Bernard Winograd came to the Prudential C-suite 10 years ago from positions in both the private and public sectors. A graduate of the University of Chicago, he joined the public relations department of Bendix Corp., which led to positions as executive assistant to W. Michael Blumenthal, both when he was CEO of Bendix, and later when Blumenthal became U.S. Secretary of the Treasury in 1977. Upon returning to Bendix, Winograd became treasurer of the company, and in 1989 he joined the Taubman Co. as CFO, where he was instrumental in creating Taubman’s innovative UPREIT structure in 1992 and the company’s successful IPO.

Bernard Winograd Discusses Why Plan Sponsors Are Embracing Real Estate

By Dees Stribling

Bernard Winograd is president and CEO of Prudential Investment Management (PIM), the investment management business of Prudential Financial. PIM invests in a wide range of asset types and offers products across the risk/return spectrum. For the first quarter of 2006, PIM had approximately $372 billion in assets under management.

Also, Winograd is chairman of Prudential Real Estate Investors (PREI), which advises institutional investors on commercial real estate investing with about $21.2 billion in net assets under management. He also chairs NAREIT's Investor Advisory Council and was a recipient of NAREIT's Industry Leadership Award in 2001. Recently, Winograd spoke with Real Estate Portfolio about how real estate came to be a favorite of plan sponsors and hedge fund managers.

Portfolio How important has real estate as an asset class become to plan sponsors?

Winograd: Increasingly important. Real estate has been the best-performing asset class for much of this decade and that always catches people's attention. However, it still represents a relatively small fraction of portfolio assets, about 4 percent on average. That's a little misleading, because it includes a large number of plans that have zero real estate exposure. Among those that do have real estate exposure, the average would be about 8 percent to 10 percent.

That exposure is increasingly in a wide range of formats, representing many different risk spectrums—direct ownership, REIT securities, and to some extent, the debt market. There are still a number of plans without any exposure, and their typical concern about the asset class has been that some of the ownership formats are more labor intensive to invest in.

That issue has become less of an obstacle as the returns have continued to be strong and relatively uncorrelated to other asset classes. People are overcoming their reluctance to invest in real estate in its various forms. However, a lot of the new money from the plans that didn't participate previously has been either invested through the REIT market or through open-end commingled funds. Many, if not all, of those funds at the lowest-risk part of the spectrum have queues of investors.

Portfolio How do pension funds typically invest in real estate?

Winograd: When you don't have a real estate portfolio or a real estate staff, the implementation issues are significant. The easiest way to proceed is to hire a single manager and request a mandate to get broad diversification from the beginning.

For many plan sponsors, the open-ended, commingled funds are a familiar model to them, because after they decide to make a commitment, they review those managers and make a choice among them. They're quite used to reviewing managers and making selections. That's also how plan sponsors began to invest in real estate through REITs, because it's a matter of reviewing track records and coming to a conclusion.

The funds that have substantial commitments to real estate with very large portfolios—75 of them—tend to have their own real estate staffs. They are more inclined to select a series of funds, invest in properties themselves or partner directly with a REIT to invest in the marketplace. All of those formats exist, sometimes in a single plan.

The typical pattern is that the closed-end fund has a higher risk tolerance and a greater return objective than the open-end commingled funds, but that's not always the case.

The latest trend in this industry has been established by a number of hedge fund managers, which have entered the real estate market as investors. Some of the foundation and endowment investors with large exposure in the hedge fund sector are getting exposure in real estate through hedge funds.

Portfolio What is the motivation for the hedge fund manager making a REIT allocation?

Winograd: Hedge funds raise money easily, but haven't always found all the investment opportunities they're looking for. Hedge funds have found it relatively easy to hire real estate experts and put them to work with a lot of leverage and objectives to do deals that are structured to yield fairly high returns. Unleveraged and unstructured real estate is a very safe and largely fixed-income investment vehicle, but you can pyramid structures on top of it because of the ease with which debt can be added to make it as aggressive and volatile as you like.

Portfolio How do plan sponsors judge how much to invest in real estate?

Winograd: That's a good question, because the standard asset allocation modeling techniques historically have recommended very large allocations that nobody has ever approached. Asset modeling might tell you that, 20 percent, 30 percent or even more might be wisely invested in real estate. However, the problem is that it's impractical, especially for the largest funds.

Portfolio Is listed real estate really the great diversifier?

Winograd: Every model that's run says that. Diversifying is one of real estate's prime attributes in a multi-asset portfolio. That's because it has a combination of equity and fixed-income characteristics. The underlying assets generate income from leases, which are the fixed-income aspects, and the equity value is driven by the option value of land and development, which can be highly volatile. The combination of those two things offers a unique series of returns that doesn't match up very well with returns from either fixed-income or equities. It tends to be somewhere in between.

Portfolio Is real estate used to generate better absolute returns?

Winograd: It depends. For those investing in unleveraged real estate, the return over the long range is somewhere between stocks and bonds to get its greatest diversification benefits. But if you have someone putting money into portfolios with leveraged strategies, the answer is yes. Clearly the hedge fund investors of recent vintage are trying to do just that.

The real estate market has been so benign in recent years that virtually every decision has worked out. The test of the soundness of those investments is the full real estate cycle. Real estate weathered the most recent recession in pretty good shape. But we are nowhere near the down cycle. Leverage is still fairly low, and default rates on mortgage portfolios are at historic lows. We don't have the usual preconditions for a drop.

Portfolio Looking ahead, are more plan sponsors going to provide plan participants a real estate option?

Winograd: Yes. Money chases returns. It has been the best-performing asset class for many years, and the money will probably continue to chase it a little too long. It's hard to know when a turn in results will come, and there will be people who get in just before it. Still, it isn't obvious to those of us in the industry that a turning point is in the near future. It'll be a while yet.