Real estate money managers are becoming the dominant buyers and sellers in today's commercial real estate market, increasing the likelihood that institutional investors could have exposure to both sides of a single transaction.
That could increase the risk in investors' portfolios and possibly decrease returns.
Risk is something investors have been attempting to strip from their portfolios since the 2008 market downturn took a bite out of their real estate profits, and many investors boosted their exposure to core investments to increase portfolio income and decrease risk.
While realty transactions have been largely on pause since the summer's public market volatility, there is no sign so far that the share of deal volume by managers investing on behalf of pension funds, endowments, foundations and sovereign wealth funds is liable to shrink any time soon. In the first half of this year, overall transactions were up 100%, according to a recent report by consulting firm Deloitte LLP, citing data from real estate research firm Real Capital Analytics Inc. Since then, transactions have cooled slightly, declining about 15% in the third quarter.
Institutional real estate managers accounted for more than a third of transactions in the first three quarters of 2011, according to data shared with Pensions & Investments by New York-based Real Capital Analytics. Real estate money managers accounted for 36% of total transactions and 31% of the sellers in the first nine months of this year. This is up from 22% of buyers and 16% of sellers in the first three quarters of 2009.
Pension funds and other institutional investors are well aware that they could be on both sides of a deal, said Vic Bucchere, managing director and head of separate acquisitions for U.S. managed accounts in the Boston office of CBRE Global Investors. “It's a concern the funds are aware of. They monitor it pretty closely,” he said.
The issue is more likely with commingled funds, which are more like blind pools in which managers have full discretion over their deals.
“Separate accounts have more frequent and specific communication because typically separate account capital is not as discretionary as private equity capital,” Mr. Bucchere said.
Sarah Angus, vice president and private real assets consultant at San Francisco-based Callan Associates Inc., agreed. In commingled accounts, where clients have no control and are less involved in the day-to-day fund matters, it is more likely investments will be sold from one fund to another and (investors) may not know it because they don't track all investments, she said.
Institutional managers dominate the industry, especially in prime locations, and the incidences of an investor's managers selling to another can be hard to track, Ms. Angus noted.
Real estate managers are being pressured to both buy and sell because they have unspent capital to invest, real estate funds to liquidate and new capital to raise.
As of Nov. 11, private equity real estate funds had $158 billion in unspent capital, according to data provided by London-based research firm Preqin.
Aside from the need to invest are the pressures to sell. Many real estate funds raised from 2005 into 2007 — before the economic crisis took hold — are coming to the ends of their lives. At the same time, funds with investment periods that were extended during the downturn, typically for two years, also are coming to an end. Managers will need to slowly liquidate these portfolios and return profits to investors before they can hope to go to back to investors to raise new funds, industry insiders say.
“There was a significant amount of money raised in the 2005 to 2007 time frame,” explained Bob O'Brien, vice chairman and U.S. real estate services leader in Deloitte's Chicago office. “Over the next three to five years, some of those funds will be hitting the end of their lives.”
According to Preqin, private equity real estate funds raised a total of $318.6 billion from 2005 through 2007.
Adding to pressures to sell is the fact that some of the properties in managers' portfolios are either becoming distressed or are in need of capital infusions that managers do not have.
“Many fund managers that were able to access capital did so two or three years ago. Due to poor fundamentals, we have seen once-transitional properties that were subsequently stabilized becoming transitional again,” said Jarret Cohen, head of private real estate at Fir Tree Partners Inc., a New York-based hedge fund firm. “Some owners are unable to contribute additional capital for leasing and required maintenance, and thus will likely sell their properties.”