Robert Steers co-founded one of the most pioneering listed real estate management companies with Martin Cohen in the 1980s. Today, he is advocating the creation of global property portfolios that blend both listed and non-listed. Richard Lowe reports
The name Cohen & Steers is synonymous with the securitisation of the real estate market. Today, there are real estate investment trusts (REITs) around the world, but when Cohen & Steers came into being in 1986 it was still a nascent sector.
The catalyst that prompted Robert Steers to found the company with fellow chairman and co-chief executive Martin Cohen was the tax reform bill of 1986, which eliminated the tax benefits for investing in real estate.
"Once we saw they eliminated tax benefits and the only reason to invest in real estate would be for income and appreciation, we felt that securitisation would begin in earnest. That is when we started the company," Steers recalls.Prior to this, both Cohen and Steers worked for Citibank's real estate investment group. Cohen established a fund for the bank to invest in public companies with real estate exposure.
"Back then there were very few companies like REITs that were intentional owners of real estate, but there were lots of public companies that were in other businesses and were accidental owners of real estate. It might have been a grocery chain that owned its stores," Steers says. "A lot of these companies… the value of their real estate alone exceeded the value of the outgoing concerned."
The most significant finding though, over the years that Cohen ran the fund, was that the returns for listed real estate far exceeded the returns from private - or directly held - real estate, all the while benefiting from greater liquidity and transparency.There is much evidence to support the notion that listed real estate matches the return profile of direct property over the long term. However, in the short term it behaves with far more volatility, as evidenced in recent months.
For the latter reason, many European pension funds prefer to invest only in direct property or in non-listed funds; many consider listed real estate as not "pure" real estate, but a sector of the equity markets.However, Steers is greatly frustrated by this line of thinking, going as far to brand such notions as "comical" and "irrational". He believes that just because direct real estate is not valued on a daily basis does not mean that the sector does not have volatility.
"We have heard this since we started our company," he says. "Those guys think the value of their unlisted real estate doesn't change just because they can't price it. That is about as unprofessional and unenlightened a viewpoint as I can imagine. Pretending something doesn't trade doesn't mean it doesn't have volatility. That has been illuminated in the world today as mark-to-market accounting has shown."
He goes on: "You can pretend that it doesn't have volatility, but what we like to say is that real estate doesn't know who owns it - it doesn't know if it is owned by a REIT or a pension fund. The value of that real estate changes with every trade on a stock market or a bond market. With every change in currencies, the value of your property changes every minute, every day, just like the value of a REIT does."
Steers believes very strongly that listed investments should be a primary component of any real estate allocation. "It has been our experience that listed real estate has generated returns that are equal to or higher than real estate with liquidity," he says.
The European pension fund love affair, as Steers coins it, with owning bricks and mortar is finally being called into question, he suggests.
This is certainly the case for UK pension funds, which have remained firmly in the unlisted-only camp, and many of which today are holding large UK-only portfolios, the capital values of which have depreciated with the rest of the UK market. Cohen & Steers has been keenly meeting with UK pension funds and their investment consultants to discuss the possibilities of transforming a direct all-UK property portfolio into a global investment portfolio that combines both listed and unlisted real estate.
Steers recalls making a global real estate securities presentation to a large UK institution in the middle of 2008. "It was clear they were in panic mode, because they had a large allocation to real estate and it was all private, mostly in London," he remembers. "They had absolutely no way to change their allocation. They were stuck… If you own that kind of portfolio privately, the real estate controls you, not the other way around. At this point, they said: ‘well, I guess we're in for another seven years'."
He adds: "You don't want the majority or all of your exposure in an asset class to be so illiquid that you don't have the ability to portfolio manage at all. If you just missed a window of opportunity, the next opportunity is seven or 10 years down the road. That is insane."And while Steers is keen to extol the virtues of listed real estate, he is even more eager to suggest a blended portfolio that combines listed and unlisted investments side by side.
One might envisage a strategy thus: non-listed real estate providing the low-risk core exposure, while the listed segment delivers the more risky, higher-returning component. However, Steers proposes turning this picture on its head, with listed real estate providing the long-term beta exposure and opportunistic private-equity real estate funds adding the market outperformance.
He likens the strategy to the way equity portfolios have developed, where "you get your beta through passive strategies, ETFs, that sort of thing and then you sprinkle around that beta exposure… alpha - specialty managers, some of the elite managers in that asset class."
Steers believes that over the next five years there will be a tremendous opportunity to generate historically high returns by putting together portfolios of some of the world's leading opportunistic unlisted fund managers because, as he says: "We are approaching a historic low in real estate valuations and there will be a massive amount of distressed selling."
