PREA's investor survey finds a rise in larger target allocations and an increase to value and opportunistic strategies. Jack Nowakowski reports

The Pension Real Estate Association (PREA) recently completed its ‘investor report', an accounting of the periodic survey of its investor members, with results indicating that plan sponsors continue to increase their allocations to real estate investments.
Perhaps not, however. The current economic environment facing investors and the real estate industry is extraordinary, and asset allocations may change significantly as real estate properties revalue, stock markets continue to gyrate, and fixed income assets are marked to market. Whether the recent volatility in asset prices simply makes for interesting future reading or a marked shift in asset allocation remains to be seen.

The report is designed to show the real estate investment activities of the universe of public and private retirement plans, endowments, foundations, and other funds in general and of the PREA membership specifically. A survey was conducted from March to June 2009 and collected data from both PREA's US and its international investors on investment strategy, property and geographic distribution, target and actual allocations, and leverage. In addition to this survey of our investor members, PREA also conducts a survey of investment manager members, and some results from that effort are also included here.

In addition to surveying its membership, PREA has also updated its analysis of data from Standard & Poor's Money Market Directories, which was last completed in 2005. This broader database allowed PREA to gauge asset class movements by investors on a historical basis from 1996 to 2008.

- For the PREA membership sample group, the actual allocation to real estate as a percentage of total plan assets was 9.6% for the latest year, up from 7.2% in 2007;
- Nine of 10 plans allowed leverage in their portfolios;
- Total assets for PREA US investor members fell nearly 24% at year-end 2008 versus the previous year. This is not surprising given the roughly 40% declines seen in US stock markets during the calendar year 2008.
- There was an increase in the proportion of investor portfolios reported as value added (23.3%) and opportunistic (21.3%) although the largest part remained core (55.4%);
- In the analysis of S&P data, PREA was able to determine the asset allocation of more than 1,050 US public and private plan sponsors, endowments, foundations, and other funds that have consistently reported data from 1996 to 2008. Based on this information, these plans held 4.4% of all assets in real estate equity for the latest reporting period (approximately year-end 2008). For a smaller number of plans that reported real estate holdings every year during the same 13-year period, real estate accounted for 7.8% of the plans' total assets, the highest percentage for the sample years.

The survey has been conducted since 2002. The bulk of the data reported on the current PREA survey is correct at 31 December 2008, the latest fiscal year-end for many plans. A handful of funds reported data current after year-end. The report is weighted consistently toward public plan sponsors, which typically have represented about two-thirds of the survey (by total assets). Corporate plans have contributed about 17% of the survey, and foundations, endowments and unions the remainder.

Real estate allocations
Allocations by plan sponsors into real estate have moved slowly. As seen in fgure 1, target allocations to real estate by PREA investor members were mostly unchanged from 2007, the year that marked the beginning of the end of the latest real estate boom, to 2008 as the real estate downturn, at least in the residential markets, was at full throttle. Two-thirds of the firms reporting did not change their targets, but 24% reported increases from 2007 to 2008. However, surveys completed in 2002, 2003, and 2004 reported that the percentage of plan sponsors (by number) with target allocations greater than or equal to 10% ranged from 31% (2003) to 34% (2002). In the most recent survey, the figure was 50%.

Recent increases in holdings, such as that seen among PREA members from 7.2% in 2007 to 9.6% in 2008, are thus noteworthy, but much of this rise was attributable to the downward valuations of other assets, such as stocks and bonds, which are quickly marked to market versus real estate holdings, which typically revalue at a much slower pace. The value of real estate held by plan sponsors can be expected to decline by year-end 2009 or 2010 should property holdings reprice and the hoped-for recovery in stock prices materialise.

Allocation into real estate assets by plan sponsors has steadily increased over the years, as shown by the industry data in figure 2. In the survey, real estate is considered to be private real estate equity, but due to some reporting issues, some investors may have included REIT holdings.

Given the recent volatility in asset prices and the uncertainty of the direction of commercial real estate, it is not surprising that investors are sitting on their hands and largely staying out of the market although significant shifts in target allocations even in stable economic conditions are uncommon. An overwhelming 83% of respondents indicated that they did not plan on any allocation changes in the current year. By comparison, at year-end 2004, the PREA survey found that 69% of members were staying put, 28% expected an increase in allocation, and just 3% were looking to reduce their exposure to real estate.

Portfolio leverage
Leverage and the lack of available credit is perhaps the major factor in determining the current and future state of the commercial real estate industry. The first time PREA asked its investor members whether their real estate strategy allowed the use of debt was in 2003, and 88.5% indicated they used leverage. Recent numbers were little changed, with 91.3% of investors allowed to use leverage. More than 70% of those reporting were allowed leverage amounts of over 35%, consistent with previous years. However, in a comparison of leverage levels in 2007 to 2008, 63% of investors increased their leverage, while the same proportion (18%) lowered levels or had no change (figure 3).

Real estate investment strategy and structure
Recent survey results indicate a movement toward value-added and opportunistic strategies compared with earlier PREA investor surveys. In the most recent survey, core allocations amounted to 55.4%; in the 2002 PREA survey, core captured 66.5% of investments. This change is not surprising as, over the years, investors sought higher and higher returns, which forced them to extend their risk profiles. Investments classified as value added amounted to 23.3%, and opportunistic, 21.3% (figure 4).

For PREA's US investor members only, commingled funds accounted for 48.5% of private real estate investments. Three-quarters of the commingled funds were closed (37.3% of the total private real estate investment). Direct investments accounted for 37.2%, and joint ventures 10.8%. Allocation by structure was similar for pension plans regardless of size (figure 5).

Property type and geographic allocation
For the most part, investors continued to emphasise major property types in the large population centres for their investment holdings.

Concentrating solely on US PREA members, holdings in office properties in the latest reporting year amounted to 27.6% of real estate, down from 2007 and off further from previous survey years, when office holdings were consistently about a third of total real estate holdings. Multifamily was a strong second, with 20.9%. To supplement this information and confirm some of the trends, PREA's Investment Management Guide is of value.

In late 2008, PREA's Investment Management Guide* collected data from 173 PREA member firms, which reported information on their property types and geographic allocations. The information is broader in that it covers public and private equity and debt allocations.

Also more robust, with more than $1.2trn in assets under management cited, the report confirms the ranges from much of the allocations shown on the PREA investor survey, particularly in the office and industrial categories (figure 6).

Hotel allocations on both reports were consistently higher (about 8-10%) than earlier survey data showed (about 3-4% from 2002 to 2004). While still a smaller component of portfolios for plan sponsors, hotels have come under particular stress during the economic downturn.

In July, Fitch Ratings' US CMBS Group indicated that 13 hotel loans totalling $596m defaulted in June, with another $608m of loans 30 days past due as of 30 June 2009. The report stated that hotels would continue to be the most volatile property type. Reviewing global allocations, reporting PREA managers held 61% of their real estate allocations in the US, with another 1.8% in Canada. The remaining 36.9% were non-North American (figure 7).



*The PREA Investment Management Guide for 2008-09 is available to PREA members on PREA's members-only website