Institutional Real Estate Americas

February 2011: Vol. 23 No. 2

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From the Current Issue


Same Plot, Different Setting: Investors Rediscover Open-End Funds

The story of open-end funds sounds a lot like your basic romantic comedy: Boy meets girl, boy gets girl, boy loses girl, boy gets girl back.

Since the first open-end fund made its debut in the 1970s, investors have had a love-hate relationship with the investment structure that promises relative immediate access to the asset class, diversification and prospects of liquidity. These privately securitized, infinite-life pools gained popularity and prominence in the 1970s and 1980s as the main squeeze for pension plans then making their initial forays into the real estate asset class. However, the bloom was off the rose and the love affair fizzled when the real estate market crashed in the 1990s and investors discovered the promise of liquidity worked better in theory than in practice.


Arrested Development: The Stalled Evolution of Private Equity Real Estate: Flexible Investment Mandates Can Improve Alignment, Performance

As institutional investors once again allocate capital to private equity real estate funds, they have the opportunity to re-think how best to avoid the pitfalls from the previous cycle. Early indications suggest that narrowed fund strategy mandates are among the improvements investors are seeking. Investors’ goals are well-intentioned: They aim to prevent strategy drift, keep a manager focused on his strengths and, most important, avoid the types of poor investments that doomed 2005 to 2007 vintage funds. However, poor investment performance was seldom due to broad strategies. Rather, it resulted from a combination of factors, including: (1) long-only and private market–only strategies (often with excessive leverage); (2) managers without the expertise to invest broadly across sectors and capital structures; and (3) the misalignment of incentives between manager and investor. In our view, enforcing stricter limits on managers’ investment parameters may actually exacerbate the issues of the previous cycle, thereby increasing risk, lowering returns and further misaligning incentives between fund managers and investors.


Financial Leverage and Risk: Property-Level and Marketwide (Systemic) Perspectives

The use of debt is widespread in real estate investment, and there is good reason for this. Real estate assets are big-ticket, lumpy and capital intensive, and hence many investors require debt financing to get in the game, especially if they want to be able to acquire enough properties to gain meaningful diversification benefits. However, investors also are drawn to debt at times not because they need it but because they believe that it changes the nature of the return-risk structure of their equity investments in their favor. In this case, investors use fixed-cost mortgage debt financing in the hopes of levering up or magnifying the returns to equity invested above those generated by the property (asset) based on total capital invested; debt is used to juice returns. The major debt overhang the sector is dealing with today is a stark reminder that investors — and lenders — can take this too far with disastrous ramifications.


REITs Continue to Impress: Equity REITs Outperform Other Asset Classes

The commercial real estate property markets may not be faring that well, but don’t tell that to equity REIT operators, who fashioned an impressive 28.0 percent total return for 2010, according to the FTSE NAREIT Equity REIT Total Return Index. REITs built on their comeback performance of 2009, when the index recorded an annual total return of 28 percent, following a loss of nearly 38 percent in 2008.

“This past year was definitely a strong year in terms of performance,” says Bruce Eidelson, director of real estate securities at Russell Investments. “This marks the second consecutive strong year following the financial crisis and is clearly a strong recovery off of 2009.”


Time to Adjust the Game Plan: "New" Inflation Requires Different Approach

Inflation is a complex matter that is broadly misunderstood. We commonly associate inflation with higher interest rates. In most recent inflationary periods, the inflation resulted from an overheated economy with low unemployment that created pressure for wage increases and general price increases. In reality, inflation is simply the destruction of the purchasing power of a currency. This destruction can be achieved through increasing interest rates, but this is by no means the only method.

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