REIT Bulls Look to Pension Funds

This year, five public REITs have been taken private, with private equity groups and pension fund money paying premiums for the stocks. In the case of apartment REIT AMLI Residential Properties Trust(AML Quote), Morgan Stanley's Prime Property Fund paid a 21% premium to where the stock was trading, which suggests that the public markets were undervaluing AMLI's real estate assets. Mueller and other industry watchers believe this privatization trend will continue so long as REITs look cheap vs. what they would fetch if their assets were sold in the real estate market.

Mueller is probably right about this privatization trend to a point. But some REIT watchers, like Barry Vinocur, longtime editor of Realty Stock Review, think it is absurd to suggest that every REIT that trades below NAV will be bought out. Not every piece of REIT-owned real estate is valuable, and some management teams have done a poor job of creating value.

Another issue altogether is whether the $50 billion figure Mueller cites as money sitting on the sidelines is reliable, given that it's a number that's difficult to gauge. Mueller was unavailable to clarify how he derived that figure.

This year, pension funds are projected to invest $51 billion into commercial real estate, according to a survey of funds conducted earlier this year by Institutional Real Estate, a Walnut Creek, Calif.-based consulting and publishing company. Of that, $3 billion is projected to flow directly into REITs. Unfortunately, there's no good data that shows much has actually been invested so far.

Recently, there have been some big votes of confidence in REITs. For example, the Los Angeles Police & Fire Pension System is edging toward allocating up to 15% of its real estate allocation (roughly $180 million) to REITs, Vinocur said.

Today, the average pension fund has an 8% target allocation for real estate in its portfolio, with 16.6% of the real estate portion invested in REITs and the remainder in direct properties, according to the research firm. Going back to 1997, the target allocations have been in the 7% to 8% range every year, with the exception of 1999, which saw a drop-off to 5.8% as pension funds flocked to booming tech stocks.