Real estate investors look beyond commingled funds

Investors are mixing it up in their real estate portfolios with funds-of-one, co-investments and separate accounts gaining popularity.

While not new in other asset classes, these structures are now gaining traction among real estate investors because they like the control and the lower fees offered by non-commingled fund structures.

Some 37% of institutional investors were investing in or considering a real estate co-investment as of Aug. 31, up two percentage points from January 2012. Another 37% of investors are investing in or considering an investment in separate accounts as of Aug. 31, according to data shared by London-based alternative investment research firm Preqin.

The non-commingled investments are more popular in other asset classes, such as private equity, because those deals generally are bigger than real estate transactions.

But today's tough fundraising environment is leaving some real estate managers without money at a time when attractive deals are proliferating, said Margaret McKnight, San Francisco-based co-chief investment officer of Metropolitan Real Estate Equity Management LLC. As a result, the managers are becoming more open to custom investment programs. Metropolitan is a real estate funds-of-funds manager acquired last week by Washington-based alternative investment manager Carlyle Group.

Institutional investors culled their roster of real estate managers after the recession and now are developing platform relationships such as funds of one — funds with a single limited partner — with managers they are retaining, said Heather Harlan, counsel in the fund formation practice of law firm Mayer Brown in an interview. Based in the firm's Chicago office, Ms. Harlan represents both institutional investors and alternative investment managers.

In a fund of one, the limited partner can invest across strategies within the asset class depending on investment conditions at the time. By contrast, a commingled fund must maintain the strategy for which it was established over its lifetime, Ms. Harlan explained.

In addition, these structures are not tied to a particular term, so a manager doesn't have to sell because it needs to distribute capital before it can raise a new fund. Fees are generally lower, she added.

One of the pioneers in alternative real estate investment structures is the $116 billion Teacher Retirement System of Texas, Austin.

Texas Teachers has investmented in funds of one since at least 2008 and has several funds of one as well as co-investments, said Eric Lang, the fund's managing director, real assets, speaking Oct. 30 on a panel at the Pension Real Estate Association's conference in Chicago.

Texas Teachers' real assets portfolio, which includes real estate, had $15.6 billion as of June 30.

In a separate interview, Mr. Lang said Texas Teachers was drawn to funds of one because of the pension fund's legal structure. But he said non-commingled fund structures are gaining popularity because of the control they give investors.

In its single limited partner funds, Texas Teachers has the ability to opt out of a transaction to “make sure we are not buying a property from ourselves ... from another of our commingled funds,” or becoming overexposed to a property sector, Mr. Lang said.

Co-investments also are more targeted than commingled funds. Texas Teachers will co-invest alongside a fund of one of its real estate managers even though the pension fund is not invested in that fund, Mr. Lang said.

For example, in March, Texas Teachers co-invested alongside a fund managed by CBRE Global Investors to buy the Leine Centre, a Laatzen, Germany-based shopping center for €117 million ($150 million). Texas Teachers is not an investor with CBRE Global Investors in Europe, but it has other investments with CBRE.

Cambridge, Mass.-based Harvard Management Co. Inc., which oversees the university's $32.7 billion endowment, revealed in its 2012 annual report that it had added direct deals — transactions made without outside investment managers — and joint ventures to what had been an exclusive diet of commingled funds run by external managers.

Harvard's direct portfolio earned a net return of about 27% for the fiscal year, according to Dan Cummings, managing director of real estate, Harvard Management Co.

Real estate separate accounts also are coming back in style. So far this year, a total of $7.4 billion has been invested in 28 separate accounts worldwide, up from $5.7 billion in 24 such accounts in all of 2012, according Preqin. However, Nicholas Jelfs, Preqin senior analyst and press officer in London, cautioned that separate account data are difficult to come by so these numbers might not be comprehensive.

This year alone, the California Public Employees' Retirement System, Sacramento, has committed to three real estate separate accounts totaling close to $1 billion; APG, fiduciary manager of the Stichting Pensioenfonds ABP, Heerlen, Netherlands, has committed a total of about £455 million ($732 million) to two separate accounts; Munich-based pension fund group Bayerische Versorgungskammer committed €500 million to one separate account; and the Los Angeles County Employees' Retirement Association, Pasadena, Calif., committed a combined $600 million to three separate accounts, according to Preqin and Pensions & Investments information.

Real estate managers are noticing the shift.

“We have always done co-investments as part of our flagship funds but we are in the process of raising some new pools of capital and expect to create more specialized vehicles to capitalize on co-investment in the near future,” Doug Lee, managing director and head of capital markets at Metropolitan Real Estate.

Those new vehicles include single-investor vehicles, according to sources.

Mr. Lee declined further comment.

Still, investors are not forsaking commingled fund investments. Texas Teachers invests its entire international real estate portfolio in commingled funds, Mr. Lang said.