Traditional retirement funds have always relied on liquidity in investment assets, which has long put real estate investment out of reach, but now that funds are shifting to direct contributions (DC) and target-date funds, property has now become an option. Experts say that may be a game changer for real estate funds that will now be exposed to a $5 trillion DC market and many other types of pension plans that may now pursue real estate as an investment vehicle. Although direct real estate funds with 100% liquidity are not yet available, many analysts believe that will be the next step in the evolution of retirement funds. For more on this continue reading the following article from National Real Estate Investor.
Retirement savings plans that once shied away from the illiquidity of direct ownership of real estate are now beginning to take on property.
Traditional direct benefit pension fund plans that were the norm for decades continue to go the way of rotary phones and cassette tapes. Retirement savings have shifted to direct contribution (DC) plans, such as 401Ks and simplified employee pension plans. The increasing sophistication of these defined contribution plans is creating new opportunities for direct real estate investment, similar to strategies direct benefit pension plans have pursued for years.
The growing demand from DC plans for real estate investment opportunities could be a game changer for real estate funds. According to the Fed Flow of Funds, private DC plans alone represent a $5 trillion market. “The growth rate in the defined contribution market is phenomenal,” says Marc Halle, a managing director and senior portfolio manager for all global real estate securities funds and investments at Prudential Real Estate Investors.
Traditionally, that $5 trillion DC market has needed 100 percent liquidity, which put direct real estate investment options out of reach for investors. But the rise of “target date” funds within defined contribution plans is putting direct real estate investment on the table. Target date funds serve as mini-pension funds with professional fund managers at the helm. Target date fund managers build portfolios and allocate assets based on a selected timeframe that is appropriate for a particular investor. That target date is usually determined by the age of an investor, tolerance for risk or number of years to retirement.
“So, what you are seeing is a big interest in using both real estate securities and direct real estate investment in those portfolios,” says Halle.
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Direct real estate investment funds that execute carefully and efficiently are poised to capitalize on that shift. DC plans have very exacting standards when it comes to fees, expenses, property valuations, investor suitability standards and overall execution. JPMorgan Asset Management is one firm that has taken a lot of time to learn about the DC market and meet those standards. “For us, it is turning out to be a substantial source of new business,” says Dave Esrig, CFA, managing director, global real assets at JPMorgan Asset Management in New York City.
JPMorgan Asset Management currently has $1.25 billion in real estate assets in third-party target date funds, as well as in target date funds managed by JPMorgan Asset Management. Another $250 million will be funded in 2014. Although that balance does include about $250 million in REIT investments, the bulk of the holdings are real property. Given JPMorgan’s larger $40 billion direct real estate business, that $1.5 billion in direct real estate investment for DC target date funds is still relatively small, but it is growing rapidly, says Esrig. “It’s a great business for us, and we think it could hit $5 billion within the next five to 10 years,” he adds.
Target funds create opportunities
Target date funds have been around for about 15 years and have been growing at a moderate pace. Growth has accelerated in recent years. One key driver is the enactment of the Pension Protection Act of 2006. Essentially, the act created certain safe harbor liability relief for plan sponsors.
Another reason behind the growth is a broader effort to boost DC plan returns. Statistics show that DC plans underperform compared to professionally-managed direct benefit pension plans. According to a 2012 JPMorgan report, DC plans underperform direct benefit plans by 75 to 100 basis points. Considering the size of the market, the underperformance of the DC sector has significant implications for retirement savings. “That is a huge amount of dollars to be underperforming by such a wide margin,” says Esrig.
At the end of the day, DC plan participants have been left to their own devices to allocate investments andtheir own portfolios. As more data is available that shows the underperformance of those DC plans, there has been a bigger push to get participants into professionally managed portfolios such as the target date funds. Currently, approximately 85 percent of all DC plans have those target date funds available, although the share of DC assets in those funds is still less than 25 percent, notes Esrig.
Investing in real estate securities is an accepted piece of the DC model. For example, the Prudential Global Real Estate Securities Fund (PURZX) is a $2.7 billion mutual fund that has both retail and institutional share classes, which means its investors run the gamut from, defined benefit plans and defined contribution plans to individual investors.
The next step for the industry is to provide direct real estate funds that can be valued on a daily basis. Prudential has offered real estate funds for several years where it daily values a $13 billion portfolio of assets. So, just like a mutual fund posts a net asset value (NAV) at the end of the day, Prudential’s real estate funds also calculate a daily NAV.
Direct real estate funds can’t offer complete liquidity—the ability for people to trade in and out of those funds on a daily basis. “However, if we can offer quarterly redemptions and subscriptions to investment groups that have lower volatility, then we can strike a daily NAV,” says Halle. So, in theory, an individual could invest in stocks, bonds, real estate securities and a sleeve of direct real estate funds through a “target date” defined contribution plan, which acts differently than real estate securities, he adds.
This article was republished with permission from National Real Estate Investor.