Institutional investors get cold feet

Institutional investors, including pension funds, are more pessimistic about their real estate return expectations than at any point in the past 13 years. In fact, they plan to commit only $29 billion of new capital to the industry in 2009, down 31% from the $42 billion invested in 2008, a new survey reveals.

“On a risk-adjusted basis, real estate actually looks worse than other asset classes for the first time in several years,” says Jim Woidat, principal with San Francisco-based researcher Kingsley Associates. Kingsley conducted the study in conjunction with Institutional Real Estate Inc., a publisher and consultant in California.

In a difficult market for any investments, Woidat says pension funds will have to take whatever returns they can get. “Real estate is still the most attractive investment strategy to help get that current yield they need to help fund their obligations, but there is great uncertainty whether investors will be able to hit their general 8.5% yield hurdle in 2009 and maybe 2010.”

The good news is that survey respondents did not expect to cut their target allocations to real estate in 2009. Real estate has averaged about 10% of institutional investors' total investment portfolio in recent years.

“They recognize that especially in this low interest-rate environment their real estate investments, in terms of cash yield, are really important to meeting those obligations,” says Woidat.

Still, Woidat realizes that change is in the air and it's not all for the good. “A big question is if real estate returns really disappoint these next couple of years, what does that mean in terms of their target allocations going forward? Investors often look at past returns as they fine tune their target allocations.”

For now, pension funds and other institutional investors appear willing to maintain the status quo. But history shows that many long-term investors are not the best market timers. The California State Teachers' Retirement System, for example, raised its real estate target allocation from 6% to 11% in September 2006, near the peak of the property markets.

Woidat worries that many funds may ratchet down their allocations just as new opportunities emerge. “That's what we might expect to see, should real estate returns meet these very low expectations over the next few years when it will actually be the right time to put more capital out into real estate.”