What is institutional real estate?
Institutional real estate can be classified as high-quality commercial properties that are usually congregated in large investment portfolios managed professionally on behalf of third-party owners or beneficiaries.

Who are institutional investors?
Institutional investors include public and corporate pension funds, endowments and foundations, life insurance companies, commercial banks, real estate investment trusts, sovereign wealth funds, among other financial entities.

How big is the institutional real estate market?
The commercial real estate marketplace in the United States currently is estimated at $4.0 trillion. The market capitalization of equity real estate investment trusts (REIT) was approximately $389 billion at year-end 2010.

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 largest pension fund real estate advisers?
Some of the largest investment advisers include J.P. Morgan Asset Management, LaSalle Investment Management, Prudential Real Estate Investors, Morgan Stanley Real Estate and CB Richard Ellis Investors. We sell a semi-annual listing of the top real estate advisers (ranked by tax-exempt assets under management) for $65. Another great resource is the Money Market Directory of Pension Funds and their Investment Managers (published by Standard & Poor's for about $1,500). IREI's sponsor firms and advertisers include the biggest real estate investment advisory firms in the United States as well as worldwide; check out the sponsor interviews and profiles on our website to learn more about these firms.

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?
Amid the current credit crisis and economic recession, commercial real estate markets are characterized by property value losses, rising foreclosures and reduced property revenues. Participants at one our recent editorial advisory board meetings identified the following topical issues.

The Economy: What impact will the decline in employment, consumer spending and inflation — both at home and abroad — have on the outlook for real estate investment over the near and long haul?

The Credit Crunch: How long do you think it will be before real estate activity is back on track? When equity capital does begin to flow again, how significant will those flows be, and why?

Foreign Affairs: Global political risks appear to escalating. How will the upcoming change in the U.S. presidency affect foreign investment risks, if at all? Are overseas markets overheating? If so, where are the trouble spots most likely first to appear? What opportunities exist in the growing global public REIT sector?

Oil: Higher oil prices, cheaper labor and higher savings rates around the world are creating huge capital surpluses — surpluses that remain mainly in the hands of nations whose political agendas differs markedly from that of the United States. What are the implications for geographic asset allocation?

Asset Allocation: Because returns for all asset classes are down, are any plan sponsors considering altering targets for the various asset classes? If we continue to receive disappointing news from the real estate sector, will plan sponsors trim their commitments to the asset class?

Risks/Opportunities: Where are we on the pendulum of pricing risk in today’s market? Where do the best risk-adjusted investment opportunities lie today: in real estate equity or debt?

Commitments: Will plan sponsors increase the dollar volume of investment commitments to U.S.-focused fund offerings in 2011? How about internationally focused fund offerings? Staffing: Will “manager/adviser compression” continue to take place over the next five years? And if so, what implications will this have for newer, smaller, emerging investment management firms?

Consultants: What will the consultant of the future look like, and what new services should they provide?

Benchmarks: The predominant benchmark for U.S. institutional investors remains based on the NCREIF Property Index (NPI). In the opinion of many, the NPI does not represent the composition of most portfolios, particularly private market closed-end fund portfolios. What is the appropriate benchmark, and is it being used to evaluate both outside manager and internal staff? What are the trends in compensation structure for investment staff, particularly senior investment staff, and how are they affected by benchmark selection?

Fees/Fund Terms: How concerned are investors that the management fee load for most closed-end funds (typically 100 basis points to 150 basis points per year) looks so dilutive to returns — particularly now that you can almost guarantee that funds will fail to achieve their stated performance targets?

Capacity: Will the top 10 largest advisers of the future be required to be full-service global providers, with capacity to do both REIT and equity investments? Or can more focused managers still compete for the limited room at the top?

Debt: There seems to be a surplus of distressed debt offerings in the markets today. To what extent does the supply of capital being raised for distressed debt investing meet or exceed the opportunity?

Infrastructure: Will more institutional investors gravitate to this capital-starved asset class? How do you properly evaluate the opportunities and the inherent risks and returns?

Will consolidation in the investment advisory industry continue?
Yes. Consolidation — the drive toward greater efficiency — is a primary force in life and can be expected to continue for some time. Following a period of strong real estate performance that produced a proliferation of advisory firms and investment vehicles, the current credit crunch and pullback in available investment capital will cause some firms to fail or to seek financial partners through recapitalization or acquisition.

What are the risk and return expectations of pension funds investing directly in equity real estate?
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).

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.

Are pension funds interested in international investing?
Yes, definitely! Interest in international investing is increasing. 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 include more mature markets such as the United Kingdom, Japan and the Western European markets, as well as emerging markets, such as Brazil, China and India.

What are some of the factors that are reshaping the supply and demand dynamics 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, strategists and investors will need to respond to the challenge of continued institutionalization 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.

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 advisory firms 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; the executive compensation survey is available for sale to non-NAREIM members.