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  2. SPECIAL REPORT
September 30, 2019 12:00 AM

Fractured year sees assets increase 7.2%

Arleen Jacobius
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    Nancy Lashine
    Arnold Adler
    Nancy I. Lashine said managers took in a lot of cash and sold some properties for a good price.

    Strong fundraising combined with property sales in the early part of 2019 lifted managers' worldwide real estate assets under management to $1.59 trillion in the year ended June 30, a 7.2% increase from the prior period.

    That total might have been higher, but a short-lived capital markets downturn in the fourth quarter of 2018 and slower global economic growth applied the brakes to global real estate AUM after an 11.5% advance in the prior 12-month period, according to Pensions & Investments' annual survey of real estate managers.

    All real estate sectors rose in the year ended June 30 except timber and farmland. Worldwide debt categories grew the most, led by loan assets up 131.2% to $22.6 billion, and followed by mortgages up 11.5% to $330.4 billion, mezzanine up 9.6% to $19.2 billion and hybrid debt growing 5.7% to $27.4 billion. Worldwide real estate equity assets were up 5.8% to $1.14 trillion.

    Worldwide farmland and timber assets reversed upward trends in recent years, with assets falling 15.7% to $16.2 billion and 9.3% to $32 billion, respectively.

    Worldwide assets managed in real estate investment trusts dropped 9.3% to $445.9 billion.

    Co-investment assets managed for global clients spiked by 40.9% to $83.8 billion and by 248.2% in the five-year period ended June 30.

    "There was a lot of money raised," said Nancy I. Lashine, New York-based managing partner and founder of placement agent Park Madison Partners LLC. There was some appreciation of real estate assets but not as much as in prior years, she said.

    For the 12 months ended June 30, the NCREIF Property index was up 6.51% and the NCREIF Open End Diversified Core Equity index returned 4.14%.

    With most real estate assets still at lofty levels, many managers took the opportunity to sell as prices began to flatten or, some cases, began to trend down, Ms. Lashine said.

    "Asset prices are high and if you are not realizing gains now, it could be problematic for performance," she said.


    Small gains

    Real estate assets managed for U.S. institutional tax-exempt clients was up, barely, by 1.1% to $585.4 billion, a much slower growth than the 12.3% rise in the year-earlier period. Real estate equity was also up slightly by 0.8% to $469.1 billion, continuing a sustained positive upswing since 2010.

    When it came to sectors managed for domestic institutional tax-exempt clients, loans once again showed the most growth, albeit from a small base, up 22.7% to $3.1 billion. Mezzanine was up 14.2% to $8.9 billion, mortgages were up 6.7% to $74.5 billion and hybrid debt was down 5.6% to $7.1 billion.

    In this period of uncertainty, some investors are moving assets into debt as part of their move toward more defensive strategies that provide more predictable income, said Douglas Crawshaw, London-based a senior investment consultant and head of Europe, the Middle East and Africa real estate manager research at Willis Towers Watson PLC.

    Investors are considering a combination of debt strategies and co-investments, Mr. Crawshaw said.

    "Co-investments also allow investors to target specific strategies that meet particular requirements whether that be in terms of investment speed or risk/return profiles at often a lower cost when compared with commingled funds," he said.

    What's more, many institutional investors are playing catch-up because they are fully invested in real estate equity but are behind in building their real estate debt portfolios, Mr. Crawshaw said.

    Timber and agriculture assets managed for U.S. tax-exempt institutions were both down as well. Timber fell by 8.7% to $18.4 billion and farmland dropped by 8.1% to $14.1 billion.


    Retrenchment in DC

    Real estate assets managed for defined contribution plans retrenched, down 17.6% to $35.9 billion in the year ended June 30. By comparison, real estate AUM in defined contribution plans grew 139% in the prior year and 152.7% in the five years ended June 30, 2018.

    Starting in the spring of 2018, at least one target-date fund implemented a new asset allocation with a significantly lower allocation to REITs, said David O'Meara, a New York-based director on the defined contribution solutions team of consultant Willis Towers Watson. He declined to name the provider.

    Multiasset funds and target-date fund providers are considering a tilt away from real estate in their funds. While there are some real asset stand-alone funds in defined contribution plans, there are very few stand-alone real estate funds, Mr. O'Meara said.

    "Real estate had a pretty good run and real estate pricing is a little rich," he added.

    These managers are starting to see signs that real estate may be peaking, he said. For example, rents are not increasing as quickly as they had been.

    "There's some reason to believe that real estate may not be as strong as in the past," he said. Over the next 10 years, the value of properties in REITs, which is the way most multiasset funds invest in real estate, may not be as attractive compared to corporate equities, Mr. O'Meara said.

