Lecture Sixteen: Institutional Investments (MS PowerPoint)

Lecture 16

Institutional Investments

Pension Funds– Many pension funds have committed 5% or more to the real

estate sector

– 2004: U.S. Domestic pension funds held over $140 billion in commercial property equity

Real Estate Investment Trusts (REITS)

Institutional Investments

Direct Real Estate Investing vs. Stock and Bond Investing

Property assets are relatively illiquid and trade in a multitude of local private markets rather than in centralized public exchanges

Real estate assets are geographically fixed and must serve space markets that are geographically segmented

Property assets trade in “whole assets” rather than in small shares

Initial Problems in Direct Real Estate Investment

Large sums of money required to purchase assets

Need for property management and asset management

Illiquidity of real estate investments– Longer time required to sell– More expensive to sell

Lecture 16

Evolution of

Real Estate Products for Institutional Investors

Evolution of Real Estate Products for Institutional Investors

1970’s: Commingled Real Estate Fund (CREF)

– Similar to Limited Partnerships– Funds from several pension funds pooled to purchase a

diversified portfolio of commercial properties– Investment Advisor responsible for asset management and

investment decisions– Pension fund investors entitled to their pro-rata share of

income and proceeds– Investors could buy into or cash out any time on the basis of

a current appraised value of the CREF shares

Evolution of Real Estate Products for Institutional Investors

Late 1980’s: Problems in Real Estate Markets

– S & L deregulations, tax-induced investing, and other sources of money in the market

– Widespread dissatisfaction among pension fund clients, pared with collapse in property markets, created shake-out and consolidation in real estate investment advisory industry through mid-1990’s.

Evolution of Real Estate Products for Institutional Investors

1990’s: Serious Interest in Publicly-Traded Real Estate Securities

– Real Estate Investment Trusts (REITs)– Commercial Mortgage-Backed Securities (CMBS)– Pension funds still rely on REIT and CMBS shares

for their real estate allocations.– Upturn in commercial property markets offered

exciting new prospects and opportunities.

Public vs. Private Asset Markets

Liquidity

Informational Efficiency

Lecture 16

REIT Performance

REIT Growth Since 1989

REIT Growth Since 1989

Before 1992:

•Micro-Cap in Size

•Low Liquidity

•Highly Leveraged

•Variable-Rate Debt

•Advised REITs with little ownership

•Little property-type focus

Since 1992:

•Small to mid-cap

•Good Liquidity

•Lower leverage – 30% - 60%

•Cheaper debt, some fixed

•Better-aligned interests and ownership

•More property focus

REIT Ownership

(as an approximate percentage of the value of all institutional holdings of the same property type)

Malls: 32%Hotels: 17%Retail: 13%Apartments: 7%Office: 6%Warehouses: 5%

Lecture 16

REIT Regulation

REIT Regulation

REITs cannot be closely-held corporations– No five or fewer individuals may own more than 50% of the

REIT stock; must have at least 100 shareholders

75% or more of the REIT’s total assets must be real estate, mortgages, cash, or federal government securities, and 75% or more of the REIT’s yearly gross income must be derived directly or indirectly from real estate property

REIT Regulation

90% or more of the REIT’s annual taxable income must be distributed to shareholders as annual dividends

REITs must derive their income from primarily passive sources like rents and mortgage interest, and not from short-term trading and the like.

Lecture 16

Industry Associations

Industry Associations

Pension Real Estate Association (PREA) National Council of Real Estate Investment

Fiduciaries (NCREIF) Association for Investment Management and

Research (AIMR) National Association of Real Estate

Investment Trusts (NAREIT) Real Estate Research Institute (RERI)