Charles Lowrey, CEO of Pramerica Real Estate Investors, the real estate arm of the US-based Prudential Financial, joined the company in 2001. A board member of PREA and NAREIM, his experience and down-to-earth approach gives fuel for some forthright views on a range of investor issues which he explains to Martin Hurst
How would you compare and contrast US and European institutional investors in real estate?
Most European investors are beginning to understand that they need to invest globally. In the US, which represents about 40% of the investible universe, US investors have traditionally been spoiled. The US has so much real estate and there are so many diverse sectors in which to invest that they did not see the need to go outside of the country. They finally became comfortable with the idea through (inadvertently) investing in opportunity funds with an international sleeve. Those sleeves grew over time and all of a sudden those US investors realised that they had an international exposure.
Today the issues for US investors are yield and total return. Again, US investors have been spoiled in that they have been able to get an acceptable return because there are so many opportunities for a reasonable return relative to the level of risk they are taking. Given the state of the US economy, there may well be more opportunities here in the future. Previously, they questioned the logic of going overseas if they are not going to get a 300-400 basis point premium for investing outside of the US.
For a long time, US investors would not go overseas without that significant yield premium - opportunistic-type returns - hence their investment in opportunity funds. Today diversification is beginning to play a far greater role in their investment thought process, so they will now consider investing overseas for less of a premium - or perhaps a commensurate level of returns - to achieve a level of diversification. This approach has been well known in Europe for years. As an example, Dutch investors have been happy to go overseas for less than opportunistic returns, understanding that they had to diversify.
There will always be those US institutions that focus exclusively on the US because they don't need to or are not able to invest abroad. On the other hand, large US funds may consider it prudent to invest overseas given the scope and scale of
their operations.
If you look at stocks and bonds over the past 20 years, the global markets have become more correlated. The exchanges merge and money flies around with extraordinary speed. Real estate, on the other hand, has retained a high degree of non-correlation between the local markets, so diversification really means something. This is also true in the real estate investment trust (REIT) market, which investors are now starting to understand better.
Much of the scepticism about investing in foreign markets has disappeared. Investors understand that there is a much higher degree of professionalism in some - though not all - of the markets. To the extent that they invest in emerging economies where the institutionalisation of real estate has not taken place, they still require a significant risk premium.
What is your view on the level of governance in the real estate investmentmanagement industry? Are we in danger of creating too many rules?
No. Investors try to push for a greater degree of transparency, governance and alignment of interests. Whether or not managers will agree to all of what is being asked for is another matter. In the case of opportunity funds, for instance, there has been tremendous frustration on the part of investors regarding the lack of information. This is partly due to the fact there has been a huge amount of liquidity trying to get into real estate so that the balance of power is in the hands of managers. Those funds with established track records have adopted a take it or leave it attitude. Investors are then faced with the choice between investing in the next fund in a series of successful funds - or not.
In many instances, investors examine the track record and decide to invest, even though they may not have as much information as they would like. It is a constant source of concern for investors, but so far they have been relatively powerless in this sellers' market.
Having said that, I think the industry as a whole is making slow but steady progress in terms of increased transparency and governance, notwithstanding the bias of some opportunity funds not to share as much information as investors would like because they don't want to give away a lot of proprietary secrets. I suspect that investors would agree that progress is being made. Still, they would always like to see more progress.
Investors' concerns are related to the running of the fund: for example, the appropriate level and structure of fees, or the rights they have if the fund doesn't do well or if all of the money doesn't get invested in the time period that it was supposed to. They want to know they have remedies if things don't go well.
There are countries where the legislation and local culture hinders the efficient movement of real estate from the balance sheet into the investible universe. How should we address this?
Our offices are in New Jersey and we get frustrated about issues like this in the US, let alone overseas. One always has concerns, whether it is zoning or cultural, but it is a firm's ability to work through these issues that creates value in this market. When yields are as low as they are, it's the people who can find their way through the labyrinth of (cultural and legislative) issues to access good real estate who will add value. In the US we have our own local concerns, and in the middle of China there is another set of issues. That's what makes it fun.
I am a firm believer that over time things work out and that ultimately common sense will prevail. In terms of changing legislation and regulation, to go and point out the right answer which everyone knows already probably isn't going to be fruitful.
What will determine things will be the weight of capital that wants to come into a market, which makes it more obvious to people what needs to
happen.
In cases like this, good old-fashioned economics and capitalism will be persuasive enough to change the market. We have seen it already happen in Germany, and we have seen it in China and in India where the markets are opening up and legislation is changing in response to the need to create opportunity. The markets will lead the way.
