By Christopher M. Wright
Pension Plans Reap the Benefits of REITs
For an industry that has long struggled to make significant inroads in the defined benefit market, the advice from a leading plan sponsor is music to publicly traded REIT executives' ears.
"Put some money in REITs," says Borge Tangeraas, chief investment officer for real estate at CalPERS (the California Public Employees' Retirement System). CalPERS has the nation's largest pension plan with $162 billion in assets as of April 2004. CalPERS currently has about $20 billion in real estate with roughly $1 billion of that in REITs.
General Motors, the largest corporate defined benefit plan with approximately $86 billion in total assets, has over $7 billion in real estate, of which over $2 billion is invested in REITs, according to Jamie Behar, portfolio manager for GM Asset Management (GMAM). Behar adds that more than 90 percent of the REIT portfolio is managed in-house at GMAM.
GMAM and other plan sponsors are attracted to REITs' high current income and diversification benefits, Behar says. In the context of a defined benefit plan's total real estate portfolio, REITs are a way to "gain exposure to certain property types and markets in a quicker and more efficient manner than is possible to do through the private real estate market," she says.
"There's a trend toward broader acceptance of REIT investing among top pension plans," says Jack McAllister, NAREIT's vice president of institutional investment affairs.
In the 10 years since pension plans began earnestly investing in REITs, REIT shares have found a place in the portfolios of 20 of the nation's top 100 corporate defined benefit plans. In addition to General Motors, other corporate plans holding at least $100 million in REIT shares include IBM, Du Pont, SBC Communications, Alcoa, Delphi, Deere and Wyeth, according to Pensions & Investments' 2004 Plan Sponsor Survey.
The Virginia Retirement System (VRS), which covers most public employees in the state of Virginia, has approximately $430 million in REITs out of $40 billion in overall plan assets. Tom Mulvin, a VRS investment officer, says that his organization studied REITs for more than six months before buying its first REIT shares in 1996. Prior to investing, VRS was concerned about REIT liquidity given the small size of the asset class at that time. Also, the universe of investment managers who had expertise in REIT investing was small in 1995, which is no longer the case.
Rates of Return
Compound annual rate in percent |
 |
| Source: Ibbotson Associates |
The benefits of REIT investing were also sufficient to overcome staff concerns at the United Mine Workers of America (UMWA) Health and Retirement Funds as to whether REITs should be treated like direct real estate or other equities, according to John Adams, UMWA's director of investments. UMWA made its first REIT investment in 2001 and now has approximately $73 million in REITs, representing around 10 percent of its real estate allocation. UMWA turned to REITs in part because fund managers found it difficult to keep their real estate allocation on target with direct real estate alone, which trades in $20 million chunks and takes a long time to restructure. REITs were seen as more responsive and liquid by comparison. UMWA was also attracted by the high dividends REITs pay and has emphasized the income stream in its REIT investing strategy ever since.
Benefits of REIT Investing
Some market professionals sum up the benefits of REIT investing this way: "high income, portfolio diversification through low correlations with other asset classes, and moderate growth of share prices which protects investors against the ravages of inflation." How do these benefits fit the needs of pension plan investors?
"Defined benefit plans want predictable, steady returns and low correlations between asset classes. REITs provide both and therefore deserve a place in pension plan portfolios," McAllister says. Adding REITs to an institutional multi-asset portfolio boosts performance in three ways: high long-term total returns, diversification benefits and liquidity.
Defined benefit plan managers are increasingly embracing REITs as a way to enhance their real estate allocations because REITs have outperformed unleveraged direct real estate, as well as other asset classes, over various time periods.
As of Sept. 30, 2004, the compound annual total return on the NAREIT Equity REIT Index was 18.3 percent versus a negative 1.3 percent for the S&P 500 over five years. Over 30 years the NAREIT Equity REIT Index was at 15.5 percent versus 13.8 percent for the S&P, according to NAREIT figures. Moreover, REITs have historically outperformed unleveraged direct real estate by 300 basis points annually.
The Most Efficient Portfolios Include REITs
Average return per level standard deviation
1994–2003 |
 |
| Source: Ibbotson Associates |
Direct real estate may have lower reported volatility, but sophisticated institutional investors today use both REITs and direct real estate to earn the highest risk-adjusted returns possible.
"The longer-term returns on the GMAM REIT portfolio have been comparable to the returns achieved on the private real estate portfolio," Behar says.
Long-term performance is also one of the reasons CalPERS includes REITs. "REITs outperform private real estate over a five-year time frame even after adjusting for leverage and volatility," CalPERS' Tangeraas says.
Total return has two components: share price appreciation and income or dividends. REIT shares have generally kept pace with increases in the Consumer Price Index (CPI) from 1983 to 2003, according to Ibbotson Associates. REITs also provide high income, averaging a 5.4 percent dividend yield as of Sept. 30, 2004.
