Real estate pros are partly surprised but wholly joyous about the return of liquidity. Banks, mortgage companies, commercial mortgage securities, REITs and pension funds were the key capital providers in 1994, a year in which an estimated $286 billion in public and private equity and debt flowed into the industry. While rising interest rates cloud the future of REITs, pension funds are on track to increase real estate investment 40% though 1996.

According to a study by Greenwich Associates, a Greenwhich, Conn.-based investment adviser, pension funds were expected to add $38 billion in real estate assets to their portfolios in the three-year period between 1994 and 1997. During this time, their allocation to the asset class will rise to 4.2% from 3.6% of total assets and bring their aggregate investment to more than $132 billion. (The firm's research is not a complete listing of pension fund investment but represents most of the country's large public and corporate funds. The investment figure represents the lion's share of pension fund investment. However, some estimates, like one by Ernst & Young, put the figure as high as $170 million.)

"The economy is still in recovery and all sectors are seeing positive absorption," says Greg Kraus, director of acquisitions for Dallas-based L&B Realty Advisors Inc. "Real estate is cheaply priced relative to replacement costs and in relation to the volatile stock market and clobbered bond market."

But, Kraus adds, discipline is the rule of today's pension fund investors. "We've seen some aggressive pricing in which people are buying into appreciation, but people are evaluating each investment on its own attributes and with more sophistication," he says.

L&B Realty, which looks to buy performing properties in the 9% yield range, was one of three pension funds to increase holdings in New York City last year. The firm took title to 595 Madison Avenue in midtown Manhattan. The 90% leased building contains some of the city's most expensive retail space -- some of which rents for upwards of $500 per sq. ft.

In September, the $14 billion Retirement Systems of Alabama increased its interest in a lower Manhattan building to 98%. The fund owned 20% of the debt on 55 Water Street when its developer, Olympia & York, went into default three years ago. It initially bought out 66% of the other holders of the mortgage, which totaled $550 million, for 28 cents on the dollar. The fund plans to acquire the remaining 2% through a "squeeze out merger" in order to turn the ownership into a corporation exempt from taxes.

"When we looked at the liquidation options and considered our position of having little to no equity participation in real estate, we saw this as an opportunity to diversify into real estate equity," says director of fixed income Tom Milne. Less than 4% of the fund's portfolio is invested in real estate. "This was a good opportunity to work our way in at distressed levels. If we lease the building at current rents for two to five years, we think we can earn a decent return."

He expects a double-digit cash-on-cash return on the 3.2 million sq. ft., 60% leased building. Its major tenants include Chemical Bank, with 1.2 million sq. ft., and Deposit Trust Co., with 400,000 sq. ft. Chemical's lease expires in the year 2002.

"Our approach is certainly more speculative," says Milne, adding that the fund is nearing completion on a $100 million renovation program. "This property is geared toward large block tenants, and leasing to these tenants is a slow process."

In October, a partnership including The State Teachers Retirement System of Ohio acquired 590 Madison Avenue, the former IBM building, in midtown Manhattan for $202 million. The deal involved the leaseback of one-third of the building by IBM, leaving more than 600,000 sq. ft. of the 1 million sq. ft. tower unoccupied.

"This is the high end of the risk scale," says Darcy Stacom, senior director in the New York office of Cushman & Wakefield. "There are a few examples of pension funds investing, but we're starting to see them bid more," she says, adding that cash-on-cash yields range from 7% to 10%.

Stacom marketed another Manhattan office property on behalf of Prudential Relty Group that attracted three serious bids from pension funds late last year. However, the funds were outbid by Equity Office Properties, a Chicago-based opportunity fund affiliated with investor Sam Zell, that is looking at a 7% initial yield. "Even with interest rates rising, real estate investors are willing to accept a lower return," Stacom adds.

Interest in downtown office property, a sector shunned by all investors, is hardly the only change in investment strategy among pension funds.

Greystone Realty Corp., a Greenwich, Conn.-based investment adviser that is an independent affiliate of New York Life, and State Street global Advisers, a Boston-based money manager, expect to raise $200 million to invest in redevelopment and perhaps new development of community and power centers and multifamily properties in small and medium-size markets. The fund expects to invest in 10 to 12 properties with outlays ranging from $5 million to $30 million.

"We're looking for opportunities that will provide more interesting returns than buying stabilized property," Greystone senior vice president Richard G. Meloy says. He expects a 9%-plus initial return and a 13% to 15% internal rate of return. "And once we've added value, we believe we might as well realize the return rather than hold the property."

Greystone hopes the Matrix Realty Fund will be fully capitalized by the end of the first quarter and anticipates New York Life will be one of the investors. The fund hopes to also attract capital from public funds and other investors.

Prudential Real Estate Investors, an Atlanta-based division of The Prudential Insurance Co. of America that manages $5 billion for third-party pension fund clients, has also targeted the multifamily redevelopment and development sectors. It invested about $230 million in forward apartment commitments between mid-1993 and mid-1994, and plans to raise more capital. The first five deals have exceeded initial pro formas by "significant margins," managing director Dale Taysom says. "More value has been created than we projected, which is really no surprise considering that the apartment market has remained strong and cap rates have come down," he adds.

Prudential has two other multifamily investment strategies. Through October it closed on two deals in a newly created "value enhancement" apartment program that invests with regional apartment developers. The fund invests in Class-A properties in which amenities can be built or Class-B and -B-plus properties that need nominal renovation.

It is also looking at senior housing, a segment in which Prudential's general account has provided mortgage money. "The (senior housing) industry made a lot of mistakes in the past, but it has matured," Taysom adds. "This housing is needed within the communities where (older) people live, not just Florida and Arizona." There are negatives, however, like long lease-up periods and a question of alternative uses for the real estate.

Funds like CalPERS and General Motors have been proactive investors in residential sector in recent years. Among the latest investment strategy by CalPERS is a forward commitment for affordable housing in California. And late last year, a joint venture that includes CalPERS bought an unoccupied 229-unit condo building in Jersey City, N.J., in foreclosure from Citibank and the Banque Indosuez of Paris. The group plans to convert the three-year-old structure to luxury rental units. The site is also approved to contain 299 units in an adjacent building, which the partners plan to build on demand.

Hotels are re-emerging as both an equity and debt investment, according to Keith Geddis, vice president of Preferred Resorts International, an Aspen, Colo.-based investment adviser. In May, Geddis' firm arranged a $12 million participating mortgage with an East Coast corporate pension fund for the $15 million acquisition of the U.S. Grant Hotel in San Diego, Calif.

"You don't see these deals everyday," says Geddis, who admits he wasn't a big fan of hotels in his more than 10 years of managing real estate investments at Public Employees Retirement of Colorado and Los Angeles County Employees Retirement Association. "Hotels are risky because room rates can change overnight, but most pension funds understand that real estate is cyclical and the opportunities exist at the low points."

Preferred Resorts had several equity deals under agreement late last year, including a $15 million acquisition in Denver and resort properties in Bermuda and Savannah, Ga.

The hotel industry is coming off a year in which revenue and profit jumped 5% to $64.8 billion, according to the consulting firm of Arthur Andersen & Co. Projections for this year are equally rosy, with a profit gain of 4.8% expected.

Many advisers and investors soften their enthusiasm about the return of money by recalling the capital-driven overbuilding of the 1980s. And they may also be wondering if liquidity can return with the alacrity seen in the last year, can it just as quickly disappear?