What is institutional real estate?
Top-quality commercial properties, usually congregated in large portfolios, managed professionally on behalf of third-party owners or beneficiaries.

How big is the institutional real estate market?
The commercial real estate marketplace in the United States currently is estimated at $4.8 trillion. The market capitalization of equity real estate investment trusts (REIT) is approximately $350 billion.

Is real estate primarily an equity vehicle or an income vehicle?
Traditionally, pension funds have viewed real estate as a relatively high-income-producing asset class with equity characteristics, and underwriting has focused primarily on assessing the quality or sustainability of cash flow. Over the past several years, many investors have been changing their perspectives, viewing real estate now as more of an equity asset class with better-than-average income characteristics.

As more and more pension funds begin to pay out more cash to beneficiaries (i.e., pensioners) than they are receiving in annual contributions, they can be expected to become much more income-oriented so that they will be in a better position to fund those negative cash flows without having to liquidate assets. Because of its inherent potential for generating relatively high cash distributions, we would expect pension funds to continue to view real estate as an income-producing asset with equity characteristics.

Who are the players?
Pension funds own an estimated $245 billion of institutional real estate; their portfolios usually are managed by investment advisory firms. REITs dominate property ownership of the retail sectors and are significant investors in other property sectors as well. In recent years, private equity firms such as The Blackstone Group and The Carlyle Group have assumed a large role with their high-yield commingled fund offerings. Other investors competing for institutional-quality assets include high-net-worth individuals, family trusts and foreign investors.

Who are the top pension fund real estate advisers?
We sell a semi-annual special report that ranks the top real estate advisers for $65. A great resource is the Money Market Directory of Pension Funds and their Investment Managers (published by Standard & Poor's for about $1,300). Our sponsors and advertisers include the biggest advisers in the country; check out our sponsor interviews and profiles. These listings provide the names and addresses of key contacts at each of our sponsor firms plus detailed information you won't find elsewhere.

Where does investment capital come from?
Commercial banks supply large amounts of capital to the market, as do pension funds and other tax-exempt investors. REITs also invest and lend, provided the capital market windows remain open. And Wall Street will continue to provide new capital in the form of existing and new securitized debt instruments, again, assuming the capital market windows remain open.

Where does construction financing come from?
Construction financing is coming and will continue to come from pension funds, pension fund advisers, opportunistic funds, REITs, commercial banks and Wall Street. Pension funds and pension fund advisers will invest directly in joint ventures on both a project basis as well as at the entity level. Opportunistic funds have been making investments in joint ventures, operating companies and projects — with the return rather than the structure driving the deal. REITs will continue to develop real estate, either for their own account or in joint venture with third-party development companies employing off-balance-sheet partnership structures or by issuing forward-funding commitments to purchase or finance completed projects once stabilized occupancy has been achieved. Commercial banks will continue to invest in construction finance, as will Wall Street, which will be attracted by the higher profits available early in the development cycle.

What are the general trends in real estate portfolio management?
The most important trend is an awareness that it exists as a profession, and that its practice is important. Most of the 1980s and 1990s were dedicated to the assembly of portfolios. While assembling portfolios is still a concern, especially with the global competition for good properties at attractive prices, the need to manage portfolios prudently also has become important. The primary role of a portfolio manager is to help define portfolio objectives, and then to construct and manage the portfolio so as to achieve those objectives at the lowest tolerable level of risk.

What's the difference between portfolio management, asset management and property management?
A portfolio manager is responsible for a portfolio of assets and typically operates for the benefit of a third party. Portfolio managers tend to operate at the strategic level, focusing on the development or clarification of portfolio risk and return objectives, on the construction and strategic management of portfolios, and on the monitoring of both market conditions and portfolio performance within the context of overall portfolio objectives.

Asset managers and property managers tend to focus more on tactics, i.e., on the implementation of portfolio strategy. Asset managers typically report to portfolio managers and work through third-party property managers, who report to the asset managers. Asset managers, therefore, are focused on managing collections of assets (as opposed to portfolios) and often are regionally focused. Their primary objective is to coordinate the activities of local property management personnel toward the achievement of the portfolio strategies established by the portfolio managers to whom they report.

Property managers typically are responsible for managing the day-to-day operations at the property level, either full-time on-site at one property or for a collection of properties within a specified submarket, market or region. Duties usually include leasing and property operations (maintenance, engineering, tenant relationships, on-site construction management, property-level accounting or data entry, and such). Property managers either report to portfolio managers (in vertically integrated companies) or to asset managers (in companies that are not vertically integrated).

What are the hot issues right now in the industry?
For our pension fund readers, the hottest issues include: 1) how to integrate public and private real estate investment portfolio strategies into a cohesive overall strategy consistent with and supportive of their overall investment portfolio strategy; 2) how to add global real estate investment to their portfolio management strategy; 3) how to capitalize, without taking undue risk, on arbitrage opportunities that might be presenting themselves in the markets, such as the present public-to-private opportunities available in the REIT industry; 4) how to improve alignments of interests with advisers, consultants and other service providers; 5) how to continue to grow their investment portfolios, without a disproportionate increase in staffing; 6) how to reduce the overall cost of portfolio administration; 7) and, as always, how to fund their liabilities at the lowest possible overall risk.

For investment advisory and opportunistic fund managers, the hottest issue is how to survive and grow their firms in an increasingly dynamic environment and in the face of ever-changing investor expectations and requirements. Should they sell, acquire another firm, allow their firm to be acquired, remain private, build a securities management capability, go international or go public are paramount issues in many advisers' minds, not to mention the prospect of how to properly price and compete with other players for new acquisitions on the margins, while ensuring best execution on the disposition side of the equation.