Pension managers may be drawn to REITs' ability to deliver stable income as payouts to retiring baby boomers increase in the years ahead.
"Demand for income-producing investments like real estate will increase," NAREIT's McAllister says. "There is no asset class better suited to produce income and at the same time protect assets from inflation, something traditional bonds can't do. Income plus inflation protection means high real returns, something traditional bonds can't deliver."
UMWA's Adams agrees that inflation protection is a major advantage of REIT investing. "When the economy grows, rents go up and REITs have higher income when leases turn over," he says. REITs keep up with inflation through both high dividends and share price appreciation, Adams says.
True Diversification
Prior to the 1990s, REITs were more correlated with other stocks, both large and small, than has been the case in the last 15 years. In research commissioned by NAREIT, Ibbotson Associates found that the correlations between listed equity REITs and
large stocks, small stocks, and long-term bonds all fell significantly between 1972 and 2003 to 0.29, 0.37, and a negative 0.03, respectively.
Eighteen of the top 100 corporate defined benefit plans have both in their portfolios, with REIT allocations varying from 2.2 percent to 90.1 percent of the overall real estate allocation, according to industry statistics. Two plans in the top 100 (Bristol-Myers Squibb and Sandia) have their entire real estate allocation in REITs, bringing the total number of plans with a REIT allocation in their defined plan to 20.
The diversification benefits of REITs are not lost on organizations like GMAM or CalPERS.
"Investing in a relatively limited number of REITs could provide a defined benefit plan with access to a well-diversified portfolio of high-quality properties and strong management teams which, for some defined benefit plans, could prove difficult to achieve through the private real estate market," GMAM's Behar says.
CalPERS uses REITs to gain exposure to the real estate industry in one of its two major portfolios. Tangeraas especially likes the way he can structure his portfolio with specialized REITs. "You can choose Class B Manhattan office space or suburban office properties in the Midwest," he says, adding that going forward, it will become even easier to target your exposure to narrow segments of the market.
| Largest Plan Sponmsors of Public Defined Benefit Plans |
|
|
|
Defined Benefit Real Estate Allocation |
|
|
|
Percent Allocation |
Investment Allocation |
|
|
Defined
Benefit Assets |
Target |
Actual |
Total |
Direct |
REITs |
REITs |
|
Plan Sponsor (ranked by Defined Benefit Assets) |
(millions of $) |
|
|
(millions of $)
|
(% of total) |
| 1 |
California Public Employees' Retirement System |
148,614 |
7.40 |
7.40 |
11,000 |
10,384 |
616 |
5.6 |
| 2 |
New York State Common Retirement System |
106,843 |
3.10 |
3.07 |
3,276 |
3,276 |
|
0.0 |
| 3 |
California State Teachers' Retirement System |
103,200 |
4.50 |
4.54 |
4,685 |
4,685 |
|
0.0 |
| 4 |
Florida State Board of Administration |
91,940 |
5.20 |
5.17 |
4,754 |
3,333 |
1,421 |
29.9 |
| 5 |
Texas Teacher Retirement System |
77,836 |
0.50 |
0.00 |
0 |
|
|
0.0 |
| 6 |
New York State Teachers' Retirement System |
73,481 |
5.60 |
6.80 |
4,995 |
4,017 |
978 |
19.6 |
| 7 |
New Jersey Division of Investment |
62,101 |
0.00 |
0.37 |
228 |
|
228 |
100.0 |
| 8 |
Wisconsin Investment Board |
56,948 |
4.00 |
3.45 |
1,965 |
1,965 |
|
0.0 |
| 9 |
North Carolina Retirement Systems |
56,300 |
3.00 |
3.02 |
1,700 |
1,700 |
|
0.0 |
| 10 |
Ohio Public Employees Retirement System |
53,656 |
6.70 |
7.72 |
4,140 |
3,584 |
556 |
13.4 |
| 11 |
New York City Retirement Systems |
51,892 |
0.00 |
0.11 |
55 |
55 |
|
0.0 |
| 12 |
State Teachers Retirement System of Ohio |
48,388 |
9.20 |
9.94 |
4,810 |
4,445 |
365 |
7.6 |
| 13 |
Pennsylvannia Public School Employees' Retirement43,525 |
43,525 |
5.40 |
6.96 |
3,031 |
2,363 |
668 |
22.0 |
| 14 |
Michigan Department of Treasury |
43,482 |
9.00 |
8.97 |
3,900 |
3,900 |
|
0.0 |
| 15 |
Teachers Retirement System of Georgia |
39,432 |
0.00 |
0.00 |
0 |
|
|
0.0 |
| 16 |
Oregon Public Employees' Retirement Fund |
38,083 |
6.00 |
5.82 |
2,215 |
1,653 |
562 |
25.4 |
| 17 |
Washington State Investment Board |
37,777 |
9.20 |
9.63 |
3,639 |
3,639 |
|
0.0 |
| 18 |
Virginia Retirement System |
35,669 |
4.40 |
4.39 |
1,566 |
1,566 |
|
0.0 |
| 19 |
Minnesota State Board of Investment |
33,238 |
2.40 |
2.40 |
798 |
798 |
|
0.0 |
| 20 |
Massachuesetts Pension Reserves Investment Mgmt. |
29,300 |
4.60 |
5.62 |
1,647 |
1,300 |
347 |
21.1 |
| Source: Pension & Investment 2004 Plan Sponsor Survey |
REIT Liquidity
"I love the liquidity of REITs compared to direct real estate," Tangeraas says. "You can get in and out easily."
