Well-Endowed: College endowments increase allocations to real estate

Despite the crisis on Wall Street and concerns about worsening commercial property fundamentals, many college endowments feel the current economic environment is a great time to invest in real estate. "Endowments are somewhat contrarian – they see a downturn as a time when efficiencies are created and an opportunity," says Jimmy Hanson, president and CEO of The Hampshire Companies, a private real estate investment fund manager that works with several large endowments and foundations.

With their long-term investment horizon, endowments look beyond current market conditions and are less likely to make knee-jerk decisions regarding their investments. This strategy has served them well – for the past decade, university endowments have outperformed all the major financial indices, earning higher returns on their investments and beating most of their private and public investment fund counterparts.

The schools have increased their allocations to alternative investments, and in doing so, have invested more of their money in commercial real estate, either through real estate-specific funds, hedge funds, private equity or natural resources such as timber, according to the most recent endowment study from the National Association of College and University Business Officers (NACUBO), a non-profit professional organization representing chief administrative and financial officers at more than 2,100 colleges and universities across the country.

"There are more endowments today who are investing in alternative investments, especially commercial real estate," says Herman Bulls, president of Jones Lang LaSalle's public institutions group. He also serves as member of the board of directors for the U.S. Military Academy at West Point and helps manage the university's $150 million endowment.

"Before we just looked at stocks and bonds, but over the past few years we've opened up to hedge funds, private equity, real estate and even timber," Bulls explains. "Today, West Point has somewhere between 15 and 20 percent of its endowment allocated to alternative investments."

Increasing allocations to real estate

From Harvard University's $35 billion fund to Azusa Pacific University's $35 million fund, endowments both large and small are finding ways to invest in commercial real estate, earning strong returns and hedging inflation at the same time.

From 1997 to 2007, endowments achieved an 8.6 percent average compounded rate of return, surpassing the S&P 500 (7.1 percent) and the Russell 3000 (7.6 percent), according to NACUBO, which surveys 785 higher education institutions and their foundations for its annual endowment study. 

"Foundation and endowment plans have a tendency to be a bit more aggressive than their corporate or public funds counterparts by having higher allocations to hedge funds and private equities, but lower allocations to fixed income," notes Craig Tome, product manager, Northern Trust Investment Risk & Analytical Services.

For the fiscal year ending June 30, 2007, endowments earned an average annual return of 17.2 percent, according to NACUBO's survey. Larger endowments out-earned smaller endowments (see chart below). Endowments with assets of more than $1 billion, for example, achieved an average annual return of 21.3 percent and out-performed the broader market. Harvard and Princeton – the number 1 and 2 largest endowments in the U.S. in terms of assets under management – posted an annual return of 23 and 28 percent, respectively.

Size is one main reason why larger endowments post higher returns than smaller ones. Larger endowments such as Harvard are not only offered the best investment opportunities, but they also have the ability to partner with the best investment managers.

But size isn't the only reason for such impressive performance, experts note. Larger endowments also are investing fewer funds into equities and fixed-income, instead choosing to place as much as 40 percent of their money into alternative investments. Harvard, for example, has allocated more than 33 percent of its endowment to "real assets", which include real estate and commodities, according to Harvard Management Company's fiscal year 2007 annual report. That wasn't always the case, however – in the 1980s, the university's endowment consisted exclusively of stocks, bonds and cash.

"Earlier this decade, larger endowments realized that domestic equities were priced for very low rates of return and that real estate and real assets allowed them to achieve those higher returns," says Eric Petroff, director of research for Wurts & Associates, Seattle-based consulting firm for endowments. He adds that smaller endowments have been slower to embrace alternative investments.

Over the past 20 years, more and more university endowments have embraced alternative investments, especially real estate. Since 1998, endowment allocations to real estate have increased a whopping 66.7 percent increase, according to NACUBO. Despite the increase, those allocations are still relatively small – only 3.5 percent of total assets, up from 2.1 percent. Likewise, allocations to hedge funds increased to 10.6 percent and private equity to 2.3 percent.

Purdue University, for example, is one college that has increased its endowment's allocation to real estate. The West Lafayette, Ind.-based university endowment, which today has about $1 billion of assets, had a target allocation to real estate of 4 percent in 2002, says Purdue's senior director of investments Scott Seidle. Currently, the university has a target of 7 percent, which is split between real estate investment trusts and private, managed real estate funds.

