Image Credit: Christophe Vorlet
By Jason Zweig | March 17, 2017 12:56 pm ET
Wall Street is offering individuals a new way to invest in commercial real estate as protection from swings in the stock market. But the approach also carries its own risks.
These funds largely invest directly in property, rather than in real-estate investment trusts, or REITs, which are pools of properties that trade like stocks.
Their key selling point is high income derived from rental payments. They have also been less prone than REITs to big price moves.
“A lot of investors will trade in and out of REITs based on what’s happening elsewhere in the markets rather than what’s going on in real estate,” says Gerry Casimir, portfolio manager of the $24.5 billion TIAA Real Estate Account, available to retirement-plan participants. In a fund that invests directly in commercial property, however, you get “returns that reflect the performance of investment real estate, rather than the vagaries of the stock market.”
Most of these portfolios are so-called interval funds, a quirky structure offered through financial advisers that allows investors to buy daily but sell only once per quarter.
Fees are stiff, generally running at least 2.5% annually.
“Individuals aren’t Yale … they need liquidity,” says Ramin Kamfar, chief executive of Bluerock Real Estate, referring to universities whose investing horizon is theoretically perpetual. His firm manages the $616 million Total Income+ Real Estate Fund.
The latest entrant to the business: On March 9, NorthStar/Townsend Institutional Real Estate Fund registered with the Securities and Exchange Commission to offer $1 billion of shares.
Such interval funds offer to buy shares back from investors at predetermined dates and amounts — typically at least 5% of their shares four times a year. The idea is to offer enough liquidity for investors to get some of their money back over time, but not enough for them to yank it all back at one time.
You also gain entreé to portfolios that normally won’t accept commoners. Kevin Shields, chief executive of Griffin Capital Co., which manages the $1.5 billion Griffin Institutional Access Real Estate Fund, says an investor would need a minimum of $65 million to be eligible to participate in the property pools his fund holds a stake in. His fund’s minimum is $2,500.
Commercial real estate returned an average of 6.93% annually over the 10 years ended Dec. 31, according to the National Council of Real Estate Investment Fiduciaries — almost identical to the 6.95% return on the S&P 500 stock index.
Property is much less volatile than common stocks, however. Historically, the fluctuations in the returns of commercial real estate are between one-third and one-tenth as jagged as those of stocks, according to TIAA.
That’s partly because much of the return on property comes through steady rental income, rather than capital appreciation, which can be fickle.
But it is also an artifact of how markets work. Stocks and bonds publicly trade some 250 days a year. Commercial real estate tends to be privately appraised once every three months. Stock prices would look smoother, too, if investors could trade only four times a year.
And how these funds value their shares, in the absence of a public market for much of their assets, is a departure from the traditional techniques of mutual funds.
These portfolios rely on quarterly valuations by appraisers provided by the property pools they invest in.
In addition, TIAA engages an independent fiduciary to check the validity of any reported change to a property’s value in excess of 6% per year. That provides “another set of eyes” to help ensure “integrity and fairness” in how the assets are priced, says Mr. Casimir.
TIAA has been doing this successfully for decades. But most of the interval funds are younger; several are too new to have weathered the storm of 2007-2009.
They use different techniques to bridge the awkward gap between quarterly appraisals on the underlying private properties and daily valuations of the funds’ shares.
Mr. Kamfar of Bluerock says his fund uses internal models and “daily observable inputs” to estimate interim values. Bluerock then reviews the daily pricing after actual valuations come in at quarter end. Mr. Kamfar says approximately 90% of the time, any adjustments are no more than one penny per share.
John Snowden, portfolio manager of the $230 million Resource Real Estate Diversified Income Fund, says the fund takes the forecast of the coming month’s pricing on commercial property as estimated by Green Street Advisors, a research firm, and divides it by the number of days in the month. The resulting number is added or subtracted to the fund’s daily net asset value. The share price is later adjusted as appropriate when actual values become available. Any adjustments rarely exceed a fraction of a percent, says Mr. Snowden.
Such pricing techniques might hold up fine in a downturn, but we won’t know for certain until one hits. Patience is a prerequisite with these funds, and not just because you can only get your money out quarterly.
Source: The Wall Street Journal, http://on.wsj.com/2nvU3PF
For further reading:
Definitions of LIQUIDITY, NON-TRADED REIT, and REAL-ESTATE INVESTMENT TRUST in The Devil’s Financial Dictionary