Determining Whether DC Plan Clients Should Offer Real Estate Investments

“While investments in real estate have long been common for defined benefit plans, more plan sponsors are turning to property markets to diversify their defined contribution (DC) portfolios,” Thomas M. Anichini, CFA, chief investment strategist at GuidedChoice, a digital investment advisory firm, wrote in a blog post.

Aside from capital market assumptions, he noted, investors cite several common considerations for including a dedicated allocation to real estate, including: inflation hedging, portfolio diversification, high tangible asset value, competitive risk-adjusted returns and attractive and stable income returns. “A substantial portion of the world’s wealth consists of property. It would seem obvious that real estate would be a part of a long-term investment portfolio,” Anichini said.

A new survey from SophisticatedInvestor.com of 2,000 Americans between the ages of 35 and 65 examines which investment option they consider to be the safest for long-term retirement investing. According to the findings of the survey, when asked which option they would choose from, 22.4% of all respondents selected real estate as the safest long-term investment for retirement—the top choice. When demographic filters were applied to the survey results, 25.1% of respondents between the ages 45 and 54 selected this investment option.

Very few defined contribution (DC) plans invest directly in real estate, according to Anichini. He added that, as a result, the only type of real estate investment typically available within a DC investment menu is a REIT. REITs, or real estate investment trusts, are companies that own or finance income-producing real estate in a range of property sectors. These companies have to meet a number of requirements to qualify as REITs. Most REITs trade on major stock exchanges.

According to Anichini, REITs perform a lot like small/mid-cap value stocks than like private real estate. He said this is not surprising, considering that most public REITs are in the major broad stock indexes.

A 2014 Callan study found that about 70% of target-date funds (TDFs) have some exposure to REITS. And, DC plan sponsors and participants may be surprised to learn that most publicly available REITs are already available in their plan’s index funds. For example, Anichini said, if a DC plan already has a large cap index fund and a small-cap index fund, it already has exposure to all the REIT exposure it could obtain by adding a dedicated REIT fund.

However, he noted that does not mean there is no basis for having a dedicated REIT fund in a DC plan. The Callan study found 22% of DC plans offer REITs in their fund lineup. The tendencies of REITs both to perform like stocks and to belong to broad indexes tend to weaken the case for including a dedicated REIT fund in the lineup, but two additional rationales may support including a dedicated REIT fund in a DC plan lineup:

• If capital market assumptions extend to the level of equity market sectors, at times DC plan sponsors and participants may find the REIT sector specifically appealing. Anichini said this rationale would make a dedicated REIT fund desirable to enable overweighting the sector.
• The lineup’s active mid-cap or small-cap funds might underweight REITs or not hold them at all. He said this rationale is the case for a completion strategy that seeks to avoid an inadvertent underweight in the sector.

James Veneruso, vice president and defined contribution consultant in Callan’s Fund Sponsor Consulting, previously told PLANADVISER, “The problem with REITS is that they tend to behave a lot like equities so they may have volatilities similar to that of equities. But what we’ve been seeing slowly over time is that through TDFs, participants are now able to access direct or private real estate. Private real estate gives you the advantage of a lot less volatility. So you’d have an asset class that over the long term could have a return similar to REITS but with a dampened volatility profile.”