He continues: "History shows that timing is everything and we think the timing in 2009, particularly 2010, is going to be optimal to be putting money into private opportunistic strategies… you have to be prepared to sacrifice liquidity for five or seven years, and I think having that core of listed [real estate] surrounded by [unlisted] opportunistic, at this point in time, would represent a world class opportunity in the real estate class."
In light of these comments, Cohen & Steers' purchase of Citigroup's unlisted real estate fund of funds business in 2008 makes a lot of sense. Certainly, the move might have looked slightly incongruous for a company that describes itself as "a manager of income-oriented equity portfolios specialising in US and international real estate securities, large-cap value stocks, utilities and listed infrastructure, and preferred securities".
"We have always believed that a real estate allocation should blend public and private," Steers says. But he believes that core unlisted real estate funds are an inefficient and costly way of gaining the necessary beta exposure.He poses a question: "If someone asked you to make an investment, but you had to lock yourself up for 10 years, wouldn't it take something pretty special for you to say: ‘Oh, that's a good idea'?
"It would to me. I would ask the same question of a pension fund: does it make any sense really to lock yourself up in core, generic real estate for 10 years and then, if you get the timing wrong, tack another seven or 10 onto that? For me, the opportunity in private is to invest and co-invest with really smart local guys with great track records but who have a specialty, an angle - they buy it better, they manage it better and so on.
The multi-manager idea is that we want to be the one-stop shop, so to speak, for everyone's real estate."Steers describes this type of offering as the "new state-of-the-art", where a pension fund's real estate allocation can be tailored to consider its individual liquidity needs and also keep in mind optimal trade-offs between the listed and unlisted sectors.
"I want to emphasise that the best way to own stabilised, high-quality, income-producing real estate is through a listed vehicle. I think the best way to access riskier, higher-return real estate is private. But that should be done by proven professionals who have shown through various cycles that they know when to buy it and they know how to buy it and how to work it at times like this."
Steers has worked through real estate crises before. The current global financial predicament is "certainly up there" with the big ones of the last few decades, he says. Of course, he remembers the stock market crash of 1987 well - it arrived just months after founding Cohen & Steers - and the real estate crisis that followed two years later.
One of the rare positives to come out of such seismic occurrences, Steers suggests, is that bad practices are generally screened out, leaving behind the strongest and healthiest companies and market players that have the most professional practices. And in addition to the best-in-class opportunistic fund managers, Steers believes strong REITs will be the biggest beneficiaries of this natural, cyclical weeding process.
"I would say the current financial crisis is among the worst we've seen," he says. "But we… have been through some serious liquidity crises and real estate crises before. And typically coming out of those cycles, the strong get stronger and the weak get weaker or disappear. It is our plan and our view that the strong REITs will get much stronger and certainly they will get stronger at the expense not only of weak REITs but most of the private real estate investors who are way more leveraged than the typical public company."
Cohen & Steers identifies a group of real estate companies it calls "the realty majors"; companies that satisfy several objective and quantitative criteria, one of which is a strong balance sheet."We rate all the balance sheets of all the companies that we follow," Steers says. "In our view, the realty majors around the globe are surviving and financially are very strong. And beginning in about six months, we think a very large volume of existing real estate holders will be forced to sell… and we believe that the biggest beneficiaries of that opportunistic or vulture investing opportunity is going to be the realty majors.
"As money managers and allocators of capital, we are doing our best to funnel capital to those companies that have billions of dollars of liquidity, shareholder-friendly management, great real estate strategies and so on, because we think the investment opportunity these guys are going to have will be comparable if not even greater than what we saw in the early 1990s here in the States. That was an all-time historic opportunity where people with cash could acquire properties at half of their replacement costs and just double-digit cash on cash yields. It was a once in a lifetime opportunity."
It has certainly been a difficult 18 months for REITs around the world as stock prices have fallen significantly across almost all markets. US REITs initially experienced the biggest falls towards the end of 2007, and while they started to recover in the first half of 2008, they have suffered heavily since September, much more in line with financial stocks.
"There really isn't any segment of the equity markets that hasn't been crushed," Steers admits. However, he points to the historical trend that REITs have generally recovered about one to two years before the economy as a whole recovers and before the direct property markets recover. For this reason, the realty majors, he says, will "be able to go on the offensive" ahead of the economy and the direct real estate market.
"Starting next year, they will be able to start making hugely accretive acquisitions when the distress selling starts," he says. "They are really going to be the first beneficiaries. The expectation for their growth rates will start to turn positive… probably well before their fundamentals do."