    Among the top 10 managers of real estate in defined contribution funds, two managers' AUM went down — PGIM Inc.'s assets plummeted 74% to $3.7 billion due to a reporting change and UBS Asset Management, down 7% to $199 million during the survey period. PGIM is now in the third spot, down from second, on P&I's list of the top managers of real estate in defined contribution plans. UBS is in the eighth position, down from the seventh spot.

    The decline in PGIM defined contribution AUM is due to a reporting change that resulted in a recategorizing of assets that PGIM manages on behalf of Prudential Financial Inc. as part of its insurance general account, said Caroline Bligh, PGIM spokeswoman, in an email.

    Nuveen LLC retained the top position of defined contribution real estate managers, with assets up 12% to $24.5 billion. J.P. Morgan Asset Management is now in the second spot, up from third with assets 1.2% higher to $4.5 billion.


    MetLife moves up

    The largest real estate manager by worldwide assets is MetLife Investment Management, with assets up 11.9% to $126.5 billion, replacing Nuveen, which had been in the top spot in 2018 but is now third with assets dropping 1.3% to $112.9 billion. PGIM is second, up from third position, on the worldwide real estate manager list, with AUM rising 6.9% to $113.9 billion.

    Nuveen is still first among real estate managers for U.S. tax-exempt institutions, as AUM increased 1.3% to $78.8 billion. Indeed, the top three managers of tax-exempt institutional assets are in the same positions as in last year's survey results. PGIM is second with assets tipping up 1.6% to $52.9 billion, while JPMAM is third, even with a 1.8% AUM dip to $47.5 billion. UBS is fourth with $25.9 billion, down 7.3%, and Principal Real Estate Investors rounded up the top five at $23.2 billion, despite a 23.3% decline.

    Principal's AUM drop was due largely to a realignment of real estate operating company assets back to a client in August 2018 at the conclusion of a successful long-term mandate, said Teresa Thoensen, Principal spokeswoman, in an email.

    Not including development transactions during the period, Principal was a net seller of properties, partially explaining the drop in AUM, said Todd Everett, CEO of Principal Real Estate Investors.

    It's a good market to sell properties that have already optimized value, he said.

    Eric Adler, London-based chairman and CEO of PGIM Real Estate and chairman of PGIM Real Estate Finance, said that during the year ended June 30 real estate went through a reversal of fortune.

    "It's the tale of two halves," Mr. Adler said.

    Capital market turmoil in the fourth quarter of 2018 produced the denominator effect: The decline in the public markets led to an increase in the percentage of alternative investments including real estate in investors' portfolios, Mr. Adler said.

    This caused some investors to draw down their investments in open-end funds, causing transaction volume to fall.

    "What kept things more or less afloat was foreign money," he said.

    According to this year's survey, worldwide assets managed in the U.S. for foreign clients rose 11.8% to $159.9 billion in the period.

    In the second half of the survey period ended June 30, transaction volume went up as the public markets recovered, Mr. Adler said. Over the period, PGIM has been relatively flat, buying as many properties as it sold, Mr. Adler said.

    "We were more net sellers in the beginning of 2019 as prices went up," he said. In the fourth quarter of 2018, PGIM sold almost nothing, with some purchases but not in huge volumes, Mr. Adler said.


    Playing defense

    It was a time to be more defensive, said Melissa Reagen, New York-based head of research, Americas, Nuveen Real Estate.

    "Most investors were certainly cognizant of where we are in the real estate cycle" Ms. Reagen said.

    Nuveen executives have been very selective where they invest, narrowing the markets in which the company would invest and taking care not to overpay for properties, she said.

    Nuveen has also been taking stock of how climate change will affect property values of assets in its portfolios. It is also in the process of integrating climate change analysis into its due diligence when its executives are considering a purchase, Ms. Reagen said.

    The lateness of the cycle is leading investors to be more cautious, which is one reason why prices haven't risen as a result of interest rate drops, PGIM's Mr. Adler said. "People are nervous, he said.

    Investors do not think that the capitalization rates will increase anytime soon, he said. The capitalization rate is net operating income divided by a property's current market value.

    Credit strategies are continuing to be popular. Many managers are finding they have a competitive advantage with lenders on core properties because investors are willing to accept slightly lower returns as long as they are additive compared to other asset classes, Mr. Adler said. That was particularly the case at the end of the year.

    "We had record core mortgage volumes," he said. "The market turmoil spooked some of the other lenders."

    Even with lower rates, real estate still looks comparatively attractive compared to public equities, Mr. Adler said. "We are happy to lend in a lower-interest-rate environment."

    However, many non-bank lenders sold their strategy to investors on the basis of absolute returns that are difficult to achieve in a lower-interest-rate environment, he said.

    The top three mortgage managers retained their positions on this year's list. Nuveen is at the top of mortgage assets with $30 billion, a 1% dip; PGIM is next with $19.5 billion, up 26%; and New York Life Investment Management with $4.7 billion, a rise of 19.4%.

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