Real estate money managers are becoming the dominant buyers and sellers in the commercial real estate market, increasing the likelihood that institutional investors could have exposure to both sides of a single transaction.
That could increase the risk in investors' portfolios and possibly decrease returns.
Risk is something investors have been attempting to strip from their portfolios since the 2008 market downturn took a bite out of their real estate profits. Many investors boosted their exposure to core investments to increase portfolio income and decrease risk.
Although real estate transactions have been largely on pause since the summer's public market volatility, there is no sign so far that the share of deal volume by managers investing on behalf of pension funds, endowments, foundations and sovereign-wealth funds is liable to shrink anytime soon.
In the first half of this year, overall transactions were up 100%, according to a recent report by consulting firm Deloitte LLP, citing data from real estate research firm Real Capital Analytics Inc. Since then, transactions have cooled slightly, declining about 15% in the third quarter.
Institutional real estate managers accounted for more than a third of transactions in the first three quarters of this year, according to data shared with sister publication Pensions & Investments by Real Capital Analytics.
Real estate money managers accounted for 36% of total transactions and 31% of the sellers in the first nine months this year. That is up from 22% of buyers and 16% of sellers in the first three quarters of 2009.
Pension funds and other institutional investors are well-aware that they could be on both sides of a deal, said Vic Bucchere, a managing director and head of separate acquisitions for U.S. managed accounts with CBRE Global Investors.
“It's a concern the funds are aware of. They monitor it pretty closely,” Mr. Bucchere said.
The issue is more likely with commingled funds, which are more like blind pools in which managers have full discretion over their deals.
“Separate accounts have more-frequent and specific communication because typically, separate-account capital is not as discretionary as private-equity capital,” Mr. Bucchere said.
Sarah Angus, vice president and private-real-assets consultant at Callan Associates Inc., agrees.
In commingled accounts, where clients have no control and are less involved in the day-to-day fund matters, it is more likely that investments will be sold from one fund to another, and investors may not know it, because they don't track all investments, she said.
Institutional managers dominate the industry, especially in prime locations, and sales between managers can be hard to track, Ms. Angus said.
Real estate managers are being pressured both to buy and sell because they have unspent capital to invest, real estate funds to liquidate and new capital to raise.
Aside from the need to invest are the pressures to sell. Many real estate funds started from 2005 into 2007 — before the economic crisis took hold — are coming to the ends of their lives.
At the same time, funds with investment periods that were extended during the downturn, typically for two years, also are coming to an end. Managers will need to slowly liquidate these portfolios and return profits to investors before they can hope to go back to investors to raise new funds, according to industry insiders.
“There was a significant amount of money raised in the 2005 to 2007 time frame,” said Bob O'Brien, a vice chairman and U.S. real estate services leader with Deloitte. “Over the next three to five years, some of those funds will be hitting the end of their lives.”
According to data provided by research firm Preqin, private-equity real estate funds raised $318.6 billion from 2005 through 2007.
Adding to pressures to sell is that some of the properties in managers' portfolios are either becoming distressed or are in need of capital infusions that managers don't have.
“Many fund managers that were able to access capital did so two or three years ago. Due to poor fundamentals, we have seen once- transitional properties that were subsequently stabilized becoming transitional again,” said Jarret Cohen, head of private real estate at Fir Tree Partners LP, a hedge fund firm.
SELLING MOTIVATION
Other managers are motivated to sell because they changed their investment objectives, switching their geographic focus, for example, or shedding properties that don't fit into new investment strategies, Mr. O'Brien said.
Other managers are selling to provide profit distributions to investors, he said.
“Given the liquidity issues of 2008 and 2009, many managers pulled the plug on distributions,” Mr. O'Brien said.
Now they are playing catch-up.
Indeed, many fund managers are selling good properties early in the lives of their funds, Mr. Bucchere said.
These managers are selling real estate to demonstrate the high quality of their real estate portfolios, to show the profit potential of their funds “and maybe as a marketing tool” for the managers' next fund, he said.
In the first part of this year, when core real estate prices were quite high, managers began selling off core properties to cash in on their increased values.
Indeed, prices in the first part of the year on core real estate — defined as the more stable properties in the most desirable locations — were in the stratosphere, said Ronald Dickerman, president of real estate investment manager Madison International Realty.
Since then, “we've seen a pause in the market,” he said.
Sometimes the parties to the stalled deals seek capital from other sources, including other real estate investment firms. That gives investors even more exposure.
“The underlying investors start counting the money, and all of a sudden, a transaction doesn't happen. Once a transaction is in play, it's hard to put it back on the shelf,” Mr. Dickerman said, noting that Madison International has been buying into a sliver of deals to help them go through.
Another way that investors might get on both sides of deals is through their investments in real estate investment trusts. REITs have been active buyers, a trend likely to continue.
According to a Deloitte report, the Commercial Real Estate Outlook, REITs that loaded up their war chests by accessing the public markets have been scooping up properties this year. Real Capital Analytics data show that REITs bought $17 billion worth of properties and sold $9 billion in the first quarter of this year alone.
So far, institutional investors don't seem very worried.
“The managers we work with have the discretion to act based on what's in the best interests of the particular fund,” Wayne Davis, spokesman for the $227.5 billion California Public Employees' Retirement System, wrote in an e-mail. “We hold them accountable for performance but leave it to them to make decisions.”
Arleen Jacobius is a reporter for sister publication Pensions & Investments.
