Geoffrey Dohrmann—founder and CEO of publishing, conference and consulting company Institutional Real Estate, Inc. (IREI)—has been reporting on institutional real estate investing trends since the dawn of real estate as an institutional investment class in the 1980s. If they don’t already know him personally or as an advisor, many investors and managers know of Geoff for his trend-spotting—sometimes even prescient—editorials in Institutional Real Estate, Americas, IREI’s flagship publication that’s now approaching its 31st anniversary.
In this interview with Juniper Square’s Brandon Sedloff, Geoff discusses some of the headwinds that may reduce capital allocations to commercial real estate, the new sources of capital that managers are trying to tap, his advice for emerging managers, and his market outlook.
Brandon: What are some of the major shifts impacting institutional real estate investor allocations? As traditional institutional real estate capital sources—such as public pension plans—mature, where do you see the next sources of capital coming from?
Geoff: One major trend that will impact real estate allocations over the long-run is the shift from defined-benefit (DB) pension plan funding schemes—where the employer is on the hook and the employee is always guaranteed a certain level of retirement benefit—to defined-contribution (DC) schemes, where the employees contribute to and make the decisions about how to invest their own retirement benefits within a lineup of choices. It’s not controversial to say that eventually all DB plans will be frozen (many are as of today), and that the default going forward will be DC plans. This is the likely path of the future of the public pension funding market, and it has big implications for real estate managers.
In a traditional DB plan, the plan participants have not been worried about or focused on fees or the administrative costs of operating that plan. Since the employees are guaranteed a benefit, they don’t care what the costs are. But when you’re a DC pension plan participant, you care a lot about the expenses because every expense dollar comes out of your pocket. You watch these things like a hawk. So a future world of DC plans is a future world focused on fees and expenses, which isn’t great for your typical manager in alternatives. Partly because of this, the DC pension plan world has been very, very slow to adopt alternative investing.
I’m optimistic that DC plans will figure out how to adopt alternatives just as the DB plans did. The reality is that these plans really need alternatives like real estate in their portfolios.
In today’s low-return environment the best you can hope to get out of the equities market over a long-term period is maybe 7% (if you’re lucky) and with fixed-income you get almost nothing. So we’re in the early days, but it’s only a matter of time before real estate makes its way into these DC plans in a more mainstream way. The benefits of inflation-protected yield and (some) lack of correlation with other asset classes provided by private real estate are too significant to ignore.
The other major shift is that we’re seeing more and more managers starting to develop products for the individual (or retail) investor market. They’re distributing through the private wealth advisory firms, the large wire houses or the independent broker dealers, or the small independent registered investment advisory firms that are popping up like crazy, and are really the growth part of the advisory marketplace right now. Of course the challenge is that most managers have built their business models and operations around large check sizes from institutional investors, and the retail market, with its small check sizes and fragmentation, requires both a different business model and a different investor acquisition strategy.
Brandon: Shifting gears, what are some of the bigger challenges facing institutional real estate investors today?
Geoff: A major issue for just about all investors and their advisors today is having access to good information about their investment programs so they can make informed investment decisions. And part of the barrier to achieving that comes from what I call the “Burger King,” or the “have it your way,” approach. Each individual investor wants reports and numbers sent to them according to their individual preferences. The problem is it forces the entire industry, from the operators to the investment managers, to custom-tailor the way they deliver information up the chain. And that information adds absolutely zero value in a non-standardized format because you can’t make apples-to-apples comparisons. So standardizing is really the answer for a lot of these investors to get better performance over time.
Aside from that, it’s just too expensive for everyone to continue operating in a non-standardized world. Twenty years ago we didn’t have the technology to enforce standardization. It would have been too expensive. But as technology costs fall, we’re getting more capable of achieving greater standardization at lower costs. And that’s really what institutional investors should be striving for. Because at the end of the day, it isn’t their money they’re allocating. It belongs to the beneficiaries and third parties they’re managing it for. And as a fiduciary, they should be doing anything they can to lower their costs.
