Monday, August 26, 2019

Investment Insights

What pension fund trustees should know 

about investing in real estate 


By Meredith Despins/Nareit

As a pension trustee you have a lot on your plate. Ensuring that your systems’ assets are diversified, in order to minimize risk of loss, is a core responsibility.

Diversification is primarily achieved by investing the plan’s assets in different types of investments or “asset classes.” Commercial real estate is the third largest asset class within the $97 trillion investment opportunity set in the United States. 


Click to enlarge chart. See footnote 1.

There are many factors that go into determining the appropriate allocation to any asset class, including real estate within an investment portfolio, and these factors are unique and specific to each pension fund. One very simple approach is the “market portfolio,” which invests in each asset weighted in proportion to its total presence in the market. This would suggest that pension funds should be allocating about 17% of their investments to real estate.

More detailed asset allocation methods that include a broad mix of asset classes and consider returns, correlations, and volatilities consistently, demonstrate that a meaningful allocation to real estate, somewhere in the 15 to 20% range, is appropriate.


 
Click to enlarge chart. See footnote 2.

Real estate is a mature asset class, and like equity and fixed income investments, exposure to real estate can be achieved through public market investments as well as through private market investment. In real estate, when we say “public market” investment, generally we mean investment in real estate through REITs (real estate investment trusts). “Private market” investments are investments in real estate through private transactions and vehicles.

For investors who are considering adding a real estate allocation or are beginning to build their real estate portfolio, REITs generally provide the most cost-effective and efficient way to gain exposure to the asset class.

For investors who have only private real estate investments in their portfolio, there are specific benefits of adding a meaningful allocation to REITs. REITs and private real estate are complementary investments within a portfolio. 


To see how this might work in your portfolio, visit www.pensionsandrealestate.com.


Click to enlarge chart. See footnote 3.

Today, most pension funds, on an asset weighted basis, invest in both REITs and private real estate. Including REIT strategies in combination with private market real estate investments helps pension funds to address several issues that have become critically important over the last decade, and which are difficult to achieve by investing solely through private real estate investment.

Access. The ability to efficiently invest fully in the real estate asset class, including “new economy” real estate.



Click to enlarge chart. See footnote 4.

Governance. Commercial real estate is a physical “bricks and mortar” asset and traditionally has been relatively illiquid. Because REITs are real estate companies traded on stock exchanges, they provide real estate investors with real estate returns in a vehicle that also provides effective governance and market liquidity.

Performance. Investing in real estate through REITs has provided not only asset class diversification, but also historically has enhanced investment performance. REITs' track record of delivering reliable and growing dividends, combined with long-term capital appreciation, has historically provided investors with total returns that outpace private real estate returns by 2.5% to 3% per year.

Cost Management. REITs provide investors with access to real estate, and because they are public market investments and listed on the stock exchange, are highly transparent. Real estate investment through REITs is often the most cost-effective and highest total return way for pension funds to invest in the asset class.



Click to enlarge chart. See footnote 5.

Risk Management. Diversification of your plan’s assets is among the most powerful risk management tools available to investors; and having real estate in the pension’s portfolio is one arrow in the risk management quiver. Diversification within the pension’s real estate portfolio is another important risk management tool.


Click to enlarge chart. See footnote 6.

Nareit hopes this information has provided “food for thought” as you consider your pension fund’s real estate investments. We invite you to visit www.pensionsandrealestate.com, a new website that has been designed especially with pension trustees in mind, and is intended to provide information to help trustees and pension fund investors think critically about their plan’s real estate investments. 

Footnotes:

  1. Stock and bond data from Board of Governors of the Federal Reserve, Financial Accounts of the United States, 2018Q4; commercial real estate market size data based on Nareit analysis of CoStar property data and CoStar estimates of Commercial Real Estate Market Size, 2018Q4
  2. The Role of REITs and Listed Real Estate Equities in Target Date Fund Allocations, Wilshire Funds Management, 2019 https://www.reit.com/data-research/research/nareit-research/reits-critical-retirement-portfolios; Global Listed Real Estate Investment: Asset Allocation in a Non-Normal World, Morningstar December 2010; Commercial Real Estate Investment Through Global Public Markets, Morningstar, November 2011; The Role of REITs and Listed Real Estate Equities in Target Date Fund Asset Allocations, Wilshire Funds Management, January 2013; Real Estate Investment In Liability-Driven Portfolios, Morningstar Inc., July 2011; Real Estate Investment Through REITs, Morningstar Inc., September 2008.
  3. Nareit analysis of quarterly net total returns for NCREIF Fund Index – Open-End Diversified Core Equity (ODCE) and FTSE Nareit All Equity REITs Index, 1978Q1-2018Q4, after subtracting assumed fees of 12.5 bps/qtr for REITs.
  4. Source: FactSet, Nareit New Sectors incudes cell tower, data center, self storage, timberlands, single family home, and farmland REITs. All Other includes all other sectors in the FTSE Nareit All Equity REITs index. Data as of June 30, 2019.
  5. Source: CEM Benchmarking, 2018 available, at https://www.reit.com/sites/default/files/media/PDFs/Research/NAREITCEMESupdate2018Oct24.pdf
  6. Source: Nareit analysis of property data from S&P Global Market Intelligence.
The views expressed herein do not constitute research, investment advice or trade recommendations, do not necessarily represent the views of NAREIT nor TEXPERS, and are subject to revision over time.

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