Report: institutional players need new approach.

A "new paradigm," or a new way of approaching fundamental issues is needed by institutional real estate investors, according to the Annual Property Report released by The Yarmouth Group, the New York-based international real estate investment advisor.

The Yarmouth report says that "only through a significant change in thinking will we (institutional investors and their advisors) be able to adjust our strategies and expectations and to move from the present near-paralysis to a level of confidence in the market."

According to The Yarmouth Group, the real estate industry and institutional investors need to challenge conventional thinking in a range of fundamental areas. Highlights from the report include:

* With respect to market fundamentals, the real estate investment market was out of economic alignment during much of the 1980's. The new paradigm re-emphasizes the immutability of real estate fundamentals, discredits the concept of growth assumptions and refocuses investors on cash or income returns. It reorients investor expectations toward the traditional, tangible benefits, i.e., stable income returns, the use of positive leverage to maximize returns on capital and the capitalization of gains or minimizing of losses through the regular sale of assets. The new paradigm requires that real estate development be demand driven except under the most extraordinary circumstances, and places the responsibility for, and risk of, development directly in the hands of investors and lenders rather than developers.

* Elements of risk must be well researched, realistically quantified, and judged manageable in order for capital to be induced into the real estate asset class. The risk associated with setting growth and other assumptions, such as were utilized in most 1980's cash flow projections, will diminish in significance by comparison to the renewed emphasis on current income returns, the prospect for continued tenant demand in a specific building (rather than the market, as a whole), and a viable exit strategy.

* Strategies. management plans and enabling investors to act through a rational decision-making process. The most fundamental consideration should be an assessment of the property's ability to attract tenants and future buyers and to experience rental growth under a variety of economic conditions.

* The role of corporate America as a space user and source of investment capital is changing. Market demand models need to be adjusted to the well-chronicled corporate downsizing of the past few years, since fewer employees require less office accommodation. A less obvious impact of downsizing lies in reduced future pension liabilities and required funding levels. Private pension fund capital pools will remain flat or may even contract, thus reducing funds available from this once-active source of real estate equity capital. This will be further exacerbated by the current shift from deferred benefit pension plans, which have provided nearly all pension fund assets in real estate, to defined contribution retirement accounts, which require a far greater degree of liquidity.

* New approaches to investor/investment advisor relationships may be necessary. Investment advisors typically have been provided with incentives to invest and manage assets; there has been far less economic incentive for them to value assets fairly or to optimize investment performance by actively selling assets under most market conditions. Liquidity may return to the market when assets are valued at levels where they can be sold, when fee arrangements more closely align the interests of investors and intermediaries, and when greater incentives are provided for disposing of assets.

* The investment characteristics of other capital market sectors have a genuine bearing on real estate capital market conditions and risk/reward analyses. Real estate investors can learn from other asset classes to become far more disciplined in terms of the hold/sell analysis on both the upside and downside, and far more nimble in reacting to events. Investors must learn to execute disciplined investment strategies as readily as in other asset classes, adopting the concept of cutting losses and realizing gains.

* Securitization of real estate remains an unfocused concept. Investors have been attracted to publicly-traded real estate securities for their fixed-income characteristics and liquidity. In fact, real estate securities' characteristics are more similar to financial rather than real estate assets. Securitization will not and can not be a panacea. Rather, it continues to serve as a means of putting a new "spin" on an old set of issues, principally that most investors are not interested in traditional illiquid real estate investments and that many portfolios remain substantially overvalued.

The Yarmouth report concludes that the new paradigm, as applied to real estate, requires investors to remember the errors of the recent past and to trade the anger and cynicism which has festered in the real estate market during the past two years for a more dispassionate view of the asset class. This win enable investors to challenge the conventional wisdom and the former adversarial relationships, and to identify market participants they can trust and with whom they can work.