Brandon: What advice would you have for managers that are either trying to raise institutional capital for the first time, or that are having some success and want to grow in the coming years?
Geoff: First of all, remember whose money it is! That’s the most important thing. You need to adopt a fiduciary mindset.
Your job is to make money for the beneficiaries of these programs, whether it be a foundation or an endowment or a pension fund. That’s your job. And that has to become so important to you that nothing else matters.
A lot of managers that come out of the real estate development business are accustomed to the partnership fiduciary standard, which means I’m going to put the interest of my partners on par with mine. But that’s not the institutional standard of behavior. The institutional standard is I’m going to put my partner’s interests ahead of my own. People are very envious of the Blackstones of the world, and they should understand there’s a reason these firms become as big as they are, and that’s because they take their fiduciary responsibilities very seriously.
You also need to pay close attention to your brand. You need to actually be what you’re presenting that you are. If you’re constantly promoting an image you don’t live up to, that doesn’t work. Think about what you’re advertising yourself as. I’ve seen so much advertising that’s banal. In a lot of the ads I’m seeing, just about everyone says the same thing. How many times have you heard “we’re leaders” or “we’re a leading firm”? Well, what does that mean? What are you leading? Is it based on size? Blackstone can say they’re a leading firm because they’re the largest investment management firm on earth. Everyone else is following Blackstone on size. What are you claiming to lead?
A lot of the work you need to do to build your brand is to think what’s really unique and special about my firm. What do I really deliver that investors want and need that they can’t get from somebody else? And then, importantly, is what I’m saying really true? Or is it just my own belief?
It’s a very difficult exercise to go through so most managers don’t do it. But it can be done. A lot of times you can do it by looking at your portfolio. If you took your property holdings, and you held them up against your three top competitors, you would find deals that all three of your competitors passed on that you didn’t. And then if you look at their portfolios, you would find deals that you passed on that they didn’t. And if you can understand clearly, by asking the right questions, like “Why did we buy those assets and not the assets that they bought?” and “Why did they buy the assets they bought and not the assets we bought?” you’ll start to understand what your competitive advantages are, what your differences are, and they usually lie in your strategy, and in your values.
Most managers don’t want to do that kind of work. It’s too hard. It causes you to do the kind of thinking that actually makes your brain hurt. But there’s a lot of value to be derived from doing that exercise.
Brandon: When it comes to the future of the real estate asset class, what keeps you up at night?
Geoff: I’m worrying about when the next downturn is going to happen. We’ve had a long run. This has been one of the longest real estate recoveries in recorded history. The yield curve is flattening, and this could be the one time when the yield curve goes negative when we don’t have a recession. But it would be the first time, really since the Great Depression, for that outcome. So if the yield curve is any indicator, we’re getting close to a turn in the economy. And when the economy turns down, real estate will have its day in court along with the other asset classes.
On the plus side, we don’t seem to have this huge overhang of spec development that we saw going into the 1990s correction. It’s still very hard to get development capital, particularly for spec office development. There has been some discipline imposed on the market by the regulators that hasn’t gone away as it usually does at this time in a cycle. So that gives me some hope that this next real estate downturn—whenever it does come—may not be as deep.
Geoffrey Dohrmann, CRE, is the founder and is a director, president and CEO of Institutional Real Estate, Inc.—a San Ramon, Calif.—based publishing and consulting company focused on meeting the information needs of the institutional real estate, infrastructure, and private wealth advisory investment communities. Dohrmann has lectured on institutional real estate market–related matters at the business schools of the University of California – Berkeley, the University of Chicago, Stanford University, Harvard University, Northwestern University, the University of North Carolina, and Yale University.
A graduate of the University of California – Berkeley, Dohrmann is a member of the editorial and/or advisory boards for The Journal of Real Estate Portfolio Management and Real Estate Research Corp. He is a Fellow of the Homer Hoyt Institute and the American Real Estate Society, a member of the Counselors of Real Estate, and a past member of the Board of Directors for the American Real Estate Society as well as the San Francisco Architectural Heritage.