One of the largest investment managers for college endowments and foundations has lost around 94% of the money that clients entrusted to it for real estate investment, according to a report in the industry newsletter “Foundation & Endowment Money Management.” (I read about it in a sister publication, “Real Estate Finance & Investment.”)
Commonfund describes itself as “one of the leading investment firms for colleges, universities and secondary schools, foundations, hospitals and other philanthropic and tax-exempt organizations,” and “manages approximately $25.5 billion for approximately 1,580 nonprofit educational institutions, foundations, health care and other nonprofit institutions.” It gives as its mission “to improve the investment management practices and to enhance the financial resources of our clients.”
According to the report, Commonfund Realty Investors “lost much of its value since 2007, when it sold well-leased properties and allocated proceeds from the sales to developments; when the market turned south, the fund was left with few income-producing properties and a cash flow problem.”
What’s interesting about this report, to me, is that I’ve been predicting since April that there would be more reports exactly like this one. Back then, the Financial Times had reported that a Goldman Sachs fund had destroyed 98 percent of its investors’ equity. I have publicly predicted several times since then (including in a column in BNA’s publication “Real Estate Law & Industry”) that losing everything would turn out to be very much the norm, not the exception, among managers of private real estate investment funds that targeted high returns—11% to 15% net of fees in the case of Commonfund, but frequently much higher than that.
That’s because the strategy that nearly all of those private real estate fund managers was following was simple: buy whichever properties were available—at whatever price necessary, in order to use their committed capital quickly—and take on whichever amount of debt was required to goose up returns to their targets. That kind of investment approach doesn’t require much real estate savvy (it’s nothing more than financial engineering), but it did expose their investors to pretty nasty losses when the bubble burst.
Bad news for private real estate investors is good news, though, for investors in publicly traded REITs. REITs were selling assets at the top of the market, and now they have access to capital exactly when the private real estate funds are increasingly being forced to let go their properties in distressed sales. REIT returns have been extraordinarily strong over the last 18 months, in large part because REIT investors understand the acquisition opportunity.
I’ll say it again: I expect a lot more private real estate investment managers to report losses comparable to Goldman Sachs’ and Commonfund’s. And the more that happens, the better it's likely to be for REITs.
Disclosure: Author is long ING Real Estate Fund and Vanguard REIT Index Fund
Disclaimer: The opinions expressed in this post are my own and do not necessarily reflect those of the National Association of Real Estate Investment Trusts ((NAREIT)). Neither I nor NAREIT are acting as an investment advisor, investment fiduciary, broker, dealer or other market participant, nor is any offer or solicitation to buy or sell any security investment being made. This information is solely educational in nature and not intended to serve as the primary basis for any investment decision.