Sophisticated DC Plan Investors Increasingly Turn to Real Estate

U.S. defined contribution (DC) retirement plan investors’ appetite for real estate investments is increasing, with the median assets under management (AUM) of an investment manager overseeing DC real estate capital increasing more than 50% over the past five years, according to a new analysis. The report is a collaboration from the Defined Contribution Real Estate Council (DCREC), NAREIM [the National Association of Real Estate Investment Managers] and Ferguson Partners to publish the first edition of the “DCREC-NAREIM-Ferguson Partners Defined Contribution Survey.”

The findings build on six years of reporting by DCREC on daily-valued private real estate strategies in the DC market.

The collaboration aims to help expand the metrics being tracked to provide a benchmark of DC capital flows and structuring considerations, as well as organizational and staffing best practices among DC real estate investment managers.

At a high level, the survey finds DC investors are increasingly sophisticated, having expanded their knowledge of the real estate asset class. According to the survey, many DC plan investors are looking closer at asset-level and manager performance, in addition to product structure, than they have in the past. As the survey report explains, the set of product choices continues to expand, as a growing number of real estate managers have launched daily-valued DC investment products over the past several years. Several say they expect to bring additional offerings to the market in the near to medium term.

Findings in the new survey echo those reached in a recent report published by J.P. Morgan Asset Management. That analysis posits that real estate is a cyclical asset class—specifically one that has been in a relative trough for several years and which can be expected to rebound and continue to grow over the next 10 to 15 years, including in the DC plan space.

J.P. Morgan’s analysts argue that, in the search for retirement income, especially with yields being so low and government bond returns even being negative, many investors are turning to real estate to deliver that income. They conclude that real estate can play a role in both the early stages of a target-date fund (TDF)’s glide path and the late stages of its glide path as a fixed-income substitute.

The “DCREC-NAREIM-Ferguson Partners Defined Contribution Survey” says DC plan investors cited diversification, risk-adjusted returns and inflation as the primary reasons for investing in real estate. The survey also shows that investors are increasingly willing to manage their own liquidity and, as they become more comfortable with the real estate asset class, they are evaluating new types of products and managers. The survey finds that a third of DC investors are investing with multiple managers rather than just one.

Despite the positive future momentum identified in the survey, today, very few DC plans invest directly in real estate, according to GuidedChioce, a digital advisory firm. Generally speaking, 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 GuidedChoice, REITs perform a lot like small/mid-cap value stocks rather than like private real estate. Analysts say this is not surprising, considering that most public REITs are in the major broad stock indexes.

When it comes to direct real estate investing within DC plans, a previous DCREC paper offered a checklist of principles and best practices to consider, including the following:

• As a general matter, DC direct real estate product structures should accommodate the unique considerations that are important to DC plan fiduciaries, such as investor eligibility, regulatory oversight and tax reporting;
• A DC direct real estate product should be structured as a tax-exempt entity or a vehicle that issues an IRS Form 1099 for tax reporting to minimize the administrative burden to plan fiduciaries and recordkeepers; and
• A DC direct real estate product should use a structure that reduces unnecessary regulatory, operational and administrative expenses, while still providing an appropriate level of regulatory oversight and investment disclosure.