By Morningstar, Inc.
There have been significant swings and uncertainty surrounding the performance of real estate investments for the past few years, causing individual and institutional investors alike to reassess their real estate allocations and their strategies for implementing them.
For most investors, gaining access to commercial real estate exclusively through publicly traded real estate investment trusts is the most practical way to invest in the asset class. However, defined benefit pension plans and some other institutional investors often face a more complex opportunity set of real estate investments.
Traditionally, these investors have not looked to their real estate portfolios as a source of liquidity, and many have allocated most of their real estate investment capital to a combination of direct-property investments and private equity real estate funds. Moreover, many large investors embraced commercial real estate as a distinct asset class before publicly traded REITs provided a large, liquid and transparent market alternative to direct real estate investments. Although many defined benefit plans include publicly traded REITs within their real estate investment programs, REITs generally occupy a surprisingly small portion of the total real estate portfolio.
According to the IREI/Kingsley Associates “Tax-Exempt Real Estate Investment 2010” survey of major tax-exempt investors, survey participants indicated that they planned to invest 96.5 percent of 2010 real estate allocations to private forms of debt and equity, including 74.0 percent to private equity real estate funds, but only 3.5 percent to publicly traded REITs. The marginal investment allocations to REITs by some of the nation’s largest institutional investors is surprising, not only because of the strong historical investment performance of publicly traded REITs when compared with private real estate investment alternatives, but also because of the heightened focus on critical funding shortfalls and improved risk management practices in the wake of the 2008-2009 financial crisis, which highlighted the value of REIT liquidity, transparency and investor-aligned governance.
Recently available data now offer institutional investors the opportunity to compare more rigorously the reported performance of publicly traded REITs with that of private equity real estate funds. Given the performance advantages of publicly traded REITs relative to private real estate funds as well as the risk-reduction benefits of combining public and private real estate investments, institutional investors that traditionally have relied primarily on private real estate investments, such as many pension funds, should re-evaluate how they balance their total real estate allocations using both private real estate funds and publicly traded REITs.