By Stacy Rapacon

Many plan sponsors have been slow to offer a real estate investment option in their defined contribution plans despite compelling evidence underlining the benefits of investing in publicly traded REITs. Evan Miller, a partner with the law firm Hogan & Hartson LLP, says REITs are a powerful tool against participants’ legal claims of imprudence by a fiduciary in picking investment options.

In the Journal of Pension Planning & Compliance (Fall 2002), Miller, whose areas of expertise include ERISA fiduciary counseling and ERISA litigation, cited the tendency of courts to rely on principles of modern portfolio theory when deciding actions by plaintiffs seeking relief under the "prudent man rule" standard promulgated by the Employee Retirement Income Security Act of 1974.

"In my judgment," Miller explains, "if an ERISA fiduciary has constructed an investment option set that will allow participants to comprise for their individual accounts a diversified, low-correlated portfolio, and if the participants do not avail themselves of that opportunity, that’s not the problem of the plan fiduciary."

"[Plan sponsors] see REIT stocks as counter-cyclical, exhibiting low correlation with more traditional equities and thus a good potential additional offering to the employees who participate in their 401(k) offerings."

The inclusion of REITs in a 401(k) investment menu, however, is a valid defense once an examination of REITs’ low-correlative qualities is conducted and the information shared with plan participants.

Miller says that over the past year there has been an increasing recognition of the low correlation between REIT stocks and more traditional, particularly large-cap, equities within the investment community.

"It has been my impression that 401(k) sponsors are looking at adding real estate stocks to the 401(k) investment options," he says. "They see these stocks as counter-cyclical, exhibiting low correlation with more traditional equities and thus a good potential additional offering to the employees who participate in their 401(k) offerings."

In April 2004, the U.S. Department of Labor granted the class exemption for the acquisition and sale of Trust REIT shares by individual account plans sponsored by Trust REITs. As stated in the Federal Register, Vol. 69, No. 82, "The exemption permits the acquisition, holding and sale of certain publicly traded shares of beneficial interest in a real estate investment trust (REIT), that is structured under state law as a business trust (Trust REIT), by individual account plans sponsored by the Trust REIT or its affiliates."

Miller views this amending of ERISA as helpful to facilitating the inclusion of REIT stocks and REIT-based mutual funds in 401(k) plans.

"The exemption only related to REIT companies offering their single REIT security in the 401(k) plans for their employees," Miller says. "But I do think that the exemption reflects an implicit view that the Labor Department does not think that REIT stocks are inappropriate for 401(k) plans."

As to the effect this exemption will have, Miller says, "I certainly think that publicly traded REITs will now routinely offer their own security as an investment option in 401(k) plans. However, it will be more difficult to predict based on the exemption whether companies outside of the REIT arena will include REIT securities and more REIT-based mutual funds in the investment option set for their 401(k) plans."