Investors Find Opportunity in ‘Core’

Some of the world’s biggest real-estate investors have lost their gumption.

Having been hammered by boom-era plays in risky “opportunity” funds that speculated in new developments, they now are flocking to “core” funds that generally feature low leverage, well-leased buildings and stable returns. The trend has effectively split the real-estate market: Values of mature, well-performing properties are increasing, while turnaround situations continue to suffer.

The move to the “core” already is under way at the California Public Employees’ Retirement System, or Calpers. It recently sold its stake in two opportunistic funds investing in residential real estate to Blackstone Group LP. The deal for the funds, managed by the Los Angeles firm CityView, was valued at $225 million including debt and equity, according to people familiar with the matter.

The J.P. Morgan Chase ‘core’ fund bought the Equinox Apartments, above, in Seattle for $66 million. 

The funds include about two dozen assets, including raw land, single-family houses and condos in nine states. CityView, which was founded by a former head of the Department of Housing and Urban Development, Henry Cisneros, has been a longtime Calpers real-estate partner focused on urban real-estate projects in cities such as Los Angeles, Dallas and Denver.

During the downturn, Calpers was burned by illiquid investments in land and single-family housing.

“We were aware that Calpers was moving away from opportunistic residential investments,” said CityView Chief Executive Sean Burton in an interview. “We went out and found Blackstone as a new partner who really understands residential real estate and has the vision and the capital to see the investment through.” CityView remains a Calpers real-estate adviser.

Such changes haven’t been lost on Wall Street, which is revamping its menu of real-estate investments. Goldman Sachs Group Inc. is launching a new business to focus on less-risky property deals, after its Whitehall family of opportunity funds suffered losses.

The new business, housed in Goldman’s asset-management arm, is trying to raise money from pension funds and other investors to acquire buildings with healthy tenant rosters and lower debt levels. Goldman recently tapped Jeff Barclay, a veteran “core” fund manager at ING Clarion to lead the effort.

Meantime, some existing core real-estate funds like the one run by J.P. Morgan Chase & Co. have seen a turnaround. At one point during the financial crisis, investors hit the $11.5 billion J.P. Morgan fund, the biggest of its kind, with redemption requests totaling as much as $1.8 billion. It has raised an additional $3 billion from investors this year.


All the changes also are upending the pay of top real-estate fund managers. During the boom years, opportunity-fund managers earned enormous “promote” fees that were tied to price appreciation of properties when sold. It was not unheard of for a manager of a $1 billion opportunity fund to earn tens of millions of dollars in one year.

Managers of core funds are on a far different trajectory. They collect fees from rental income and assets under management, which are much more limited. A manager of a $1 billion core fund might make about $1 million annually, said investors.

The demand for core properties comes at time that values are rising for buildings leased on a long-term basis by credit-worthy tenants. Once scoffed at, 6% annual returns look attractive when 10-year government bonds are yielding 2.66%.

J.P. Morgan paid $234 million for the 600,000-square-foot Advanta Office Commons in Bellevue, Wash.

The J.P. Morgan core fund has spent $1.2 billion this year acquiring properties. It paid $234 million for the three-building, 600,000-square-foot Advanta Office Commons in Bellevue, Wash., leased entirely to Microsoft Corp. It also paid $66 million for the Equinox Apartments, a recently completed 204-unit apartment building in Seattle.

Core property prices are rising. Houston-based Hines recently sold a near-fully leased office tower at 300 North LaSalle St. in Chicago to KBS Realty Advisors Cos., a Newport Beach, Calif., money manger for pensions and sovereign-wealth funds. The price was a record for Chicago: $655 million, or about $500 a square foot.

By contrast, buildings with high vacancies look toxic to many institutional investors. With the economy weak, rental rates anemic and the number of defaults and foreclosures rising, the value of these properties is likely to keep falling.

The response was tepid last year when Macquarie Office Trust, an Australian real-estate investment trust, now known as Charter Hall Office REIT, put One California Plaza in downtown Los Angeles on the block. Its vacancy rate was more than 20%, and the building never was sold.

Real-estate yields are attractive to pension funds because they are under pressure to keep hitting what many critics said are unrealistically high-return expectations.

Real estate’s lure proved a little too strong in recent years. For the past 15 years, opportunistic property funds have produced a gross return of 10.8%, according to Townsend Group, compared with 7.4% by core U.S. funds and 12.7% of all types of real-estate funds.

Pension funds changing their real-estate investment strategy include the $132.2 billion California State Teachers’ Retirement System, known as Calstrs. It is looking to increase its allocation to core property funds to 50% from 35%, while decreasing its allocation to 50% from 65% to the riskier funds that borrow more than 50 cents for every dollar of asset, according to people familiar with the matter.

Calstrs has been moving more assets from opportunistic to core investments to “reduce its volatility and level of risk” since last September, a spokesman said.

Other pension funds are following suit. According to Townsend, a large U.S. real-estate adviser to institutional investors, core property funds have attracted a total of $7.2 billion in capital this year. While some 405 higher-risk funds are trying to raise more than $120 billion, only $6 billion of that targeted amount has been closed year to date, Townsend’s data show. The successful few include funds run by distressed specialists Lone Star Funds and Angelo, Gordon & Co., according to people familiar with the matter.

Source:  WSJ


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