Realty consultants shift gears

Some real estate money managers are crying foul over consultants moving into their business.

And for some consultants, it's not just a side business.

Townsend Group, in response to an RFI from the Santa Barbara (Calif.) County Employees' Retirement Association, said that 60% of its revenue comes from discretionary mandates and 40% from non-discretionary consulting. The response, obtained by Pensions & Investments, was from a request for information from the $1.7 billion system for a $119 million fully discretionary separate account for a real estate manager of managers.

Finalists for the portfolio included two other real estate consultants: ORG Real Property and Courtland Partners Ltd.

The debate started heating up in October when Townsend revealed it was hired by Korea's $258 billion National Pension Service, Seoul, to manage $300 million in discretionary North American real estate. Townsend has similar mandates from two other Asian sovereign wealth funds, Kevin Lynch, principal of the Townsend Group, wrote in an e-mailed response to inquiries at the time of the announcement. He would not identify the funds.

Mr. Lynch was traveling and other Townsend executives were unavailable to comment further by deadline, according to an e-mail from Mr. Lynch.

Townsend Group is one of the largest real estate consulting firms. According to its website, Townsend advises 22 of the largest 36 U.S. public pension plans. Worldwide, Townsend advises 90 institutional clients and the firm advises on or invests more than $90 billion.

Townsend also manages two co-investment funds, with a combined $1 billion in discretionary capital: Cayuga Lake Fund and Seneca Lake Fund. In addition, Townsend manages two core-plus open-end real estate funds of funds, according to documents filed with the Securities and Exchange Commission.

The $70 billion State of Wisconsin Investment Board, Madison, is a recent investor in one of Town-send's open-end funds. Courtland Partners is the system's real estate consultant.

Cleveland-based ORG also manages two co-investment funds: the Lake Hempstead Fund and the Lake Success Fund.

The $132.8 billion New York State Common Retirement Fund is an investor in the Townsend and ORG co-investment funds. Town-send Group is also the Albany-based fund's real estate consultant.

Dennis Tompkins, communications director, said State Comptroller Thomas P. DiNapoli, the fund's sole trustee, requires that each of the deals brought by Townsend be reviewed by another independent consultant as an extra layer of protection against conflicts of interest. Also, New York law requires that all real estate deals have to be approved by the real estate advisory committee, Mr. Tompkins said.

In October, the $6.4 billion Arizona Public Safety Personnel Retirement System, Phoenix, increased its maximum commitment to ORG AZ Secondary Opportunity Real Estate Fund LP to $96 million from $65 million. ORG is also the system's real estate consultant.

James Hacking, system administrator, said officials considered the question before making the investment and concluded there is no conflict of interest. Arizona Public Safety Personnel Retirement System is the only investor in the ORG fund, which buys small real estate limited partnership interests that would be too small for a larger pension fund to be interested in buying, he explained. ORG has to bring each potential purchase before the board to be reviewed. Mr. Hacking added: “It's our call.”

Steve Gruber, ORG co-founder, said the firm invests in secondary funds for all of ORG's investors but that some investors have them set up separate accounts. ORG manages co-investment funds for New York State Common, he said. However, he added ORG does not manage funds of funds or commingled funds.

Michael J. Humphrey, managing principal and co-founder of Cleveland-based Courtland Partners, said his firm does not manage assets, although it does have discretionary mandates.

“We act as a discretionary consultant where we have to check the manager box,” Mr. Humphrey said in an interview. “We have not raised a pooled fund.”

Courtland acts as a consultant to a fund of funds managed by Chicago-based Mesirow Financial, and Courtland also is a qualified professional asset manager for union pension funds. Mr. Humphrey said this is another form of advisory service that includes reviewing real estate transactions by the union pension plans and opining on the reasonableness of the transactions.

(Some investment managers, including Glendale, Calif.-based American Realty Advisors, also provide these services.)

Some institutional investors say they have taken measures to minimize conflicts.

The $120.9 billion Florida State Board of Administration, Tallahassee, has a policy under which consultants and money mangers must, among other things, promptly and proactively disclose actual or potential situations that may create a conflict of interest, monitor their business for conflicts and warrant they are fiduciaries under federal and state law. Also, Florida SBA's consulting contracts address fiduciary responsibilities and potential conflicts of interest, Dennis D. MacKee, board spokesman, wrote in an e-mailed response to questions.

Townsend Group is the Florida SBA's real estate consultant but does not manage any discretionary portfolio for the board, he added.

“In regards to impacting quality of the advice we are getting, we believe it is quite possible that Townsend may be better prepared to provide sound advice with active involvement in investments,” Mr. MacKee said. “We are confident that any Townsend recommendations would meet the highest professional and fiduciary standards.”

At the $138.6 billion California State Teachers' Retirement System, conflicts are avoided with Townsend, its real estate consultant, because the firm only advises on policy and strategy, and doesn't recommend managers or deals, said Ricardo Duran, spokesman for the West Sacramento, Calif.-based system.

Industry insiders say there is a host of potential conflicts that could arise. As a consultant, the firm could recommend a fund of funds rather than direct real estate investment strategies, and then recommend itself for the job. As a consultant, a firm also obtains proprietary information that money managers would not normally reveal to competitors.

Courtland's Mr. Humphrey agreed. “There's a big conflict when you act as a manager of funds of funds and also act as a consultant. In addition, when you act as a manager to recapitalize funds, that's a conflict of interest,” Mr. Humphrey said.

Real estate investment consultants are not the first to add investment management capabilities. Traditional investment consultants have done it and a number of private equity consultants also manage funds of funds and discretionary mandates.

Real estate consulting firms are moving into investment management because that's where the money is.

But one firm — PCA Real Estate Advisors — is getting out of the real estate consulting business entirely. The former real estate consulting arm of Pension Consulting Alliance started winding down its consulting unit when it was sold to investment management firm Partners Group, Zug, Switzerland.

“PCA (Real Estate) was in the advisory and the consulting business prior to its sale to Partners Group four years ago and from that time, we made a strategic business decision to only be in the discretionary global real estate investment business,” said Nori Gerardo Lietz, chief strategist-private real estate at Partners Group and a co-owner of PCA before the sale. “We made a conscious decision to wind down the advisory consulting business.”

For their part, investment managers say there is not much they can do about the conflict they see in providing proprietary data to consultants, possibly giving a consultant's investment management side the edge in winning business.

“Townsend is the 100-pound gorilla. They represent 80% of the market,” said one real estate manager who spoke on condition of anonymity. “We can't hold back (proprietary information), not if we want to win” mandates.

Executives at real estate money manager CB Richard Ellis Investors, Los Angeles, say they trust consultants to keep their investment management and consulting activities separate unless they prove otherwise.

“The assumption basis is that there is trust going in and it is alive and active until there is a reason for questioning it,” said Mike McMenomy, global head of investor services at CB Richard Ellis Investors. So far, none of the real estate consultants the firm has worked with breached that trust, he added.

“It is our point of view that you have to give it your best effort in order to compete effectively for any new perspective investment mandate. Therefore, we don't hold back,” Mr. McMenomy said. “We do rely upon the sense of trust and individual colleague respect that ... information does not find a free flow to the principal execution side of the house from the consulting side of the house without disclosing to the manager that it can happen and it will happen.”

Indeed, the continued health and success of the real estate investment management industry is based on performance, regardless of who owns the investment manager, Mr. McMenomy noted.

If managers do not perform, both in terms of returns and how they treat their clients, institutional investors will vote with their allocations, he said. n