Real estate investors get inventive with allocations

Institutional real estate investors are finding new ways to invest their ever-increasing allocations to the asset class.

Among the routes they're taking are joint ventures with real estate operators, instead of placing money with traditional real estate money managers, and investing in alternative real estate securities such as distressed debt of real estate companies and real estate investment trusts trading at a discount.

"It's becoming much more difficult for the investment community to place funds in real estate because there is such a high demand," said Sandy Presant, North American leader for real estate private equity fund services at Ernst & Young LLC, New York.

Also pushing investors into new routes is the belief that traditional realty investments are expected to produce lower returns, said Allan Bufferd, treasurer of the Massachusetts Institute of Technology, Cambridge, which has a $6.4 billion endowment fund and a $2.1 billion defined benefit plan.

"It's very clear that the enormous liquidity on a global basis makes it difficult to find the kind of returns that previously were there," Mr. Bufferd said. MIT has a 10% allocation to real estate.

So, some investors are broadening the diversification of their portfolios to include such things as coal mines, art, farmland and power-generation plants, Mr. Bufferd said.

Just last week, the Tigard, Ore.-based Oregon Investment Council, which oversees the $48 billion Oregon Public Employees Retirement Fund, Salem, invested $135 million in a co-investment, Heritage Fields LLC.

Heritage Fields was launched earlier this year to redevelop the shuttered El Toro Marine Corps Air Station in Orange County, Calif. It was formed by Lennar Homes of California Inc. and LNR Property Corp., in partnership with capital investment firms Rockpoint Group LLC, Blackacre Institutional Capital Management LLC and MSD Capital LP. Other investors are the $182.8 billion California Public Employees' Retirement System, Sacramento, and the $117.5 billion New York State Common Retirement Fund, Albany.

"We're looking into doing more co-investments," said Kevin Max, Oregon spokesman. Currently, the council has invested 5.5% invested in real estate with an 8% target allocation, he said.

The $126.9 billion California State Teachers' Retirement System, Sacramento, has been investing in joint ventures with real estate operating companies such as First Industrial Realty Trust, New York, with which it invested $300 million in U.S. industrial property.

"We are very opportunistic investors," said spokeswoman Sherry Reser. "We go where the opportunities are without chasing a lot of targets."

Investors are moving from core up the risk/return sale, said Bob Zerbst, president, CB Richard Ellis Investors, Los Angeles. Some are deploying real estate capital by investing abroad in specialized country funds; others are investing in specialized deals such as timber or projects that convert contaminated properties such as abandoned industrial sites and gas stations to productive use.

"I don't think there's a right or wrong here at all," MIT's Mr. Bufferd said of the choice to accept lower returns or invest in non-traditional real estate strategies. "In general, the long-term results have demonstrated that the much more diversified approaches have rewarded those organizations."

In developing its new alternative investment allocations, the New Jersey State Investment Council, Trenton, which oversees the state's $67.1 billion pension, has included real estate in a new "real assets" allocation, said Kathy Hennessy, spokeswoman.

According to the council's investment policy, real assets include oil and gas, timber, commodity-linked investments and royalty trusts. The target allocation for real assets is 4% to 5%.

Some pension executives use less traditional real estate investment approaches to put the allocations to work more quickly.

Officials at the $12.2 billion Los Angeles Fire & Police Pension System are choosing to invest in REITs. The fund is searching for a manager to invest $150 million to $175 million in a REIT portfolio.

"Why REITs? It's another way of accessing the real estate allocation," said Tom Lopez, chief investment officer of the fund, which has 10% allocated and 7% committed to real estate.

It's been more difficult to invest in separate accounts, he said. "We have money for real estate we would like to invest," Mr. Lopez said. "With REITs we can pick an amount."

Officials at the $4.5 billion Sacramento (Calif.) County Employees' Retirement System have asked consultant Mercer Investment Consulting to look into alternative real estate investments, said Richard Stensrud, chief executive officer. After acting on Mercer's recommendations once the board gets them, officials expect to begin searches by the summer, he said.

Fund officials could be looking at possible investments in REITs or collateralized mortgage-backed securities, but "there are aspects of both of those approaches that are not fully satisfying," he said.

One concern is that since a downturn is expected in the REIT market, pension funds might have to hold onto their REIT investments to get value from their investment, Mr. Stensrud said. This would run contrary to fund officials' need to keep their non-traditional real estate investments liquid.

As for collateralized mortgage-backed securities, the question is whether it is really real estate or just a form of bonds. "Aren't you really just getting a bond? It is bond-related real estate, but is there a better way to get real estate exposure?" he asked.

For Sacramento County officials, alternative real estate would be more of a stopgap measure. They would prefer investments liquid enough to allow system officials to buy tangible real estate when the right investment comes along, he said.