HARTFORD, Conn. - The $14 billion State of Connecticut Trust Funds has set a precedent by agreeing to sell its entire $450 million real estate commingled fund portfolio to Landmark Partners Inc.
The deal - expected to close in December - would be the first time a large dose of liquidity was provided to the pension fund real estate commingled fund industry.
As a result, other pension funds might follow Connecticut's lead; or other investors might raise investment partnerships to buy pension fund commingled fund interests in the secondary market.
Landmark is a private investment firm that made its reputation by providing liquidity to limited partnerships.
Landmark will receive interests in 27 commingled funds managed by seven firms, an industry source said.
Estimates of the discount from net asset value at which Landmark will purchase Connecticut's interests ranges from 10% to almost 30%, according to industry sources.
State Treasurer Christopher Burnham, sole trustee of the pension fund, and Landmark Chairman Stanley Alfeld declined to disclose the amount.
"If they (Landmark) follow through and close this, it will be a great deal for us," said Mr. Burnham. "We've yet to see any money."
"We have an agreement in place," said Mr. Alfeld. "It's beyond the discussion stage."
"If this closes, buyers will provide much needed liquidity for investors in commingled funds," said Peter Levine, first vice president with Cantor Fitzgerald & Co., a New York broker dealer.
Mr. Levine's firm is the system manager for the Institutional Real Estate Clearinghouse, an industry initiative that is trying to institute trading of commingled fund interests.
"Their (Landmark's) strategy is to optimize value, not necessarily to maximize value," said Mr. Levine. "They want to work with the manager within the context of the fund termination date to accelerate the liquidation of the real estate."
Connecticut's commingled fund real estate managers are: Copley Real Estate Advisors, Boston; Heitman Capital Management Corp., Chicago; LaSalle Advisors L.P., Chicago; The RREEF Funds, San Francisco; Sentinel Real Estate Corp., New York; Westmark Realty Advisors; and The Wachovia Bank of Georgia, Atlanta.
Mr. Levine said permission from Connecticut's commingled fund managers would be required to do the deal.
"Most of the commingled funds never contemplated secondary market transactions, so the documents (the trust agreements between the pension fund and the manager) never provided for transfer of interests," said Mr. Levine.
Landmark approached Connecticut with the offer to buy, said Messrs. Alfeld and Burnham.
Mr. Burnham said he hasn't decided how the proceeds from the sale will be invested, but that other real estate investments and publicly traded real estate investment trusts would receive consideration.
"We are not abandoning real estate," said Mr. Burnham. "We have had an asset allocation in real estate far greater than our peers."
As of June 30, 1995, Connecticut had 8.7% of its then $12.2 billion invested in real estate.
"We are bringing it into line with other multibillion dollar funds," Mr. Burnham said.
Further commingled fund investments will not be considered because there is no alignment of interest between the investment manager and the investor, said Mr. Burnham.
"If we do separate accounts, it will be with managers that put up a significant portion of their own money," he said. "We are also interested in REITs.
Many of Connecticut's closed-end fund investments are scheduled to mature in four years, with some as long as 10 years.
But the potential of reinvesting the proceeds now, rather than waiting an average of six to eight years for the return of the money, appealed to Connecticut, said a real estate professional knowledgeable of the deal.
"There's a fair amount of pent-up demand for liquidity in (real estate) commingled funds," said Mr. Alfeld. "It's a natural extension of our business."
Pension funds have invested an estimated $39.6 billion in real estate commingled funds, according to Institutional Property Consultants, a San Diego real estate consultant. Of that amount, $23.8 billion is in closed-end funds; the remainder is in open-end funds.
Mr. Alfeld said Landmark intends to be a passive owner. Real estate professionals noted, however, that Connecticut, on average, owns a large percentage interest in its commingled fund investments. Thus it would not take many more purchases for Landmark to gain a controlling interest of some funds.
Other investors might be motivated to sell because they have been frustrated in attempts to stop commingled fund real estate managers from extending the expiration dates of closed-end funds. Overriding the manager requires a majority decision.
"Their objective is not to run the real estate but to oversee the managers that are running the investments," said Mr. Levine.
Mr. Alfeld said Landmark might acquire real estate commingled fund interests from other pension funds.
Connecticut's real estate returns have been poor, and the commingled fund portfolio has been the source of the drag on performance. Mr. Alfeld, nonetheless, doesn't consider the properties distressed.
"We're not buying distressed properties, but we may be buying from investors who are distressed about the results," he said.
"They're (Connecticut) in the liquidation stages for the most part," said Mr. Alfeld. "It's a very attractive situation for us, and I think very attractive to the state."
Landmark has $1.5 billion under management in six funds set up to acquire interests in venture capital, mezzanine and leveraged buy-out partnerships. This is the firm's first initiative in real estate.
Richard W. Maine was hired last summer to lead Landmark Realty Advisors L.L.C., the real estate arm. The New York-based accounting firm Coopers & Lybrand was retained to value Connecticut's commingled funds.
Last month, Mr. Burnham selected Aldrich Eastman Waltch L.P., Boston, to manage its entire direct property and mortgage investments. The fund previously had seven separate account managers - including AEW - overseeing close to $700 million of property and mortgage investments.
The six other separate account managers were terminated.
The pension fund doesn't segregate the performance of its commingled funds in its annual report. According to the report, its total real estate investments lost 2.78% for the year ended June 30, 1995, the latest data available.
That return was 10 percentage points behind the benchmark NCREIF-Property Index's 7.22%.
For the trailing three-, five- and seven-year periods, the pension fund's real estate return was -4.83%, -6.68% and -2.96%, respectively, net of all expenses. The benchmark had positive returns during the three- and seven-year periods and a negative return (although better return than Connecticut) over the five years.
If an investor had placed $10 million in Connecticut's real estate portfolio seven years ago, the investment would have been worth $8.1 million as of June 30, 1995.
To date, there has been but a trickle of liquidity in real estate commingled funds. Redemption usually occurs when an investor sells back shares to the manager at net asset value, but this can only occur when there is cash from new investors, the sale of property or cash from operations.
Because there has been little interest in the funds since the late 1980s, combined with a falling property market that slowed sales, investors had to line up and wait to be cashed out.
A few negotiated transactions, primarily for a sole commingled fund, have occurred between pension funds, but not much else.
Liquidity Financial Advisors, Emeryville, Calif., undertook an effort a few years ago to negotiate trades of commingled fund interests among pension funds. It and the Clearinghouse have been unsuccessful in completing transactions.
Marlene Givant Star contributed to this article.
