REITs are becoming a more common option in defined contribution plans.

By Steve Bergsman

If an employer was wise enough to include a REIT fund in its corporate 401(k) plan, employees who invested in that option three, five or even 10 years ago probably are pleased with their decision.

The most recent data from the Profit Sharing/401(k) Council of America's (PSCA) annual survey of profit sharing and 401(k) plans show that the proportion of plans offering a real estate fund for participant contributions has increased from 4.8 percent in 1999 to 18.8 percent in 2005.

The proportion of DC plans that include a distinct real estate fund on their menu of investment choices is growing. Given the performance and rationale of REITs, will the trend continue?

Good Choices

Anyone who has invested in a REIT fund, either individually or through a defined contribution plan, has a right to smile. Over the past decade, it could very likely have been their best performing investment. Whether one considers a period of one, five or even 10, 20 or 30 years, the FTSE NAREIT Equity Index outperformed the Dow Jones Industrial as well as the Standard & Poor's 500 indexes.

		Age Appropriate Investing

Barclays Global Investors created its first REIT strategy in 2000, but it wasn't until 2003 that it unveiled a REIT option for DC plans. Today, that DC REIT fund boasts $1.3 billion in invested assets. "Defined contribution plans are definitely a growing area for us, considering we attracted more than $1 billion in less than three years," says Corin Frost, senior investment strategist for Barclays. "The fund exceeded our expectations in terms of asset gathering."

Frost declares real estate an incredible diversifier and an investment that makes perfect sense on a risk-adjusted basis. As a result, Barclays offers real estate within its own set of lifecycle funds.

Even though their real estate investment option has performed well, Barclays is still a rookie compared to some major players in the field.

TIAA-CREF has offered a real estate option in 403(b) plans since 1995 and now boasts approximately $12 billion in assets. The early real estate option was a direct investment in real estate. A more traditional REIT investment option was rolled out in October 2002. That investment option now holds $550 million in assets.

"The REIT market has taken off, and we have been very pleased with making the REIT fund an investment choice that offers diversification," says Scott Terada, director of mutual fund product management for TIAA-CREF. "The acceptance rate has been right where we wanted it to be and participant acceptance has been very strong as well."

There is continuing business growth in TIAA-CREF's real estate fund. "We are still seeing institutions accept our REIT fund as part of the offerings to their participant base," Terada says. "We are still seeing forward momentum in acceptance rates."

The Numbers Don't Lie In an annual survey that was conducted from 1995 through 2005 by the Profit Sharing/401(k) Council of America, which promotes retirement income through the use of 401(k) and profit sharing plans, found the percentage of plans offering a real estate option grew between 1995 and 2000 from 3.8 percent to 6.3 percent, respectively. REIT representation jumped to 11.8 percent in 2002 and vaulted to 18.8 percent in 2005. Percent of Plans with a Real Estate Fund for Plan Years 2005 18.8% 2004 15.6% 2003 11.8% 2002 11.8% 2001 8.6% 2000 6.3% 1999 4.8% 1998 5.1% 1997 4.8% 1996 5.2% 1995 3.8% Source: PSCA Separately, a July 2005 survey conducted by PLANSPONSOR magazine revealed that 18.9 percent of DC plans responding to the survey offered a real estate investment option in 2005, up from 17.5 percent in 2004. However, the PSCA and PLANSPONSOR results differ from a Hewitt Associates, Inc. survey, which showed slower growth. In 2003, Hewitt first reported 7 percent of the plans it survey ed had a REIT option. By 2005, the survey showed REIT representation increased to 10 percent. The difference between the two surveys can probably be attributed to different target audience characteristics; Hewitt concentrated its study on plans of 5,000 or more participants. Hewitt asked those employers who were likely to add new fund offerings in 2006 what type of funds they intended to bring to their DC plans. If an employer indicated it was going to add a specific investment type, the most popular choice was a REIT fund. However, only a low percentage of funds indicated it planned to add a specific type of investment, and the percentage of employers planning to add a REIT fund, even though the most frequent choice was only 6 percent.

Principal Financial Group is also happy with the progress of its real estate fund option for DC plans. "We have seen good growth in the number of plan sponsors adding real estate to funds," says Michael Finnegan, vice president of investor services at Principal.

In 1982, Principal launched a direct investment real estate fund and began offering a REIT option for DC plans seven years ago. "Five years ago, the company probably had $50 million," Finnegan says. "Today, the fund holds more than $1 billion in assets."

It's easy to see why. Over the past five years, the return for the REIT fund has been 22.6 percent, while the direct real estate option has been up 10 percent, Finnegan says. Perhaps this is why 56.3 percent of the 32,820 plans using Principal DC investments include a real estate option, according to Principal Financial.

