The case for REITs is mired in the apparent vested interests of institutional investors, consultants and advisers. Patrick Sumner explains
At the recent NAREIT Investor Conference in Chicago, much of the discussion revolved around the lack of institutional investment in real estate investment trusts (REITs), despite supportive long-term performance. A 2010 survey of pension plan sponsors in the US by IREI/Kingsley Associates found that the average allocation to REITs stands at 8% of the total real estate allocation. Moreover, according to a 2009 survey by Casey Quirk, that figure is boosted by the 32% of real estate exposure that endowments and foundations allocate to REITs; pension funds allocate just 5%.
The aggregate US institutional investment in real estate is estimated at $325bn (€264.5bn). The value of the US REIT market is $275bn, so even a minor shift in strategy could have a significant effect on the listed sector.
The list of reasons typically given for this institutional reluctance includes volatility, illiquidity and a high correlation with equities. But there may be other, more sinister motives preventing allocators from using REITs as part of their property strategy.
Sam Zell, the doyen of the US REIT industry, pulls no punches: "The attitude of institutions to REITs is an employment story. There are all these guys making a living out of investing in real estate. If they switched their allocation to REITs, what would they do?"
Even more damning is the view expressed by Arthur Coppola, chairman of shopping centre REIT Macerich: "The low penetration of REITs with institutions is because of an inherent conflict of interest among advisers and consultants who get fees on each [private market] investment and review. REIT investments don't pay."
Looking around Europe, only in the Netherlands do pension funds hold significant positions in listed property companies as part of their property allocation. This may be explained by the disproportionate size of their pension funds relative to their domestic property market and by an experience of investing in property abroad that has led them to prefer indirect to direct investment. They balance listed and unlisted investments, but they tend to be long-term, stable shareholders in listed companies, which all invest outside the Netherlands.
In the UK, meanwhile, institutional investors often have some exposure to property stocks, but it is normally as part of their UK equities strategy and relatively insignificant.
Institutional allocations to unlisted property are more constant, but they nevertheless stand at less than 5% of total assets. Pension funds and insurance companies have tended to steer clear of the property companies, latterly REITs, as proxies for direct property exposure. Now that the tax obstacle has been largely eliminated, new objections have been found. The overall problem, however, is that the research produced by both sides in the argument tends to be one-sided, and there is very little in the way of a balanced assessment.
There has at least been some debunking of the correlation argument. According to Andrew Baum, professor of land management at Henley Business School and the University of Reading and honorary professor of Real Estate Investment at Cambridge University, "The correlation of unlisted funds with equities during the financial crisis was high. The discounts to stated NAV at which secondary market trading took place were often very substantial. The case for private real estate has certainly been damaged by this, and although memories are short the case for an exposure to both listed (for liquidity) and unlisted real estate funds (for lower volatility post-crash) has become stronger."
An additional obstacle may lie in the education of property professionals. Baum says: "The property courses at universities such as Reading, Cambridge and the Cass Business School certainly cover the listed sector these days, and many academics are happier researching REITs. The problem is that as soon as most graduates on the RICS route start work their focus is wholly on the private market."
Managers of listed property funds need not only a knowledge of property markets - ideally in several countries - but also of company accounts, equity portfolio management and the workings of stock markets. This is a demanding combination and one that only a handful of firms have tackled.
The property departments of UK asset managers are often separated physically, as well as culturally, from equity and bond managers. At Henderson the listed property team has for the last 10 years worked among the equity and bond teams, absorbing the constantly fluctuating themes that drive real-time pricing. Property market knowledge, on the other hand, does not require such immediate, frontline market exposure. At the risk of incurring the wrath of the RICS, I would argue that it is easier to train an equity fund manager than a chartered surveyor to manage listed property .
The listed property funds available in the UK are almost exclusively sold, directly or indirectly, to retail investors, and the institutional clients of UK-based firms tend to be foreign, notably Dutch pension funds.
The earlier evolution of an institutional listed property sector in the Netherlands is no accident, but a function of necessity and a response by educationalists. The establishment at the University of Maastricht of a successful real estate finance course that covers international and listed real estate has engendered a remarkable Dutch pool of expertise in the listed property sector.
The UK, on the other hand, has a large domestic property market, and it is some time since UK institutions ventured into foreign property markets - but not long enough to eradicate the painful memory. In addition, the aversion to REITs may have something to do with the inauspicious, top-of-the-market timing of the legislation, and it may take a while for the after-shocks of the 80% peak-to-trough decline to fade.
The conclusion to the debate about REITs as part of a real estate strategy depends, like statistics, on what you want to prove. However, there is much that could be done to remove the bias from the respective entrenched positions. Moreover, it is time to recognise the vested interests, even moral hazard, that stand in the way of the listed sector playing a larger part in the real estate game.
Patrick Sumner is head of property equities at Henderson Global Investors