Cohen & Steers Looking Beyond REITs and Real Estate
Synonymous with real estate investment trusts, New York–based Cohen & Steers has been moving into other investments, including commodities and natural resources.
Martin Cohen and Robert Steers are nothing if not patient. Sitting side by side in Steers’ Midtown Manhattan office, the co-founders of Cohen & Steers take turns explaining how their firm was at least seven years too early when it began peddling publicly traded real estate investment trusts in the 1980s. “You can’t affect when investment tastes change,” says the white-haired and patrician Steers. “So we said, ‘Let’s put our heads down and just keep cranking out the best record we can. When the world decides they like what we do, we’ll be the only horse out there in the race, and assets will come.’ ”
The two old friends have concentrated on the REIT market through its ups and downs, becoming industry leaders while other asset managers raced to offer everything from equities and bonds to alternative investments. Steers accuses the investment business of mediocrity, citing active managers’ failure to outpace their benchmarks. “Diversification is a formula for failure,” says the 59-year-old, who works across the hall from Cohen, 64.
But Cohen & Steers has diversified too. Synonymous with REITs for almost three decades, the firm began moving into other investments ten years ago. Its newest vehicle is the Real Assets Fund, which includes exposure to commodities and natural resources. Steers and Cohen say their expansion perfectly positions them for the next wave of investment growth. When interest rates rise, they reckon, investors will dump bonds for real assets that will protect them against inflation and throw off income over the long term. The two also think more institutions will embrace REITs, which they say outperform private real estate while offering coveted liquidity.
Cohen & Steers started down the path to diversification by launching a preferred stock fund and a listed infrastructure fund in 2003 and 2004, respectively. In a bid to be less reliant on a single asset class, the partners chose investments similar enough to real estate that their expertise would give them an edge.
In addition to those strategies and the year-old Real Assets Fund, Cohen & Steers, which has 240 employees, now offers a large-cap value portfolio of income-producing stocks and a series of global REITs, including one for emerging markets. It also has a small alternatives effort consisting of a global real estate long-short hedge fund and a private real estate strategy, and it has opened investment offices in Brussels, Hong Kong, London and Seattle. Cohen insists that the firm’s future is far more interesting than its past.
Launched in 1986, Cohen & Steers grew steadily after its lean early years by capitalizing on a novel idea — the easy-to-access REIT — and insatiable demand for stocks. Along the way it weathered setbacks such as the technology stock bubble of the late 1990s and the 2008 crash.
The latter event proved the founders’ thesis: Focus your energies on one thing, and you’ll win. As REITs swooned, Cohen & Steers led a recapitalization of the market. When the recovery started, investors flocked to the independent firm. It also gained as institutional investors saw the benefits of investing in real estate through a listed — hence liquid — vehicle. Cohen & Steers’ assets grew to $45.8 billion at the end of 2012 from $29.8 billion in December 2007. Last year the publicly traded shop earned $274 million in fees.
Although global turmoil has shaken Cohen & Steers of late, its long-term numbers are solid. Through January 31 its U.S. Realty Total Return Composite, which consists of the core U.S. REIT strategy and the Cohen & Steers Realty Shares mutual fund, had returned 12.1 percent annually since its 1985 inception, compared with 10.8 percent for the FTSE Nareit Equity REIT Index. Over five years the composite has gained an annual 8.1 percent, versus its benchmark’s 6.4 percent.
Cohen & Steers’ rise parallels the development of REITs, whose U.S. market capitalization has climbed to $544.4 billion from about $10 billion in the early 1990s, according to the Washington-based National Association of Real Estate Investment Trusts (Nareit). “Many of the name-brand REITs that exist today got off the ground and were engineered with corporate governance, balance sheets and business strategies that were in part informed by Cohen & Steers,” says Steven Wechsler, president and CEO of Nareit.
The two partners spent many years educating investors about the benefits of REITs, even as consultants and institutional investors remained skeptical. Long the Rodney Dangerfield of the investment world, the REIT has won respect, says Cohen & Steers president and CIO Joseph Harvey, who joined the firm in 1992.
An early convert to REITs, Fairfax County Retirement Systems began investing with Cohen & Steers in 1989. CIO Laurnz Swartz, a 15-year veteran of the $5.8 billion Virginia system, says the board agreed to avoid private real estate and use REITs for all of its exposure to the asset class. “Liquidity was a big part of that decision,” Swartz explains.
Although Real Assets manages just $74 million, Cohen and Steers are undaunted. “As interest rates rise there will be a tsunami of capital that leaves fixed income,” says Brooklyn native Cohen, the quieter of the two.
Steers, who grew up and still lives in Rye, New York, is equally bullish. “If we’re right, this is going to be a very large sector,” he contends. “Many of the largest endowments have 20 percent allocations to real assets, and many of them struggle to determine which investments thrive in an inflationary environment.”
Cohen and Steers met when they were both analysts at Citibank in New York in the late 1970s. In 1980, when Cohen was managing a real estate stock fund for Citi’s pension clients, Steers left the bank to become CIO of Greenwich, Connecticut–based National Securities and Research Corp., which was later sold to Phoenix Home Life Mutual Insurance Co. He hired Cohen, who had dabbled in REITs as a pet project.
