Significant pension fund investment in public real estate investment trusts was unimaginable a few years ago. Now, it isn't a matter of if pension funds will invest in REITs, but how.
"If real estate is 5% to 15% of a large fund's asset allocation, up to 25% of that will be public securities," said David Glickman, chief executive officer of Prime Residential Inc., a Chicago REIT. "That is a growth area," said Mr. Glickman, pointing out that traditional pension fund real estate managers like Heitman Advisory Corp., LaSalle Advisors Ltd., The RREEF Funds and Jones Lang Wootton Realty Advisors now have REIT management operations.
Significant developments showcasing the growing influence of REITS include:
A joint venture between Alliance Capital Management, New York, and real estate manager Koll Investment Management, Newport Beach, Calif., to offer REIT portfolio management services; and
The eagerly awaited completion of a search by the $62 billion California State Teachers' Retirement System, Sacramento, for a real estate manager to help it securitize all or parts of its $1.6 billion property portfolio. Industry professionals speculate the fund wants to contribute properties to a public REIT in exchange for a substantial ownership stake in the company.
Pension funds are investing in REITs in three major ways: they are buying and creating portfolios of REIT common stock by hiring a dedicated REIT manager or by managing it internally; they are making direct private placement investments in the companies; and they are co-investing with REITs to acquire property portfolios or finance development.
The amount of pension money flowing into REITs is difficult to track, particularly the direct private placements and the co-investments, which are not always subject to public disclosure requirements. But there are some plausible estimates.
Pension fund investment in dedicated portfolios of REITs total between $5 billion and $6 billion, according to Nicholas D. Tannura, vice president with EII Realty Securities Inc., a Chicago manager of REITs. It was about $1.5 billion two years ago, estimates Mr. Tannura.
"If you look at the top 100 pension funds, 33 of them are invested in REITs," said Mr. Tannura. "About half of them are doing it directly and half are doing it through managers."
Mr. Tannura counts an additional 14 pension plans with total assets of between $1 billion and $3 billion as REIT investors, but concedes there could be more.
A conservative estimate of a $100 million average portfolio size for the 33 large funds yields about $3.3 billion invested in REITs. The balance would be made up by the smaller pension funds that primarily use external REIT managers.
To the $5 billion to $6 billion, Kenneth Campbell adds $1.6 billion of money invested in REITs through direct private placement and joint ventures in 1995, the majority of which was from pension funds. Since 1991, pension funds have invested more than $3.7 billion in REITs via direct placements and joint ventures, said Mr. Campbell, chairman of CRA Real Estate Securities, a REIT portfolio manager based in Radnor, Pa.
"This is the year of the private placement," said Mark Jorgensen, a former pension fund real estate executive and pension fund manager turned REIT consultant. "It makes sense from a REIT point of view," said Mr. Jorgensen. "They can move quickly and the stock doesn't get penalized.
"Also, the cost of capital is 1% to 2% vs. 7% to 8% if they do it through Wall Street.
"From the pension fund point of view, it's the only way the big guys can get in without moving the market. They are getting a slightly better deal than with the common (stock)."
Mr. Campbell estimates 90% of the investments that pension funds will make in REITs will be done by purchasing the securities in the open market, but that the larger funds will prefer direct private placements and joint ventures.
"Pension funds seem to like to have a deal where it's a classic property transaction but with an exit strategy," said Mr. Campbell, noting that the funds can get stock for the properties they contribute and, after a holding period, sell it. "For big deals - $200 million to $500 million - that is probably the way they will go.
"The institutions have gotten comfortable in that they can exit ultimately," said Mr. Campbell. "They have developed a pretty broad feeling that securitization is here to stay and it is an impact on their strategy.
"They have become more receptive to a (public) market out."
Mr. Campbell declines to make a projection for the level of direct placement or joint venture investment in REITs by pension funds, noting it depends on a number of factors affecting the cost and availability of capital.
"It's not a projectable number," he said, but noted $250 million had been raised through March.
John Parsons, managing director with Chicago-based real estate consultant MacGregor Associates, estimates joint ventures between pension funds and REITs will bring more than $2 billion into the industry in 1996. One important deal he cites: last year's collaboration by General Growth Properties and the New York State and Local Retirement Systems to acquire the regional shopping centers owned by Homart Development Co.
Mr. Parsons views insurance companies that have to rebalance portfolios to meet risk-based capital guidelines as the source of properties for these ventures.
Pension funds haven't always been embracing of REITs.
The massive securitization of commercial real estate debt, born of the thrift crisis of the late 1980s but now standing firmly on its own, and real estate equity, which had its origins in the credit crunch of the early 1990s, have created a sizable industry that now merits consideration from pension funds.
The market capitalizations of the public REITs continue to grow, making it easier for pension funds to invest more money in these companies.
The public REIT industry grew from an equity market cap of about $5.5 billion at the end of 1992 to almost $50 billion at the end of 1995, according to the National Association of Real Estate Investment Trusts, Washington.
The recently announced merger of shopping center REITs Simon Property Group Inc. and DeBartolo Realty Corp. would result in a company with an $8 billion market cap and would be included in the Standard & Poor's 500 Stock Index.
The deal would create the nation's largest public REIT, a distinction now held by Meditrust, a health care REIT.
Also, the quality of the properties held by REITs - particularly those that own apartments and shopping centers - are now, arguably, of equal or better quality than those held in private partnerships.