The Wall Street Journal featured an interesting article this week, titled "Big Investors Shun Pools and Swim on Their Own." The article discusses the recent trend of large institutional investors moving into real estate directly, rather than via pooled funds. The reason for getting closer to property, cutting out the middlemen, are the high fees and disappointing performance of external fund managers. Especially during the crisis, many investors were hard-hit by the use of leverage in pooled funds (and of course by the choice of opportunistic investments, such as speculative development and land, but that was mostly the decision of the investors...). The Harvard endowment, the Canada Pension Plan (CPP IB) and Abu Dhabi Investment Authority are mentioned as examples. But add to that other big players on the capital market, like GIC (Singapore) and NBIM (Norges). (Never heard of? Well, that's where the new money is. Continuous inflows and no or limited liabilities.)
Interestingly, I recently wrote a paper on real estate investments of public pension plans. In this paper, presented at the Real Estate Research Institute in Chicago, we document that fees paid by US pension plans are consistently higher than the fees of institutional investors in other countries, by about 40bp. (And that's not just in real estate, but in all asset classes.) If that were to lead to outperformance, fine, but in fact US pension plans underperform their benchmarks over the period 1990-2010. This is mostly driven by the massive losses over the past couple of years (more than 50% for some pension funds...including CalPERS and Harvard), and is not compensated by the "good years" that preceded the crisis. We conclude, amongst others, that large institutional investors should consider to get closer to real estate, by building an internal real estate department. Yes, this is difficult. Yes, it requires human capital (that should be paid a competitive salary, including performance bonus). And yes, it requires critical mass. But there are some good examples across the border: OMERS has Oxford Properties, their very successful real estate investment division, OTPP has Cadillac Fairview, etc. And, like Harvard and ADIA, more and more investors are partnering with property/fund managers rather than investing in "blind" pools. Of course, this will not work for the many small pension funds that are out there. But we make another recommendation: these funds should reconsider their allocation to REITs, or the lack of allocation, that is. For small investors, investing in property through listed property companies readily provides access to the global real estate market, with liquidity as one of the main advantages. I know, REITs are not real estate, at least not if you look at quarterly correlations. But if the holding period is long enhough (we're investing for the long run, right...?), correlations with direct real estate are high, and correlations with other asset classes are low. Moreover, fees are low (at about 40bp), especially compared to fund-of-funds (add 120bp...). So, it's time for institutional investors to reconsider their investment strategy in real estate, and not just for the big investors!
Slides on The Performance of Pension Funds Investments in Real Estate