Large institutional investors are breaking the mold on how they invest in non-core real estate.
Seeking to take greater control of their poorly performing portfolios, several larger pension funds are considering separate accounts for non-core portfolios and entering into club deals with other pension funds to buy real estate.
“In this market, in the last year, everything went down significantly,” said Sarah Angus, vice president in the real assets group at consultant Callan Associates Inc., San Francisco.
Some industry insiders wonder if investors got any extra return for the risk they took on investing in the more illiquid funds.
“Two things you would expect from an opportunity fund are higher returns in exchange for the extra risk and additional return for the illiquidity,” said David S. Lazarus, senior managing director of EdgeRock Realty Advisors LLC, a real estate investment bank in New York.
“Part of real estate investment is knowing when to get in and when to get out, and opportunity funds are not smarter than anyone else,” Mr. Lazarus said.
Even if some investors did get a percentage point or two of extra return over other types of real estate investment vehicles on an annualized basis, the premium was not enough, said Michael A. Mounts, managing director of Jones Lang LaSalle, Chicago. “It's all theoretical. There's no current return. It's all predicated on the future, which may or may not happen. You're buying today and betting it will go up in three to five years, which may not happen.”
What investors are trying to do is get more control. What they realized last year when everything in real estate hit the rocks was that it is difficult to get the entire group of limited partners to agree on a course of action, Ms. Angus said.
In reaction to the mayhem their portfolios endured over the last couple of years, the largest institutional investors in real estate, such as CalPERS and CalSTRS, are considering investing in separate accounts.
Separate accounts provide fee savings and are easier to manage because staff deals directly with a single manager, she said.
But separate account structures do not guarantee higher returns. Like many large institutional investors, the $199.5 billion California Public Employees' Retirement System, Sacramento, invests in real estate through limited partnership funds, separate accounts and direct ownership, noted Clark McKinley, spokesman.
Many of the large blowups in CalPERS' portfolios were from the system's direct investments, such as Peter Cooper Village and Stuy-vesant Town and LandSource Communities Development LLC. Last week, lenders started foreclosure proceedings on Peter Cooper Village and Stuyvesant Town; LandSource Communities filed for bankruptcy in 2008.
What's more, even with the same manager, some separate accounts fared better than others. For example, CalPERS' separate account with Hines Interests investing in Brazilian real estate has been performing well while other separate accounts with Hines are in negative return territory, Mr. McKinley said.
The real estate funds in the $134.1 billion California State Teachers' Retirement System's real estate portfolio underperformed its other investment vehicles. That was mainly a function of strategy, rather than type of investment vehicle, said Ricardo Duran, spokesman for the West Sacramento-based system.
CalSTRS' real estate fund investments are mostly in its tactical portfolio, whose one-year performance as of March 31, 2009 was -50.3%. The system's directly owned real estate holdings are in its core portfolio, which had a one-year return as of the same date of -29.5%, Mr. Duran wrote in an e-mail response to inquiries.
Some large investors are discussing joining with a few other investors of similar size to buy properties directly, Ms. Angus said.