Besides the new opportunities they see abroad, many U. S. pension funds continue to step up their commercial real estate investment activity domestically.

Recent asset studies performed by their general consultants have led pension funds to expect stable to higher returns for reel estate at the same time that they can expect lower returns for financial instruments. Market indicators show that most commercial property sectors have bottomed out and are climbing back up to levels of good health. And most overall economic forecasts paint a rosy picture of slow and steady growth.

All of this provides comfort to many pension funds, which have developed in' creased sophistication with real estate as an asset class and in many cases are "making a greater effort to reach their target allocations," says Sylvia Ferrell-Jones, senior vice president at Aldrich Eastman Waltch, Boston. And some other investors are increasing their investment allocations, enjoying newer investment options such as opportunity funds, real estate investment trusts (REITs) and, to some degree, commercial mortgage-backed securities (CMBS).

Scott Tracy, executive managing director of Westmark Realty Advisors, Los Angeles, says he is seeing a bifurcation in pension fund investment in real estate. Some investors are looking at real estate exclusively on a total return basis and others, whom he calls "core investors," continue to view real estate based on its correlation to other investments, seeking the traditional benefits of real estate, such as an inflation hedge.

"Pension funds are sometimes schizophrenic about their investments," says Steven Shepsman, managing partner at E&Y Kenneth Leventhal, New York. "They are motivated by a higher level of liquidity and safety on one hand, which makes REITs and CMBS attractive, but the other hand says, 'Gee, yield is nice,' which prompts them into opportunity funds," he says.

Regardless of the method of their investment, all active pension funds are increasingly concerned with "enhanced governance and control," Tracy says, with the exception being those who are participants in opportunistic funds, normally sponsored by Wall Street investment banks.

But a variety of other investment funds are also "back in style" that do provide not only more control but offer more efficiency than direct one-off deals to pension funds which desire to be less passive than in the past, according to G. Andrews Smith, president of L&B Real Estate Counsel, Dallas.

As pension funds continue to change and expand the ways they invest, they are also changing the methods in which they do business with their investment managers and advisers. "We are starting to see pension funds looking to form strategic alliances with their managers. A manager's job is becoming more than just going out and buying properties. They must have an understanding of the total portfolio," Tracy says.

Managers are in many cases being given more - but not total - discretion, Smith says, and are more frequently playing a role similar to funds' stock managers. "Five years ago a client may have said that they want retail. Now a lot of them say, `We want more real estate,' and they will give the manager more discretion to select the property types," he says.

Tracy says that the pension advisory business is also witnessing, increased "linkage of technologies," in which managers can on a regular basis provide pension fund clients with more thorough information and analysis on levels that relate not only to the specific property but to their overall portfolio.

The pension advisory business continues to experience some consolidation, Shepsman says, mentioning that this trend is similar to what is occurring in all real estate service businesses. "Everybody is involved in some level of buy, sell or merge in advisory firms," which mirrors the consolidation in real estate ownership, he says.

Pension funds are tending to rely on fewer managers, Smith says, explaining that public funds that may have traditionally had up to eight managers may be cutting that number in half. Since they are giving their managers more discretion, they don't need as many. But those who are left must know the business. "Two years ago, all you needed was cash," Smith says.

The abundance of capital in the market combined with a paucity of new construction makes for heightened competition for acquiring attractive properties at reasonable prices. Opportunities are harder to find, Smith says, and all the activity forces the need to redefine what is a bargain, Shepsman says.

Acquisition decisions are based on a variety of factors including geography and price points, and include "a little bit of everything" when it comes to property type, Shepsman says. Those seeking higher yields turn their attention to those property types that are considered out of favor, such as retail.

Smith says that the understandable bashing that retail has recently received has resulted in "opportunities to buy interesting retail from a price standpoint, and the type of retail that would not normally be on the market," such as high-end "lifestyle" specialty centers, which have better accessibility and security than a large mall yet lower operating expenses.

In the office sector, "the low-hanging fruit has been picked," Smith says. Long-favored suburban office properties present "fewer and fewer opportunities," forcing investors to look at select downtown areas, Tracy reports. Smith adds that the most preferred downtowns are those that operate on a 24-hour basis.Industrial and multifamily properties remain the steady darlings of most investors, with "no big swings from the past," according to Tracy. Beyond acquiring individual assets, pension fund investors are increasingly turning their attention toward acquiring real estate operating companies, according to Ferrell Jones. "The game is now a battle for market share" as opposed to the past when growth was the chief concern," she says.

Tracy says pension funds are also making "multiple forms of investments in REITs," and Ferrell-Jones says she expects continued growth in this area. Investment is occurring both on a direct investment and fund basis, largely depending on the size of the pension fund, Tracy says, and depending on tax and other motivations, according to Shepsman, who says there is also increased investment interest in private REITs, either as a long-term plan or by the eventual issuing of a public offering as an exit.

While some pension funds are funding their REIT investments out of their equity portfolio, their participation is taking a myriad of forms, leading Shepsman to believe that "perhaps the fundamental difference in equities and real estate is disappearing," he says.

Tracy says he expects the increased capital flow into all forms of real estate to continue for the foreseeable future, although he reports that a minority of pension funds are seeing the current high level of liquidity in the market as an ideal time to leave real estate altogether. But this is not at such a level as to negatively impact overall market liquidity. Ferrell-Jones says that "most large investors in the public sector are making significant efforts to invest capital in the next year or so, as they see the relative value in real estate compared to other asset categories."

Shepsman mentions that all of the institutional capital flooding into the market today may be perceived as "planting the seeds for the next cycle down," but says that he believes to day's underlying economics will not allow that to happen, as today's borrowing is based more on stability in the real estate marketplace as opposed to the 1980s, when valuations were based on an assumed growth curve. "Today you are buying on today, and if you get an uplift, great. That single difference between today and eight years ago provides a relatively comfortable safety zone," he says.