How can one address the limits imposed on pension funds by regulators regarding
foreign investments? These have no logic.
In some Scandinavian countries where it was not possible to invest overseas, they were bidding the home stock down to as little as 1% cap rate. The situation reached a stage of imprudence where legislators had to allow investors to buy real estate outside of the home country. If restrictions are placed on how an institution can invest, market forces are such that two things will happen. Either the institution does everything it can and then stops because of the imprudence of buying a 1% cap rate in its own country, for example. Or the institution looks around at the rest of the world and sees investors buying internationally, the returns being achieved and proclaims that the opportunity cost of these regulations is hurting them. Eventually legislation will change so that institutions can compete globally - and that is clearly what has happened in many European countries and will continue to happen over time.
There are a large number of real estate associations. Could they work together more effectively?
There are a significant number of organisations and you can't participate in all of them. Having said this, as the real estate market increases in scope and size against a backdrop of globalisation, I think these organisations will either consolidate or they will pick their focus within the real estate sector. Eventually organisations with a comparable focus in the different regions will need to co-operate and co-ordinate their activities to a far greater degree than today.
In view of the weight of institutional capital in real estate, institutions' involvement in real estate associations would seem to be disproportionately small. Would you agree?
We are involved with many of the associations in the US and in Europe and it is a constant concern of all participants to ensure that there is sufficient institutional representation at these conferences so that the few investors that are there don't become completely surrounded by their potential manager service providers. How do you persuade investors that a conference is going to be worthwhile and that they won't just be surrounded by managers trying to sell them the latest product?
It is difficult. One can achieve this through limiting the number of managers and limiting the number of people managers can send. We have tried all sorts of different approaches at the various conferences. This is something that every organisation must be vigilant about - the efficacy of the gathering will be lost if you don't have significant representation of each constituency that you are trying to bring together.
In addition, we have to make the content of the meetings extraordinarily worthwhile to lure a sceptical audience of pension funds, endowments and foundations, which by its nature is stretched because of the numbers of staff they have - or don't have - to devote to this. This is one of the greatest difficulties facing these associations, which is made more difficult by the fact there are so many conferences.
An investor with a $1bn to invest in real estate - not small but not particularly large either - may have a staff of two or three people. How do you make the choice of the one or two conferences you can go to each year when you have 20 invitations on your desk and when your main job is to invest the capital and follow up on your existing investments?
Furthermore, some pension funds may not have dedicated resources. It is highly likely that the real estate manager of a medium-sized pension fund may do real estate, timber, infrastructure and two or three other things. This makes things worse because they may have to choose between a real estate conference, a timber conference, etc.
Joint conferences on the other hand will suffer from a lack of focus as we have seen the few times that this has been attempted in the US, with the result that the conferences become less attractive, and in the case of the few attempts that have been made in the US, unmitigated failures.
What do you see as the best investment prospects?
In this time of uncertainty there will be opportunities in all regions. In each of the markets we look for dislocations - opportunities where people are getting out when we think we should be getting in. An example is the eventual entry of central and eastern European countries into the EU.
In other markets we are looking at the macroeconomic and demographic changes that are taking place - whether in China, Mexico, Brazil or India - where we aim to get in ahead of these economic and demographic changes to take advantage of them. In the US, where there is significant dislocation taking place in the real estate market at this time by virtue of the lack of liquidity, we think there may be some opportunities.
What do you perceive as the effect on the market of the current liquidity crisis?
It has imbued the market with a new degree of prudence: while the real estate markets have behaved very well over the past five years in terms of not overbuilding and being more transparent, the debt markets have shown a degree of euphoria in terms of the amount of lending that was occurring, and this retreat is a wake-up call.
The sub-prime issue has shaken up the market and the view that we have seen a return to normality is accurate. The only point I would make is that while it may be a small part of the market, this is irrelevant if it affects the psychology of the market. This small part of the market has been widely distributed - it has affected everything from banks in Europe to mortgage originators in the US to banks in Asia who bought some of this paper. Anyone who has bought CDOs or lower-rated CMBS tranches is now at least nervous, if not worried. It makes a very wide audience nervous, hence the lack of liquidity - it's becoming a self-fulfilling prophecy.
The nervousness is reasonably high right now because people are in a wait-and-see mode. They want to see how this works out and see what institutions and governments around the world will do. This fear appears to be beginning to dissipate, but the nervousness will continue for a period of time until a new direction is established.
Note: Prudential Financial is in no way connected with Prudential in the UK
