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Real estate

Line between core, core-plus investments blurring

Definition of segment changing as investors look for more return

Katherine Giordano
Katherine Giordano said more managers are offering core-plus, open-end funds.

Real estate investors are continuing to favor core strategies, with some cutting back on opportunistic funds, but their definition of core is expanding.

Some investors are expanding core to include higher return and higher risk investments — what used to be classified as core-plus assets — because core is just too expensive at this time in the cycle.

“The lines between core and core plus are blurred,” said Phil Marra, partner in the New York office of KPMG LLP. ”Core is blurring with core-plus to deliver the returns that are hard to get in core these days but investors still want stable, income-producing property.”

Even pure-play core funds are investing the maximum percentage of their assets allowed by contracts in riskier value-add properties to boost returns, industry insiders say.

“Everyone's definition of core is changing,” Mr. Marra said. “The lines are blurring as a result of interest rates (being) so low.”

Still, investors aren't throwing caution to the wind.

“Open end (funds are) a little in vogue today because investors think there is more liquidity. Of course, in a black swan event, open-end funds are no better (than any other investment).”

Managers are launching core-plus open-end funds to take advantage of the shift in demand. Some of these managers had been known for opportunity funds, said Christopher Lennon, principal at Cleveland-based real estate consulting firm Townsend Group LLC. The new core-plus funds are targeting leverage of about 50%, he added, declining to name the firms.

However, Blackstone Group LP, The Carlyle Group LP, Brookfield Asset Management Inc., Rockpoint Group and Starwood Capital Group LLC are among the firms formerly known for opportunistic real estate investments that have launched core-plus funds in the past few years. Others offering core-plus include Principal Real Estate Investors Inc., Intercontinental Real Estate Corp. and J.P. Morgan Asset Management (JPM).

Blackstone Group's core-plus strategy had $14 billion in assets as of Dec. 31, more than two years after it launched in 2014, noted CEO Stephen Schwartzman during the firm's Jan. 26 earnings call. Sources said Blackstone's core-plus fund has a queue of $1 billion waiting to invest.

“The majority of open-end core and core-plus funds still have queues of capital waiting to get into them,” Mr. Lennon said.

And real estate managers continue to unveil core-plus strategies.

“There are more and more entrants to (the) core-plus, open-end fund space,” said Katherine Giordano, head of property multimanager in the New York office of Aberdeen Asset Management.

“We are looking closely at what it means to be in that space and what tactics managers are using,” Ms. Giordano said. “We believe they can still fit within the risk appetite of our investor base that a 65% to 75% leveraged closed-end opportunity fund would not.”

However, Aberdeen executives are not satisfied with a portfolio of stabilized assets if there is no opportunity for income growth, she said.

“We look for funds with portfolios that we believe are underrented and have rents that are under market. We believe that even if the economy slows down and growth slows, if properties are underrented, as leases roll, they can be brought to market. We see safety in that.”

Strict core managers are bumping up the risk in portfolios to capture returns.

“We are not focusing on ODCE funds, which in a lot of cases are maximizing their allocations to value-add (properties),” said Aberdeen's Ms. Giordano, referring to funds included in the NCREIF Open-end Diversified Core Equity index. “They are doing ground-up development and repositioning. They are using that portion of their portfolios to generate some alpha. We are not so sure about taking on that risk at this point of the cycle.”

Eyes wide open

Investors are making the moves with their eyes wide open. After seven years of near-zero lending, more capital is moving into core strategies and sovereign wealth funds with lower capital costs are beating out managers for deals, noted a February staff report to the Oregon Investment Council on the $8.7 billion real estate portfolio of the Oregon Public Employees Retirement Fund.

In September, the Tigard-based council, which oversees the pension fund's investments, increased the target allocation ranges of its core portfolio to 45% to 65% from 20% to 40%, while decreasing real estate investment trusts and opportunistic investments and widening the band for value added. Currently, 30.9% of the council's real estate portfolio is invested in core.

Oregon Investment Council executives are seeking consistent income from its core portfolio. They don't expect property appreciation. “The focus now shifts to sustainable income/NOI (net operating income) growth,” the Oregon report noted.

Future core returns will be lower and so, the report said, the focus of the council's core portfolio would be on cash flow durability and quality.

Oregon officials expect to be evaluating core-plus open-end funds because they “may provide risk-adjusted outperformance to late-cycle core,” the report stated.

Some investors are investing in core and core-plus for diversification. New Mexico Public Employees Retirement Association, Santa Fe, in January committed $15 million to a closed-end core-plus fund of one managed by Sarofim Realty Advisors to invest in core and core-plus properties.

New Mexico PERA is boosting its core and core-plus investments because its portfolio is underweight core, said Jonathan Grabel, chief investment officer of the $14.5 billion pension fund.

This article originally appeared in the March 6, 2017 print issue as, "Line between core, core-plus investments blurring".