VRS' Mulvin agrees that there's a huge liquidity difference between REITs and private real estate. "It can take 90 to 120 days for our third party managers to sell an asset," Mulvin says. "But you can trade a REIT position in a day or acquire or liquidate an entire $150 million REIT portfolio in a week without taking a discount for liquidity. There's no question REITs are much more liquid."
REITs enhance the liquidity of GMAM's portfolio, Behar says. REITs allow GMAM to "gain exposure to certain segments of the real estate market in a more efficient manner, i.e., at a lower cost and in a shorter period of time."
GMAM had reservations about REIT liquidity at the time it made its first REIT investment in 1992. At that time, the total equity market cap of the REIT sector was only around $13 billion. As of Sept. 30, 2004, however, the equity market capitalization of listed U.S. public equity REITs stood at $245.8 billion ($270.9 billion if mortgage REITs are added in), according to NAREIT.
Moreover, REIT investing today is multi-faceted and can accommodate several different pension plan portfolio strategies and preferences, VRS' Mulvin says. For a pension plan or endowment entering real estate for the first time, REITs can serve as the entire real estate allocation. REITs can also be used as a completion strategy to round out a direct real estate portfolio (e.g., to pick up exposure to regional malls). REIT investment platforms have proliferated, Mulvin says, citing passive indexing, customized separate accounts, exchange-traded funds, mutual funds, and international REITs as examples.
"There are many ways to invest in REITs today," Mulvin says.
REITs Can Diversify
Fixed Income Portfolios,
Reducing
Risk and Increasing Return
1972–2003 |
 |
|
REITs Can Diversify to Reduce Risk and Increase
Return
Stock and Bond Investors
Stock and Bond investors
1972–2003 |
 |
| Source: Ibbotson Associates |
An Efficient and Effective Choice
The REIT investment vehicle will continue to serve defined benefit plan needs even as the marketplace changes in the coming years. "Investment in direct real estate remains difficult because of high prices and competition from other buyers," UMWA's Adams says. Entry into private commingled funds is hampered by the large amounts of capital currently waiting to get in, he adds. If these trends continue, "defined benefit plans will probably increase REIT holdings," he says.
Another trend will serve to reinforce high prices and stiff competition for individual properties. Consolidation among real estate operators is creating huge retail property powerhouses that will dominate their property types. The recent acquisitions of Chelsea Property Group by Simon Property Group (NYSE: SPG) and The Rouse Company by General Growth Properties, Inc. (NYSE: GGP) are harbingers of this trend.
In the future, "REITs may be the most efficient and profitable way for defined benefit plans to gain exposure to these property sectors," NAREIT's McAllister observes.
International REIT investing is also expected to become deeper and broader, allowing defined benefit plans to achieve some of their international diversification goals through the real estate asset class and REITs in particular. U.S. industrial REITs such as AMB Property Corporation (NYSE: AMB) and ProLogis (NYSE: PLD) are beginning to meet their large international customers' space needs outside the U.S. by developing or acquiring facilities in major markets around the world.
Declining Equity REIT Correlation
60-month rolling periods |
 |
| Source: Ibbotson Associates |
In addition, many foreign countries (e.g., Japan, Singapore, Australia) are adopting REIT-like structures, allowing defined benefit plans to globalize their real estate allocations for the first time using publicly traded securities in a meaningful way.
"The rise of a large, liquid global market for real estate securities will provide an effective and cost-efficient way for large tax-exempt investors to gain the diversification benefits of international investing in their real estate allocations and to take advantage of differences in pricing, valuation and yield around the world," McAllister says.
To meet the growing needs of investors to benchmark their global real estate securities investments, the European Public Real Estate Association (EPRA) and NAREIT have created the EPRA/NAREIT Global Real Estate Index which tracks the performance of publicly traded real estate companies across the globe (see story, click here).
Whether it's yield and inflation protection today or ease of entry and global investing tomorrow, the REIT story is a good one for defined benefit plans. "As more and more sponsors of defined benefit plans begin to recognize the benefits of investing in REITs, and as the public market for real estate continues to expand, it is likely that REITs will grow as a proportion of such plans' overall allocation to the real estate asset class," GMAM's Behar says.