For our REIT readers, there are different issues. For the largest REITs, it's how can they achieve and sustain market dominance, with all of the economies of scale, efficiencies and superior access to lower cost capital that it provides. For the mid-sized REITs, it's how can they achieve the critical mass necessary to compete for dominance within their market niches. For the smaller REITs, it's how can they survive without being subjected to a hostile takeover bid from a larger, better capitalized company or investor group. And for the smallest REITs, it's how can they continue to operate quietly undisturbed, under the radar screen, until they can figure out what their next steps should be. How to sustain continued growth in earnings and shareholder value remains at the top of every REIT executive's list, as does how the current wave of public-to-private acquisitions will continue to affect the industry.

For REIT investment managers, the primary issue is how to increase market share of the tax-exempt investment market, while continuing to produce competitive returns. Other concerns are how to broaden distribution channels to reach ever-broader constituencies (for tax-exempt advisers, the issue would be how to access individual investors; for mutual fund managers, the issue would be how to access the tax-exempt investor markets; for all managers, the issue is how to develop market share in the exploding defined-contribution pension marketplace).

Will consolidation in the industry continue?
Yes. Consolidation — the drive toward greater efficiency — is a primary force in life and can be expected to continue for some time. Meanwhile, although the entry hurdle bar will continue to rise, there will continue to be a proliferation of new entrants to the markets each year. Such has it ever been. Such will it ever be.

What's the impact of the Internet on the real estate investment business?
Given the geometric increase in the amount of information that is now available to investors and the further geometric increases almost certain to come, it will become harder and harder for firms to differentiate themselves.

Access to low-cost information and low-cost technological tools to analyze that information will reduce size advantages and make it easier for smaller firms to compete with larger firms. The emergence of buyer clubs will provide some of the same economies of scale in purchasing once available only to the largest players in the markets. Smaller players, therefore, may be able to occupy niches at much less risk than larger players.

Relationships will continue to be important; but relationships are built on mutual trust and respect. Mutual trust and respect are built on doing what you say you are going to do, and on consistently meeting or exceeding expectations. Consistently meeting or exceeding expectations relies upon knowledge and skill. So knowledge and skill will continue to be critical weapons in the battle for market share or, more importantly, share of mind.

What are the risk and return expectations of pension funds investing directly in equity real estate?
Most investors in "core" properties (i.e., high-quality, stable, income-producing office, industrial, multifamily and retail properties) expect to receive around 8 percent to 9 percent on their unleveraged real estate investments. If they leverage, they tend to leverage assets between 5 percent and 60 percent, with average portfolio leverage ranging between 20 percent and 40 percent. Leveraged return expectations for core real estate investments, therefore, range between 10 percent and 15 percent. Some investors are beginning to look at the private markets as a high-yield investment alternative and, therefore, they demand and expect higher returns from their real estate investment portfolios. Investors expect value-added investment returns of between 12 percent and 15 percent and opportunistic returns in excess of 18 percent to 20 percent. Most of these investors expect their portfolios to be highly leveraged.

Many of the larger investors have both core and high-yield investment components within their portfolios and, therefore, have different risk/return expectations, depending upon the strategy for each portion of the portfolio. Some investors focus only on core strategies, others only on high-yield. The ability to find core properties at reasonable prices is becoming more and more difficult. Because of that, many investors are increasing the high-yield portion of the real estate portfolios.

Are pension funds interested in international investing?
Interest in international investing is exploding. Surveys of the tax-exempt plan sponsor community conducted by Institutional Real Estate, Inc. in conjunction with Kingsley Associates show that, year after year, pension funds plan to increase their foreign holdings; now, two-thirds of plan sponsor respondents indicate they are currently invested in or are considering investing in foreign real estate. The bulk of these investments will consist of private equity investments made via pooled funds that target specific markets. The most popular countries are the United Kingdom, Japan and the Western European markets. Emerging markets, such as Eastern Europe, China, Mexico and India, also are receiving investors' attention.

What are the challenges facing leaders in commercial real estate?
Demographic changes will continue to have a dramatic impact on both the make-up of the available workforce and the needs of space users. The two most significant challenges will be anticipating the implications of an aging baby boomer population — which may make traditional viewpoints of supply and demand dynamics for certain property types obsolete — and the implications of the surge in immigration, particularly among Hispanic and Asian populations.

Equally important, leaders will have to respond to the challenge of continued institutionalization, securitization and globalization of real estate. This has implications for how capital is formed, accessed and deployed, how customers are serviced, and how entities must be organized as well.

How are these changes affecting investors?
These changes are causing the traditional capital sources to respond in a variety of ways. Some are deliberately focusing on a "hit 'em where they ain't" strategy, identifying niches where the REITs and conduits either can't or aren't playing right now. Others are allowing discipline to slip. (It's easy to maintain discipline if your discipline is allowing you to take down deals. But when the fifth or sixth or seventh deal slips away, you start to believe that maybe you are the one who doesn't understand market pricing.) Others simply are sitting on the sidelines, effectively, because they are holding to their discipline and can't afford to compete. Still others are floundering — actively bidding, losing every bid, and getting more and more frustrated. These players either eventually will move to the sidelines or will jump into the feeding frenzy.

Where can I find a recent salary survey of the institutional real estate investment industry?
Each year Ferguson Partners Ltd. in Chicago conducts a compensation survey for the entire real estate industry; it covers practices at advisers as well as other segments of the industry (312) 368-5040. Also the National Association of Real Estate Investment Managers has survey results available free to its members; there's a $5,000 charge to non-participating members and a $7,500 charge to non-members.