Top realty investment firms see their equity shrink

Real estate money managers are seeing the equity in their property investments begin to dissolve. Combined worldwide taxable and non-taxable assets of the top real estate managers — excluding real estate investment trusts — sank 30% to $710 billion in the one-year period ended June 30, according to sister publication Pensions & Investments' annual survey of the largest real estate managers. U.S. institutional tax-exempt assets of the top 50 managers declined 26% to $316.3 billion. This year, 100 managers reported total real estate assets, down from 103 in 2008. During the survey period, the NCREIF Property Index returned -19.6%. Fifty-five percent of U.S. institutional tax-exempt real estate assets were managed by the top 10 managers on the list. Not one manager in the top 10 increased its U.S. institutional tax-exempt assets under management, and six managers lost less than the NCREIF Property Index during the period.
“The overriding big issue is that any investor who bought real estate in any sector within the last three years, with leverage of 70% or more, has lost most, if not all, of the equity in their properties,” said Scott Farb, managing principal for the consulting firm Reznick Group PC. “Think of all of the deals that closed in the last three to four years when competition was fierce and everyone was jumping in. Today is a whole new paradigm.”

"REALISTIC WRITE-DOWNS'

Some managers say their assets under management declined because they took their lumps early and marked down the values of their properties. For example, Prudential Real Estate saw its U.S. tax-exempt assets drop 27% for the one-year period ended June 30. “We attribute the decline to what we believe are realistic write-downs in value, combined with lower investments into our funds from new clients,” said Theresa Miller, a spokeswoman for Prudential.
And real estate managers will be facing further declines as the market adapts to fundamentals such as increased vacancy rates, said Bill Krauch, managing director of ING Clarion Partners. ING Clarion's U.S. institutional tax-exempt assets dropped 26% to $10.7 billion during the 12-month survey period. The decline in U.S. institutional assets is the result of a drop in valuation and redemptions from its open-end funds, Mr. Krauch said. ING Clarion is not alone. During the survey period, most managers with open-end funds had lines of investors looking for redemptions. “Those 12 months have been referred to by some as the Great Liquidation, when everybody wanted their money back,” said Gary Koster, leader of real estate fund services for the Americas at Ernst & Young LLP. Pension plan asset allocations were out of balance because equities were down, and their real estate portfolios were underwater. The pipeline of real estate redemptions increased dramatically, especially on the core end of the spectrum. For example, two of ING Clarion's three open-end funds lost 9% of their value because of redemptions alone, said Suzanne Franks, a vice president of the firm. She declined to disclose the names of the funds or their asset sizes. Also hit was Morgan Stanley's Prime Property Fund, a core fund with more than $500 million in redemptions as of Dec. 31. And while investors were clamoring for redemptions, little new capital was flowing into real estate, Mr. Koster said. For example, private-equity-style real estate funds raised a total of $10 billion in the second quarter, according to data released by Preqin, a London research firm. In the second quarter of 2008, real estate firms raised $37 billion. Plummeting property values also played havoc with real estate returns. The drop was accentuated in the portfolios of opportunistic managers and others with highly leveraged portfolios.

"SUFFERING A HANGOVER'

“We are suffering the hangover from the freewheeling days of highly leveraged transactions and easily obtainable debt capital,” Mr. Farb said. At Morgan Stanley, U.S. assets declined 54.2%. The firm took substantial write-downs on two opportunistic funds, which have the most leverage. It wrote down 80% of the properties in Morgan Stanley Real Estate Fund V U.S. and 60% in Morgan Stanley Real Estate Fund VI International. The former also was hurt when a joint venture between the fund and Duke Energy Corp., called Crescent Resources LLC, filed for Chapter 11 bankruptcy protection. Assets also fell because of a decision to quit the separate-accounts business. Morgan Stanley spokeswoman Alyson Barnes declined to detail how much of the bank's real estate business was in separate accounts. “Morgan Stanley offers clients a range of real estate solutions across the risk and return spectrum. Many clients have selected our opportunistic strategies, which typically accept higher levels of risk and use higher leverage in the execution of the fund's strategies. During this period of falling values, this level of leverage has led to a larger decline in net asset value than other less leveraged strategies,” Ms. Barnes wrote in an e-mail. A number of managers sustained large drops in the international assets managed for U.S. clients. Morgan Stanley retained its top spot on the list even though its assets dropped 60% to $3.2 billion, reflecting the drop at Morgan Stanley Real Estate Fund VI International. Invesco Real Estate's international assets dropped 41% to $2.7 billion, and third-ranked TIAA-CREF declined 32% to $2 billion. And despite the downturn, some managers successfully closed funds and added to their assets under management. The Blackstone Group closed the largest fund raised in the first half of 2009, the $4.6 billion Blackstone Real Estate Partners Europe III. A few real estate managers reorganized during the 12 month-period ended June 30. ING Clarion's worldwide assets fell by about 30%, largely due to a bankwide reorganization by ING Groep NV, the parent. Over the summer, the bank moved two of ING Real Estate's three divisions — development and mortgages — to the bank business side. ING Real Estate had $52 billion in mortgages and $4.5 billion in development, Mr. Krauch said. Both units invest primarily bank balance sheet assets, he said. ING Clarion was put under a new umbrella investment management unit, global investment management. Some managers saw the economy as the biggest obstacle to holding on to assets. A year ago, the collapse of Lehman Brothers Holding Inc. “triggered the biggest economic crisis since the Great Depression,” Mr. Farb said. “We all knew that by the third quarter of last year, this unprecedented crisis would have an enormous impact on the entire real estate industry. We are now experiencing firsthand the results of this once-in-a-generation financial meltdown,” he added. Real estate took major hits across all sectors, he said. Plus, the industry is coming off of a long period of easy debt. Property fundamentals such as employment rates and consumer spending are weak across all real estate sectors. Unemployment is high and is expected to stay that way for the foreseeable future. Businesses are contracting, and consumers aren't spending, Mr. Farb said. This affects managers with office and retail portfolios. For example, Shorenstein Properties LLC, which invests in the office sector, saw its tax-exempt assets drop 32.6% to $2.7 billion in the survey period. Shorenstein executives declined to comment for this article. The office sector vacancy rate increased to 15.55% in the second quarter, according to CBRE/Torto Wheaton Research. That's the highest since the third quarter of 2004, Real Estate Research Corp. noted in its summer 2009 report. For the 12-month period ended June 30, the NCREIF Property Index returned -25.54% for central-business-district offices and -20.15% for suburban-office portfolios, the report noted.

MEZZANINE FLOORED

The pain felt by managers was not strictly in equity; mezzanine assets fell by 34.5% to $6.1 billion. Capri Capital Partners LLC, which tops the mezzanine manager ranking, saw assets fall 15% to $1.6 billion, while BlackRock Realty Advisors Inc. withstood a 44.6% drop to $640 million. Mezzanine is in the same boat as other types of real estate, Mr. Koster said. “Mezzanine had equity behind it, and as real estate values declined, the mezzanine became the equity and declined too,” he said. Money flowing from foreign clients to U.S. investments fell by 17.2% to $32.3 billion. One firm, Colony Capital LLC, ran contrary to the downward trend, with assets managed for foreign clients gaining 120% to $3.7 billion from the same number of clients (65). Assets of Principal Real Estate, last year's foreign leader, sank by 60% to $1.9 billion. Arleen Jacobius is a reporter for sister publication Pensions & Investments.