Last year, the $1.8 billion City of Dallas EmployeesÂ' Retirement Fund decided to reallocate a 10% stake, voting to invest in real-estate stocks, not actual buildings.
Big deal? Actually, treating real-estate stocks as a substitute for directly owning real estate is a radical notion to some -- especially to the vast industry that helps advise public and private pension funds on how to directly invest in office buildings, shopping malls, strip centers and other property.
But the Dallas fund wasnÂ't interested in buying buildings. 'We just donÂ't have the staff to do that, frankly,' says Carla D. Brewer, vice chairwoman of the Dallas fundÂ's board of trustees. 'We were looking at the diversification benefits of [real-estate investment trusts] and the cash flow they throw off.'
Pension funds and their advisers have long argued that directly owning a portfolio of office buildings and owning stock in a company that owns office buildings are two different investments. Real-estate stocks are volatile and risky, they say, while actual real estate is stable and safe, offering diversification that a stock canÂ't.
'ItÂ's a different beast,' says Wyle Greig, principal in charge of research for Chicago-based RREEF, a big pension-fund adviser. 'ItÂ's a simplistic idea that there is such a thing as Â'real estate.Â' It can be very different things in different forms. Different forms will work better in different situations.'
But as publicly traded real-estate companies become more of a mainstream investment, advocates are becoming increasingly emboldened. They say direct real estate isnÂ't as stable as it may appear. Its putative 'stability' stems mostly from fact that real estate isnÂ't bought and sold as frequently as stocks are and values are only assessed once a year -- not day-to-day like REITs. The say buildingsÂ' main selling point -- stability -- is a function of how their value is measured, while REIT stocks have other attributes that make them more desirable.
'Not peeking' at building values keeps them stable, acknowledges Susan Hudson-Wilson, chief executive of Boston-based Property & Portfolio Review Inc., which advises pension funds. 'YouÂ're living in a dream world.'
Roz Hewsenian, managing director at Wilshire Associates Inc., which advised the Dallas fund in its decision to own real estate by the share, rather than by the square foot, says, 'The appraisal process masks the volatility of direct real-estate investing.'
REIT advocates also argue that REITs have outperformed direct real-estate investing over the past 20 years, though much of the difference can be chalked up to the fact that REITs carry leverage of 30% or more, which adds to risk. But even if returns are the same -- a Wilshire study of returns from 1991 to 2001 found that they basically were -- stock advocates say direct real estate has plenty of other faults. ItÂ's expensive, requiring an office full of employees to manage it; itÂ's illiquid, since buying and selling buildings takes months; and it lacks the accountability and transparency of public companies, whose moves are closely tracked by Wall Street analysts.
Jon Fosheim, a principal of Green Street Advisors Inc., the Newport Beach, Calif., real-estate stock research firm, says direct ownership of real estate makes as much sense as directly owning oil-and-gas wells, a common pension-fund investment in the 1970s, instead of oil-company stocks, like Exxon Mobil Corp.
The stakes in the debate are high. Public and private pension funds have about $200 billion invested in real estate, according to Jack Nowakowski, director of research for the Pension Real Estate Association, Hartford, Conn. ThatÂ's more than the market capitalization of the entire REIT industry, now at about $168 billion, according to the National Association of Real Estate Investment Trusts.
For now, though, direct investing in real estate dominates. The $150 billion California Public EmployeesÂ' Retirement System has about $13 billion invested in real estate, and only a fraction of that in REITs. 'We donÂ't like our eggs in
