Outlook for pension fund investment in real estate.

Pension funds are renewing their interest in the finance and purchase of real estate. Most pension funds are being cautious. however, as they pay more attention to strong current yields instead of forecasted returns or hoped-for appreciation.

While cautious, there are widely divergent views among pension funds about how to invest in real estate. Some pension funds and their advisors are aiming for a strategy of diversity. Others prefer to concentrate their money and attention on only one or two narrow markets. Some pension funds are tightly reigning in their advisors, while others seem to be giving their advisors even greater discretion to buy and sell without calling the pension fund first for approval. And, certain pension funds are sticking only to the most conservative investments, while others try their luck with new "opportunistic" funds that offer the promise of higher returns in return for more risk.

The latest theory being put forth by some pension fund investment advisors is that pension funds should be invested in four real estate "quadrants." Those quadrants are private equity (direct ownership of real estate), public equity (buying REITs), private debt (making loans) and public debt (commercial mortgage-backed securities).

"The four quadrant theory is clearly a trend pension funds need to focus on," suggested Robert Davis, managing principal of the Churchill Group in West Los Angeles. Investing in public equity and in public debt helps to allay the concerns of pension funds about liquidity, Davis said, because it is much easier to sell off an asset in the public arena. Four quadrant investing is better suited for larger pension funds, Davis conceded. "If you're willing to put in serious money, you have a much better investment stance," Davis said. "If you are small you are very limited in your ability to do many different things," he added. "I would not, for example, suggest direct investments for smaller players."

Despite the attempt to discuss real estate in terms of the four quadrants today, there is no way to easily categorize the approach of pension funds to real estate investments. Some funds and their advisors are assessing potential investments with real estate experts. Others view certain real estate investments as akin to fixed-income vehicles and there are those that turn to their equity departments to decide about investments such as REITs.

Richard Pink, executive managing director at Westmark Realty Advisors LLC in Los Angeles, believes that the jury is still out on whether investing in all four quadrants provides diversification, safety and a way to increase investment yields for pension funds. It is also imprudent for one advisor to attempt to advise in too many diverse areas of investment.

"Pension funds are investing in real estate again," Pink observed. "They are recognizing that real estate has become less of a contrarian investment and more of a prudent investment because the real estate market is improving and there is more liquidity in the market." The funds, however, are demanding that advisors prepare a back-up exit strategy - just in case the markets goes sour again. "Pension funds have also placed more pressure on the advisors to align their fees with investment performance," Pink said.

Advisors are coming under much closer scrutiny from plan sponsors than ever before, Pink said. "Pension funds are exhibiting a new approach to investing in real estate by giving the advisors less discretion with funds and by retaining more approval rights over operations of the advisors."

But, while most pension funds and their advisors talk a lot about less discretion for advisors, so-called discretionary relationships - where the advisor has the discretion to manage a portfolio with relative independence - are not a thing of the past yet.

T. Robert Burke, president of AMB Institutional Realty Advisors Inc. in San Francisco, has experienced an increase versus a decrease in discretionary relationships. "We have several discretionary relationships," Burke said. Not having to contact the pension fund about whether or not to purchase a particular property "allows us to be more competitive and act more quickly," said the executive at AMB, which will invest approximately $500 million in 1995.

The willingness of certain pension funds to let AMB invest their money at its own discretion is probably tied to the fact that AMB focuses almost exclusively on industrial and sub-regional retail properties. "Diversification in real estate is a good idea," Burke said, "but it doesn't follow that the same advisor should be involved in all types of investments." Burke believes that both AMB and its clients benefit from AMB maintaining a more narrow scope of investments. "We feel we're better able to acquire industrial properties and neighborhood and community centers," he said.

AMB and its clients are, however, allowing themselves to take on greater risk - and opportunity for higher investment returns - with AMB's new Value Added Funds. $60 million has been raised so far toward the purchase of industrial and sub-regional retail properties that offer opportunities in re-leasing, expansion or restoration. By mid-1996, AMB hopes to raise a total of $250 million, Burke said.

