.

"Each year you are actively investing capital and selling assets," he said. "In 2003 the slight change downward was the result of us pushing more assets to benefit from the pricing and harvest the gains."

In high-yield fixed income, a tremendous amount of money was invested with managers in 2003 compared with 2002.

"In 2003, assets skyrocketed," said Raymond G. Kennedy, managing director and high-yield portfolio manager at Pacific Investment Management Co., Newport Beach, Calif.

PIMCO surpassed Oaktree Capital Management LLC. Los Angeles, as the manager with the most institutional assets under management in high-yield bonds in this survey. PIMCO reported $9.9 billion, up from $6.4 billion in 2002; Oaktree had $8.2 billion, up from $6.9 billion.

Mr. Kennedy attributed a lot of the overall interest — and asset flow — to the asset class's poor performance in 2002, when the Citigroup High Yield Market index returned -1.52%. By the end of that year, he said, observers believed high-yield was significantly undervalued, and a lot of investors came into the market very quickly. "In 2003, high yield rallied. Fund flows into high yield were hugely positive," he said.

And investors' return expectations were fulfilled. The Citigroup index returned 30.6% for 2003. But that flood of money also worked against the managers.

For example, all five of the high-yield managers that run a combined $958 million for the $157 billion California Public Employees' Retirement System, Sacramento, underperformed the Citigroup index, according to a report to fund officials by the system's investment consultant, Wilshire Associates, Santa Monica, Calif.

"Quite simply, in 2003 the vast majority of the universe of high-yield bond managers would have had to take an excessive, and a normally unacceptable, amount of risk to overweight CCC-rated bonds sufficiently to outperform the broad high-yield bond indexes," the report noted. "A flood of liquidity entered the market, driving the CCC-rated segment to the highest level of all others before the high-yield bond market returned to trading on fundamentals."

"It's difficult to beat your bogey when all assets moved significantly up," PIMCO's Mr. Kennedy said. "You would have to be super, super aggressive."