Feature: CRE and its Clunky Past

It was the quote heard ‘round the world, or at least the world of commercial real estate, that is. Roger Urwin, global head of investment content at Towers Watson, a respected global investment consultant, actually said it out loud. Speaking to a group of leading institutional investment professionals at the recent IPD Conference in Lisbon, Portugal, he said that as an asset class, commercial real estate is “still clunky and poorly integrated with the mainstream investment world.”

Now here’s the rub: I’ve been among the many in our industry who agree that commercial real estate is finally showing promising signs of breaking from its former “alternative” status into a more mainstream asset class. However, I have to agree with Urwin on several counts.

Yes, real estate is at a sort of crossroads when it comes to completely shaking off the vestiges of its clunky past. There is no denying it is now a favored son for many of the world’s largest investors who are striving to integrate it into new allocation models. This includes what Urwin dubbed the “Thrifty Fifty,” or the 50 largest pension funds and sovereign wealth funds on the planet.

Urwin also recanted a few familiar themes: Real estate is still not transparent enough. It costs a lot to own and manage. And it’s illiquid. These arguments ring true enough on many levels, however, if one fundamentally believes in the power of diversification and “managing risk,” then the rewards can be plenty.

Unfortunately a strategy limited to investing in core coastal markets with major barriers to entry will not cut it when it comes to generating the much-needed returns that today’s institutions so crave. By now, it’s really no secret that trophy assets in major markets, particularly New York, have reached bonafide frothy status. Examples abound, but in late-May Clarion Partners purchased a Midtown South office building in Manhattan for 2.5 times its selling price just 2.5 years ago.

Herein lay the catch-22 for institutional investors. When it comes to transparency, which is easier to value, a Midtown South office building or a 10-story office building in downtown St. Louis? Investment committees are still under the gun to approve sound deals based on logic and the facts/data. And yet, higher returns are likely to be achieved in the long term on a secondary or tertiary acquisition.

There is some evidence that institutions are starting to spend a bit more to add more bodies to their investment teams, which will certainly help in originating property purchases in the noncoastal markets, but the “clunky” stigma will take some time to overcome.

The point is that alternative assets like real estate are still favored by institutional investors, a notion recently driven home in a survey by London-based researcher Preqin, which noted that 93% of real estate investors plan to either maintain or increase their exposure to the asset class over the course of 2013.

Ultimately we are now at a stage in the recovery cycle where sophistication and professionalism are becoming increasingly important assets to every real estate firm that hopes to conduct business with like-minded institutions at the highest levels.

The fact remains that institutions are still doling out large money to real estate. The Employees Retirement System of Texas is investing up to $495 million in real estate in the next year or so. The Texas Employees example is a good one in illustrating the difference between institutions that just “get” real estate and those that haven’t, yet. And I emphasize the word “yet.”

In fact, Texas Employees is demonstrating that it is not afraid to change up its strategy to fit the times. Now it is jumping on a new investment bandwagon called “European debt,” as well as seriously considering core properties in top European markets. Likewise, the New Jersey Division of Investment is moving ahead with plans to invest a fresh $350 million in European real estate.

Though Europe presents its own unique set of challenges, institutional investors tend to think globally and the Continent is indeed increasingly on their radars. With that in mind, here’s an interesting factoid: The aggregate target capital raise of Europe-focused real estate debt funds currently in the market is more than four times the amount of capital being targeted a year ago.

This continued globalization bodes well for the asset class and will do much to dispel Mr. Urwin’s “clunky” characterization. Still, we understand it and we see it as an ongoing challenge as we keep pushing real estate into the mainstream.

This column appeared in the June 2013 issue of Real Estate Forum.