Meanwhile, allocations to equity and fixed-income investments have declined, although they still represent the overwhelming majority of investment. "Endowments are becoming more sophisticated and they want to diversity their risk from equity markets, as well as fixed-income markets," says Joe Heider, president of Dawson Wealth Management, a Cleveland, Ohio-based firm that manages more than $450 million in assets for clients including Ashland University in Mansfield, Ohio. "Commercial real estate offers an opportunity to do just that, producing very good returns over the long-term."

Various investment strategies

Endowment investment strategies related to commercial real estate vary depending on the university's tolerance for risk, endowment size and return expectations. While endowments tend to be much more forward-thinking than pension funds, they still approach investments conservatively and most expect an annual return of 8 percent to 9 percent, Petroff says.

Larger endowments have invested in commercial property in several ways including direct investment, managed investment funds and joint venture partners with operators. Mid-size endowments tend to invest through managed funds rather than investing in property directly or through JVs, while small endowments also gravitate to managed funds or REIT stocks.

However, endowments of all sizes often directly invest in property and land near campus. "Endowments tend to gobble up real estate around campus when they can," Bulls notes, pointing to Ohio State University's effort to develop the South Campus Gateway in Columbus, Ohio, as a good example of an endowment investing directly in commercial property.

The investment jump started the project, allowing the university to assemble land and solicit participation from the private sector. "It was an excellent use of their endowment money because it did something good for the university, and at the same time it achieved an appropriate yield," Bulls says.

Azusa Pacific University's endowment also invests directly in real estate near its campus, which is situated near Pasadena, Calif. The Christian college, which has an enrollment of roughly 8,000 students, has an endowment with $35 million in assets under management, according to David Reid, director of asset management for the endowment. Roughly 30 percent of the endowment is allocated to real estate – far more than most endowments, even the larger ones.

"We've always looking at real estate as a primary asset class instead of an alternative asset class," Reid says, adding that the university's endowment owns office buildings, shopping centers, apartment communities and vacant land. "We like the steady revenue stream and the long-term appreciation that real estate provides."

Long-term investors

Endowments, unlike most private equity firms, hedge funds and even pension funds, have a long-term investment horizon and that investment horizon drives its investment strategies and decisions, Hanson says. His firm recently launched its seventh investment fund, Hampshire Partners Fund VII, a commingled, discretionary value-added real estate investment fund. Fund VII raised $350 million from 20 investors including endowments and foundations.

Hanson began targeting endowments as potential investors in early 2000 when it launched its first pooled investment fund. Previously, the firm had raised capital from high-net worth individuals, but decided to broaden its investor base to include endowments, foundations and pension funds. After the first fund, the company focused exclusively on endowments and foundations. "We wanted to make sure that the interest and money would be consistent and there over a long period of time," Hanson says. "We felt that endowments and foundations invest for the long-term."

While pension funds match their investments to their future payout obligations, endowments usually fund on-going expenses and require their investments to provide consistent returns through several economic cycles.

"A university acts as if it's going to live forever because its mission – to educate and to research – is not one that is ever going to be completed," says Evelyn Asch, co-author of the recently released book on university revenue sources called Mission and Money, published by Cambridge University Press. "So a university is going to have a very long-term horizon because it has to think not just about the students it has today or next year, but far into the future."

Average Rate of Return by Asset Class, FY 2006 & 2007

Asset Class	Average Return (FY 2007)	Average Return (FY 2006)
Equity (US)	19.3%	10.3%
Equity (Non-U.S.)	28.3%	24.8%
Fixed Income (U.S.)	6.0%	0.6%
Fixed Income (Non-U.S.)	6.3%	3.2%
Real Estate (Public)	14.3%	19.0%
Real Estate (Private)	16.8%	15.8%
Hedge Funds	14.8%	10.4%
Private Equity	19.8%	17.9%
Venture Capital	15.0%	10.2%
Natural Resources	14.2%	28.2%

Average Allocation to Selected Asset Classes, FY 1998 & 2007

Asset Class	1998 Allocation	2007 Allocation	Percent Change
Equity	63.5	57.6	-9.3%
Fixed Income	25.6	18.6	-27.3%
Real Estate	2.1	3.5	66.7%
Cash	4.3	3.5	-18.6%
Hedge Funds	2.8	10.6	278.6%
Private Equity	0.4	2.3	475.0%
Venture Capital	0.7	0.9	28.6%
Natural Resources	0.2	1.6	700.0%
Other	0.4	1.4	250.0%

 Source: National Association of College and University Business Officers

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