Asset Allocation Rules May Lead Institutional Investors to Reduce Real Estate Holdings

The high concept of this Wall Street Journal story is that because the stocks have fallen so badly, institutional investor may have to cut their real estate exposures to keep them from becoming a disproportionately large component of their portfolios. Note however that this may not be achieved via sales, but simply by not making any purchases until the ratios reach the level that the institutions likes.

From the Wall Street Journal:

Falling stock prices are leaving institutional investors overexposed to real estate, which could trigger further declines in property values as some of the market’s most-active players move to the sidelines to recalibrate their portfolios.

Big pension funds, college endowments and insurance companies typically allocate most of their investment dollars to stocks and bonds and sometimes a smaller amount — about 6% to 10% for pension funds and as much as 30% for other institutions — to real estate…

Now that stock values are beaten down, and because real estate is typically appraised only once a year and not daily like stocks, the relative size of the real-estate portfolio has grown and in many cases is now higher than the funds’ guidelines. This is known as the denominator effect.

Real-estate demand “has been destroyed effectively by the unintended consequence of the total pie shrinking,” said Stephen B. Hansen, a managing director at ING Clarion Partners LLC in New York… “Certainly these institutions are less prone to making new real-estate investments today than anytime in the past seven or eight years,” Mr. Hansen said.

Last December, a swath of pension funds surveyed by Institutional Real Estate Inc. held a total of $331.5 billion, or 8.5% of their portfolios, in real estate. In sum, these funds were below an average target allocation of 9.6% in real estate by a total of $42.9 billion. Last month, these same funds still held about $321.6 billion in real estate. But because of the declining stock market, they held $42.2 billion of property beyond their target, with an average of 11.1% of their portfolios in real estate….

Funds are loath to try to sell their privately held real-estate holdings in the current market…

Institutional investors concerned about their real-estate allocation may respond to the denominator effect by pulling back on future investment — setting the stage for a further decline in demand for commercial real estate next year, and adding to the downward price pressure in an already embattled market.

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  1. Anonymous

    Hmm. I’ve lost my shirt in tulip futures. And French
    Panama Canal bonds. And the South Seas Bubble. But
    Im doing fine real estate. Solution, buy more of 1-3?
    Maybe asset allocation should be re-classified as a
    faith based strategy?

  2. Anonymous

    So the argument here is that because stocks have fallen alot and in percentage terms more than real estate investment then a re balancing of investment portfolios needs to be done to keep the balance of investments by the likes of pensions at the stated values.
    If you use this argument they ought to be massively selling treasuries as they have probably fallen less in value than real estate. This does not appear to be happening yet.
    Not all pensions and funds stick to percentages and it is possible institutional investors are acting very differently to private ones.When more private investors have withdrawn from the markets then this may well happen. Sorry not really convinced on this one even though it appears on the surface to make sense.

  3. tompain

    Private equity allocations are also a huge problem. Because they are not marked to market, their weight in institutions’ portfolios has grown dramatically. Worse, many institutions are still committed to provide additional capital when the PE firm calls for it. A number of institutions are facing serious liquidity problems because of this, and some have begun to try to sell their private equity holdings in the secondary market. These transactions will take place at a very deep discount.

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