The real estate securities sector is in the midst of a seven-year rally, but as pension funds and endowments increase allocations to the asset class and more real estate-focused funds come to market, one expert warns that the honeymoon won’t last forever, and investors should chose property-focused funds with care.
“As real estate continues to do well, you see more and more funds being launched, but after six or seven years of very strong returns for real estate securities, investors should be thinking about a real estate fund that has the ability to react under any market conditions,” said Christopher Pappas, who is preparing to launch a long/short property-focused hedge fund in the fourth quarter.
While he won’t go into specifics, Pappas, a former portfolio manager for a REIT fund at Deutsche Bank and former head of a long/short real estate securities fund at the Praedium Group, believes that, on a risk-adjusted basis, a relative value strategy makes the most sense.
“I wouldn’t expect a strong downdraft, but I wouldn’t be expecting 10-20% returns going forward, either,” he said. “I see the market as flat-ish in real estate securities, which is when investment strategy becomes important.”
Just last week, Morgan Stanley announced that it has raised a whopping $2.24 billion for its Special Situations Fund III, which will invest in real estate debt and equity securities around the world. And while large firms like Morgan Stanley and small boutiques like Pappas’ create new real estate securities funds, demand from institutional investors grows each day.
Recently, the $144 billion California State Teachers Retirement System boosted its real estate allocations to 11%, up from 6%, and just this week, the board of the University of California Regents met to decide whether to move in to more aggressive strategies with their $321 million real estate portfolio, including halving the school’s more conservative core real estate allocation to 25% while plowing 40% into enhanced strategies (up from 25%) and increasing high-return strategies to 25% (up from 15%).
While real estate securities in general are a popular investment, Pappas, who said his fund will focus mainly on the U.S. but have an international element, sees great opportunities abroad.
“Real estate is expanding overseas with the REIT structure being adopted in places like the U.K., Germany and Asia,” he said, adding that there are a lot of IPOs coming out of Asia as their real estate capital markets mature, and that Eastern Europe is just behind that region.
While Pappas touts his specialized investment experience as a competitive advantage, he said that you don’t have to be a real estate guru to invest in the asset class.
“A generalist hedge fund manager can make money in real estate when the market is on the rise,” he said, “But when the momentum weakens, watch out!”