Greater Liquidity for Private Commingled Equity Funds

The emergence of real estate investment trust (REIT) initial public offerings (IPOs) helped to sustain the investment real estate market through the credit crunch of the early 1990s. A major factor behind the success of the REIT market was the active secondary market that provided liquidity for REIT investors. Because of the liquidity of this asset, investors who had traditionally stayed away from direct real estate investment purchased REITs.

Unfortunately, such a secondary market did not exist for private commingled equity funds. Consequently, during the severe real estate downturn during the early 1990s, commingled fund share prices plunged as portfolio managers scrambled to find purchasers.

Private commingled funds are privately securitized funds that offer undivided interests in income-producing real estate portfolios. Commingled funds is an umbrella term that encompasses a wide variety of private placement entities, including insurance company separate accounts, group trusts, limited partnerships, and private REITs. The number of assets contained in a portfolio ranges widely by the structure of the fund. Limited partnerships could potentially have a single asset while larger private REITs can have more than 100 assets. Portfolio sizes range from $25 million to $3.5 billion.

With total capitalization approaching $60 billion, commingled funds are a primary real estate funding source. This importance is underscored by the fact that total capitalization for commingled funds exceeds equity REIT capitalization by $20 billion.

Given the size of the commingled funds market, it is somewhat surprising that a secondary market was not created until 1995. Historically, commingled funds were traded based on their appraised value between portfolio managers of pension funds. This approach worked well when investment real estate was on the upswing and share values were increasing. However, when investment real estate values declined dramatically during the early 1990s, the market for commingled fund shares evaporated. Consequently, deep discounts were required to liquidate the shares.

The collapse of the commingled fund market was due to two primary factors: declining portfolio values and the lack of broad-based share ownership. Pension fund investment in commingled funds is in the $50 billion to $55 billion range. Because pension fund real estate investment allocations are strictly controlled, there was little flexibility to purchase additional commingled shares even at deep discounts. In fact, real estate allocations were decreased during the real estate downturn of the early 1990s. During those years, pension fund managers had the unenviable task of attempting to sell commingled shares to colleagues who were under the same orders. Consequently, the sellers far outnumbered the buyers, which caused share pricing to decline in excess of the decreased value of the underlying portfolio.

Having identified the liquidity gap in commingled funds, Blake Eagle, chairman of the Center for Real Estate at the Massachusetts Institute of Technology, and Barbara Cambon, president of Institutional Property Management, formed the Institutional Real Estate Clearinghouse. The Clearinghouse facilitates the transfer of commingled fund shares. The Clearinghouse says that it will deliver standardized real estate portfolio-level information on a timely, regular basis for investment analysis and pricing of private real estate securities and will sponsor an independent central facility to operate a trading market for institutionally owned and privately placed real estate securities.

The securities trading firm of Cantor Fitzgerald will perform trading for the Clearinghouse. Trading will begin immediately after the Federal Trade Commission issues a No Action Letter, according to Anthony Labozzetta, managing director of the Institutional Property Group at Cantor Fitzgerald. Trade volume for the first year is expected to be in the $200 million range, with average trade size in the $1 million to $5million range. Commissions will be based on a sliding scale starting at 75 basis points for transactions of $5 million or less and decreasing to 31 basis points for transactions of $50 million and more. Trading will be conducted through a computer network that provides a list of buy and sell orders.

As a centralized trading center, the Clearinghouse creates access to the commingled funds market that was once only available to pension funds and life insurance companies. Institutional investors that have historically stayed out of real estate commingled funds are showing strong interest, Labozzetta says. The Clearinghouse goes a long way toward liquefying the commingled funds market. However, the level of trading performed through the Clearinghouse will be the ultimate barometer of its success.

George Green

George Green is a policy representative/senior economist for investment real estate at the National Association of Realtors in Washington, D.C.