In August of this year, W.P. Carey & Co., Inc., a new York real estate investment firm, announced that it will receive an allocation of $100 million per year to invest in real estate on behalf of the California Public Employees' Retirement System (CalPERS), which has $87 billion in assets overall. These investments are being made on a discretionary basis by W.P. Carey, said the company's senior vice president and acquisitions officer Gordon DuGan.

Jack Haley, national director of pension funds for Ernst & Young Kenneth Leventhal Real Estate Group, sees an atmosphere where pension funds have plenty of money they are willing to allocate to real estate. "There is so much money around," Haley said. "Pension funds and other investors are paying higher prices for real estate-related investments," he added. "Many investors have decided that they want back into the real estate market," noted Haley, whose practice includes doing audit, tax and due diligence work for pension funds and their advisors. Pension funds haven't, however, figured out how much to allocate to real estate. Somewhere between 5% and 10% of a total investment portfolio should be in real estate, Haley reasoned, "But I don't think the consultants, advisors and others really know."

How much money is allocated by an institutional investor to real estate overall or annually depends on the size and circumstances of the investor, said Charles Beaver, senior vice president at Equitable Real Estate Investment Management in Chicago. Equitable has about $232 billion in total assets, $35 billion of which is concentrated in real estate-related investments. Roughly one-third of the $35 billion is invested on behalf of Equitable's so-called general account and the other two-thirds comes from third parties.

Ironically, Equitable considers itself "fully invested in real estate," Beaver said. So while Equitable's staff solicits new money from other investors, Equitable itself is not making any new commitments to real estate at the moment. Beaver insists that this has not hurt Equitable's ability to attract money from third parties who often like to see their advisors investing in the same investments they are advocating for.

The Yarmouth Group, Inc. of New York manages both its own capital and the investments of insurance companies, pension funds, endowments and foundations. Thanks to an alliance with Sydney, Australia-based Lend Lease Group, Yarmouth is able to continue investing for its own account - unlike Equitable.

Yarmouth substantially withdrew from the acquisition market in 1992 and 1993. But, in 1994, Yarmouth made $671 million in new acquisitions. Pension funds and other investors placing their money with Yarmouth have a renewed interest in "opportunistic" buys, reported Charles R. Purse, senior vice president at Yarmouth. Yarmouth Capital Partners 1 is a fund comprising 17 major investors which have contributed $300 million for acquisition of real estate assets from distressed, undercapitalized or reluctant owners and lenders in the form of direct and indirect debt and equity positions. Yarmouth expects to raise even more money for opportunistic investments through Yarmouth Capital Partners II. The plan is for this newer fund to acquire interests in office and hotel properties from reluctant or distressed owners.

Yarmouth isn't the only company marketing opportunistic investments to pension funds and other institutional investors. It's becoming something of a trend, said G. Andrews Smith, president of L&B Real Estate Counsel, based in Dallas. The higher returns promised by opportunistic funds are gained by accepting higher increments of risk, though, Smith observed. "Jumping onto the opportunistic bandwagon without the proper degree of caution could cost plan sponsors dearly in the years ahead - and once again shake up newly restored confidence in real estate generally."

RON GALPERIN, ESQ. IS A REAL ESTATE ATTORNEY AT WOLF, RIFKIN & SHAPIRO IN WEST LOS ANGELES AND A PRINCIPAL IN BEVERLY HILLS-BASED REAL ESTATE NEWS GROUP - A REAL ESTATE NEWS AND FEATURES SYNDICATE. GALPERIN IS COORDINATOR OF UCLA's 1995 ANNUAL REAL ESTATE FINANCE CONFERENCE AND FORMERLY REAL ESTATE EDITOR OF THE LOS ANGELES BUSINESS JOURNAL.