The message from the PREA spring conference is that while recovery is on the horizon, progress will be slow and painful. Although real estate will retain its central role in investment, there will be a return to fundamentals. Stephanie Schwartz-Driver reports

More than half of the delegates who attended the 2009 Pension Real Estate Association (PREA) conference in Washington in March believe that the global recession will begin to end in 2010. Yet although they are broadly optimistic that the plans drawn up by US president Barack Obama and his Treasury secretary, Timothy Geithner, will accelerate recovery, they know that, in the words of one speaker, the experience will be "long and deep and ugly".

This mix of optimism and pessimism ran throughout the two days of the meeting, attended by more than 600 delegates. Financial Times columnist Martin Wolf set the tone in his opening address on the global economy. Noting that the International Monetary Fund is predicting recovery in 2010, Wolf said: "I hope they're right. I don't see any reason why they should be."

In Wolf's view, a deep recession is certain in the US and Europe, with no significant spending offsets occurring in the rest of the world. The most likely scenario, he explained, is one of "muddling through", as lower oil prices, monetary and fiscal easing, and a modest pick-up in private sector spending lead to a weak recovery in the US and elsewhere in 2011.

Asked where the investment opportunities lay in current markets, Wolf remarked that "nothing is seriously cheap by historical standards - it is just less insanely expensive than it was a few years ago".

Donna Dean, CIO of the Rockefeller Foundation, summed up the difficulties facing pension funds and endowments and foundations when she said: "None of us effectively modelled a condition where capital calls would continue but distributions would dry up."

Dean said the liquidity crunch had encouraged her to think about the endowment investment model, which is heavy on alternatives, and widely deployed across the sector. "Many of us in the endowment and foundation community had an ideal model of how we want to invest, but it was too homogenous across institutions," she said. "We have been pushed to compete against our peers by investment committees, without enough thinking about risk."

The denominator effect is making liquidity an even bigger challenge for managers, particularly those that are heavily invested in alternatives. The Rockefeller Foundation's allocation to alternatives today stands at 65%, compared with 45% in June 2007 and a target of 50-55%. At the Maryland State Retirement Agency, CIO Mansco Perry said that they are "thinking about taking a little away from public equities for liquidity".

Liquidity concerns are forcing CIOs to think much like chief financial officers (CFOs) under current market conditions, noted David Henry, president, vice-chairman and CIO of Kimco Realty Corporation, a retail real estate investment trust (REIT). REITs themselves attracted much attention. The REITs market is down 70%, but as David O'Connor, president of High Rise Capital Management, pointed out, "the public markets have certainly priced in a lot of the pain".

"Today short sellers are dominating the market, but those investors who want to take a close look at companies, their debt situations, and the sectors they focus on will find opportunities," he added.

Delegates across the board were not expecting positive returns this year. A poll of delegates found that 44% expected total returns for the NCREIF index to be in the range of -20 % to -15%, with investors somewhat more optimistic than managers. Similarly, 28% of delegates expected returns for the Wilshire REIT index to be lower than -20%, while 26% pegged returns at between -15% and -10%. Around 70% of delegates also said they believed that 2009 was a good year to create or raise their REIT allocations.

And while REITs are subject to unusual volatility at the moment, at least there is activity in the space, compared with the private markets, which remain at a standstill. But as Henry said: "When you can't pick the bottom, it sure doesn't hurt to wait in this economy."

One of the most pressing issues was the availability of financing. O'Connor said that, with the maturities coming due in commercial mortgage-backed securities (CMBS), there would be a "train wreck" unless financing activity revived.

Although Len Cotton, former vice-chairman of Centerline Capital Group, pointed out that most CMBS maturities are two years or more down the line, there was strong concern. There are more than $800bn of securitised commercial and multi-family loans in around 1,000 pools, and the complexity of getting loan extensions is daunting when the direct relationship between borrower and lender is no longer paramount.

What that complexity will mean to default rates in future is still unclear. "There is a new definition of a good borrower," said Cotton. It is not someone who never defaults, but rather someone who is "honourable" in facing default.

However, lenders are not averse to extensions. As one banker said: "Existing lenders will refinance by restructuring - you want to avoid defaults or foreclosure. Things will get resolved through extensions. We can raise interest rates and charge fees."

There was a general consensus that, to avoid these problems in future, a new regulatory environment was needed. "We need an overall systemic regulator, across products, across charters, to have the power to deal with some of the more systemic problems in the financial services industry," said Timothy Ryan, president and chief executive of the Securities Industry and Financial Markets Association (SIFMA).

However, Tom Flexner, global head of real estate, Citi Institutional Clients Group, took a slightly different view. "I don't know if you need an all-powerful, centralised regulator, but it is clear that you need coherent regulation," he said.

While plans for a new system of regulation are in preparation, plans for stabilising the financial system in the US are more developed. Ryan pointed out that although press attention had been focused on residential and consumer loans, the Treasury was focused on CMBS and commercial real estate. SIFMA believes there is no reason why the securities programme, run by the Treasury and financed by the Term Asset-Backed Securities Loan Facility (TALF) should not succeed. "The only difficulty is getting the team and executing it properly," said Ryan.

Plans by the Federal Deposit Insurance Corporation (FDIC) to co-ordinate the loan rescue programme are likely to be more complicated, Ryan said. "It will be very interesting to see how the government coaches the financial services industry to be a willing seller. The problem is the delta between the buyer's and the seller's price. We need clear market prices and we haven't had them."

However, the opportunities are there, says Ryan. "In the early stages, those prices will be lower than we expect, but they will appreciate very quickly."

Speakers who have experience of the Resolution Trust Corporation (RTC), such as Ryan and Bob Larson, chairman of Lazard Real Estate Partners, are the most optimistic about the unwinding of the current crisis.

Larson and Ryan both emphasised that private sector involvement in the rescue process was crucial. "The differential between losing 1X and 3X is all servicing, all detailed work. The government is not really good at that," said Ryan. "SIFMA's hope is that the private sector will coach the public sector." Larson noted that in the case of the RTC, more than half of the operating budgets, and three quarters of the employees came out of the private sector, and this was central to the success of the operation.

While recovery may be on the horizon, the shape it takes may surprise some. "There is an adjustment of expectation that will have to take place," said Larson. "We're not going to get back to where it was - and we shouldn't. Real estate will continue to occupy a central, prized role, but values will represent the fundamentals, which are more conservative than they were 18 months ago."