Last year, says Gerard Lyons, the London-based chief economist of Standard Chartered Bank, many of his conversations with bankers and investors ended up centered on China. This year, there is a new obsession on the cocktail circuit: “Almost any topic you start talking about now, you end up talking about sovereign wealth funds,” he says. Sovereign wealth funds are state-owned funds composed of financial assets such as stocks, bonds, property or other financial instruments.

With $2 trillion or more of investable assets, sovereign wealth funds have more cash under management than all the hedge funds combined. And some forecasters estimate that the number may grow to $15 trillion over the next seven or eight years.

To many in a capital-hungry world, that sounds good. Real estate professionals are among those waiting. Established as a way to keep their country's revenue flowing even when the oil runs dry or the economy falters, sovereign wealth funds could end up being even more of a force in global real estate than private equity.

Ten percent of everything?

If sovereign wealth funds follow the portfolio style of sovereign pension funds, says Stephen Jen, the chief currency economist for Morgan Stanley in New York, as much as 10% of that total could end up allocated to real estate or real estate debt. That's a lot, especially in a global real estate market that's estimated to have a total value of about $10 trillion.

Where will they stash the cash? Several sovereign funds have invested more than $35 billion in cash-strapped U.S. banks and brokerage houses, including Bear Stearns and Citibank. When it comes to real estate, they may be more selective.

Michael Haddock, an analyst at CB Richard Ellis in London, predicts they won't be investing in two markets: their home countries — because their charters generally require diversification — and the U.S., for macro-economic reasons. Many of the funds are filling with dollars brought in from oil and other dollar-denominated commodities, he says. As their country's insurance policy, it makes sense that these portfolios would be designed in a way that reduces their currency risk.

Even without the pressure of the dollar, Lyons thinks funds will focus their investments mostly on emerging markets, where the opportunities are going to be.

Not much of this is likely to be owned directly, analysts say. “[Unlike securities] real estate is harder to own at a distance,” Haddock says. He expects that they won't turn to REITs to find the management they need because of the investment vehicle's relatively higher correlation to the stock market. Instead, Haddock says they will likely turn to closed-end funds, particularly funds with a conservative bent that look to buy institutional-grade properties in major markets at low leverage.

Others take the opposite view. “I think there's a strong case for these sovereign wealth funds to move up the risk spectrum because of their limited need for current or near-term income,” says Peter Hobbs, head of global research for RREEF, an alternative asset management unit of Deutsche Bank.

Threat or opportunity?

On the securities side, some see the funds' arrival as a grave political threat to the financial system. While no one is worried about Norway, a number of countries with large sovereign funds aren't democracies, and some pundits argue they might be tempted to make investments to further national strategic interests. Haddock believes that the funds' long-term focus is likely to make them more of a force for stability.

It's also possible that all those dinars and yuan from heaven may not materialize. RREEF's Hobbs, for one, is skeptical. The projected growth may not happen at the forecast rate, for one thing. Also, the people who push prices tend to be the most highly leveraged investors. Sovereign funds tend to be cautious.

Bennett Voyles is a veteran commercial real estate reporter and National Real Estate Investor's Paris correspondent. For questions or comments, e-mail benvoyles@yahoo.com.



TOP 10 SOVEREIGN WEALTH FUNDS

Sovereign wealth funds, state-owned rainy day funds, are growing. Some analysts say 10% of their assets may end up in real estate.

Country Funds in $billions
United Arab Emirates $500 to $875
Singapore $100 to $330
Norway $308
Kuwait $174
Russia $122
Singapore (Tamasek Holdings) $108
China $66
Qatar $50
Algeria $43
Australia $42
Source: Peterson Institute for International Economics