When asked if participants in Principal's REIT fund were performance chasers, Finnegan responded negatively. "What you find with defined contribution investors is that they tend to be fairly passive. The average investor does not make changes on a yearly basis. That's a good thing. You will always have a handful of people who react to market events, but honestly that is not a big portion of our base."

However, Michael Barad, vice president of communications with Morningstar Inc., has come across situations where the "bubble" aspect of real estate put the brakes on a plan sponsor opting for a REIT fund. If participants invest based on past performance and the market suddenly changes, there would be a whole lot of unhappy employees. "One defined contribution plan was reluctant to include REITs in its portfolio because of poor timing and property prices have already run up because of an investment bubble in the sector," Barad says.

Roth 401(k): A Better Option for Those with Rising Tax Brackets By Mary Wilson With the birth of the Roth 401(k) plan on Jan. 1, 2006, U.S. employees were given another option to invest wisely for their retirement. The Roth 401(k) joins other defined contribution tools such as the traditional 401(k), 401(b) and Roth IRA. With a traditional 401(k) plan, taxes are deferred until funds are withdrawn during retirement. With a Roth 401(k) plan, investors are pre-taxed on their contributions, but money can still accumulate, and withdrawals during retirement are tax free. The plan employees should choose depends on an individual's income and tax bracket, says John Doyle, vice president of marketing and communications for T. Rowe Price Retirement Plan Services. This plan will benefit those who may have a difference in tax rates when contributing versus withdrawing. "It is a simple rule—if your tax bracket is higher when you withdraw, Roth 401(k) is probably better," he says. Since the Roth 401(k)'s inception, there have been mixed views on the plan's acceptance. "Roth 401(k) plans will benefit younger people whose salaries and tax rates will increase as well as older people who have run up against the income ceiling with Roth IRAs," says Glenn Sulzer, senior tax analyst at CCH, Inc., a company providing tax and business law information and software. "Companies have been offering the Roth 401(k), but participation has been slow," says Matthew Moore, senior policy analyst of the National Center for Policy Analysis. A recent study performed by human resources firm Hewitt Associates evaluated more than 60,000 employees at companies that offered the Roth 401(k) plan. The study calculated an 8 percent average employee enrollment rate in the plan, which has been highly accepted among younger and newly eligible employees. However, only 4 percent of employees age 50 to 59 invested in a Roth 401(k) plan. "It confirmed that younger employees as well as lower tenure employees are more likely to use the Roth 401(k) option," says Pamela Hess, defined contribution consultant at Hewitt. Traditional 401(k) plans offer mutual funds that invest in REITs and more than likely the Roth 401(k) will offer the same, says Hugh Bromma, CEO of The Entrust Group, a consulting firm specializing in various retirement plans. Hewitt has seen about 10 percent of its client sponsors add real estate or REIT funds in their 401{k). It is important to save for your retirement and to be educated on how to invest, Moore says. "Regardless of where you are saving, the important thing is that you are doing it. People should think about the future and need to prepare for it."

Sector Fund Setbacks

David Wray, president of PSCA, says there is a "disagreement" in the investment community about REIT funds in a DC plan. According to Wray, the key problem is that REIT funds are sometimes viewed as a sector fund in the same way one would categorize technology funds. If one sector fund is included as an option, then all sector funds need to be considered. This is at a time when employers have decided less investment options are better than many, which could confuse employees.

"Employers want to keep it simple," Wray says. "They don't want 1,000 fund choices. There is inertia against adding new kinds of sector funds to a plan."

In addition, plan sponsors do n ot want to make fiduciary decisions, to include one sector fund over another. "You have a division in the investment community over just what REIT funds are for the purpose of DC plans and that has inhibited the funds being chosen as an investment option," Wray says.

It's not just the labeling of a REIT fund as a sector that has deterred some growth. Others group the REIT fund into the small value stock fund category that can be better covered in a general fund.

One of the discussions about REITs is that it is an attractive asset class but trades similar to small-cap value equity, says Phil Suess, principal and head of the investment consulting group at Mercer Investment Consulting, Inc. "One of the challenges you find is deciding if it is a small-cap value fund."

Despite the trading patterns of REITs, Suess maintains that many employers still regard the sector as a great diversifier, as well as an inflation hedge.

"Plan sponsors are more limited in the number of options, but at the same time, they are smarter in targeting the type of options to offer and able to articulate the role associated with each option," Suess says. "In this context, there has been a movement toward REITs as an asset class in the context of a diversifier and inflation hedge."

"Depending on the allocation, real estate increases return and simultaneously decreases risk, and that flies in the face of the principals of investing that most investors are familiar with," Barad says.

Tracking the FTSE NAREIT index, Barad says, REITs have shown favorable risk-return characteristics. In other words, they have a higher return than large company stocks as well as lower risk over the long term. "When you combine REITs in a portfolio that has traditional assets like large and small stocks, they typically increase return and lower risk. It is quite a phenomenal characteristic."