REITs were created under president Dwight Eisenhower in 1960. Modeled on mutual funds, they gave mainstream investors access to commercial real estate at a time when America’s richest families still controlled the sector through private companies. The New York Stock Exchange listed the first REIT in 1965, and tax-sheltered real estate partnerships raised billions of dollars in the 1980s.
In 1985, while at National Securities, Cohen and Steers started the first mutual fund focused on REITs and other real estate assets. The Tax Reform Act of 1986 prevented real estate partnerships from sheltering earnings and allowed REITs to be internally managed. Believing these changes would spur growth, Cohen and Steers decided to launch their own firm that year.
But by 1989 a commercial real estate downturn had begun. Although their shop had some marquee clients, including Stanford University’s endowment and telecommunications company Bell Atlantic, the two partners struggled, even recruiting their wives to work for free.
“We had a chicken-and-egg problem,” says Cohen, an accomplished classical guitarist. “There wasn’t critical mass.” Adds Steers: “Institutional investors used to laugh. We could buy the whole REIT industry, and it wouldn’t move the dial for us.”
In 1991, at Stanford’s suggestion, Cohen & Steers launched an open-end mutual fund. The university had a relationship with San Francisco–based Charles Schwab Corp., which was just starting its now-dominant supermarket distribution platform for funds. (Cohen & Steers Realty Shares now manages $4.9 billion in assets.)
The firm’s fate started to turn that year when Hyde Park, New York–based Kimco Realty Corp. went public in the first successful listing of an equity REIT in many years. REITs started tapping the public markets to withstand the downturn. The motto at the time was “Don’t go broke; go public,” president Harvey recounts. From 1992 to 1995 there were more than 90 REIT IPOs. In 1993 new legislation made it easier for pension plans to invest in securitized real estate, and Simon Property Group, based in Indianapolis, raised $840 million in the largest IPO to date. By then Cohen & Steers had competitors, but it was one of the few pure REIT plays. Today, CBRE Clarion Securities, Fidelity Investments, LaSalle Investment Management, Morgan Stanley Investment Management and Rreef Real Estate are among its biggest rivals.
The next challenge was the 1997–’98 bear market in REITs. But instead of retrenching, Cohen & Steers hired staff and prepared for life after the correction. A turnaround came quickly, but it proved short-lived when investors began shunning income stocks in favor of technology and other growth companies.
After the tech bubble burst in 2000, though, REITs looked attractive again. Publicly traded real estate got another boost from investors seeking to globalize their portfolios. Only the largest and most sophisticated players had access to global private real estate, so REITs were an easy way to increase allocations.
In 2003, Cohen & Steers expanded into preferred stocks. It had first invested in REIT-issued preferred stocks during the dot-com era, when they were trading at huge discounts. “Here’s an area where no one else is doing this, they are complex, and we can add value through research and active management,” says Harvey of the rationale for the new strategy.
The next year the firm started investing in listed infrastructure companies, a small sector that it believes may follow the same trajectory as REITs. “It was a capital-intensive business that generated regular streams of income and paid a dividend,” Cohen notes. “You wouldn’t know the difference between a utility and a REIT if you took the names off.” Also in 2004, Cohen & Steers went public on the NYSE in a deal that raised $104.3 million.
The financial crisis improved the firm’s fortunes, even if the immediate effects were painful. Because real estate had always been financed using debt, highly leveraged REITs were particularly vulnerable during the credit crunch. The FTSE Nareit Equity REIT Index fell 37.7 percent in 2008, while Cohen & Steers’ U.S. Realty Total Return composite lost 34.2 percent. Assets plummeted to $15.1 billion, and net outflows were $3.4 billion by the end of the year.
But the crash underscored Cohen & Steers’ commitment to the sector and revealed how much influence it had over the underlying REITs in its portfolios. The two co-founders assured staff that they would keep investment professionals. They had no debt and about $4.55 per share in cash; the majority of equity was in the hands of Cohen, Steers and employees, who now own 60 percent of the firm. “We saw the system where we never thought it would be,” Steers says. The rapid decline in REIT valuations meant that clients would have locked in big losses by cashing out, he adds. “By the time they were thinking about doing something, prices had gone down too much.”
To lead a recapitalization of the industry, Cohen & Steers raised money by selling European and Asian REITs that had held much of their value and dipped into $500 million in reserves for redemptions. It offered money to REITs only if they would use the Cohen & Steers imprimatur to raise new equity and refinance debt. In the end, more than a dozen REITs took the money, including high-profile names like AMB Property Corp., Prologis and Simon Property.
“Cohen & Steers’ role sent a vote of confidence to shareholders,” says Michael Kirby, chairman and director of research at Newport Beach, California–based real estate research firm Green Street Advisors. Nareit’s Wechsler agrees: “They helped separate the wheat from the chaff during the crisis to help people understand that there was tangible value embedded in these companies.”
The firm started gaining assets in 2009 as investors saw value in the downtrodden real estate sector. More institutional interest helped too. In 2009, Cohen & Steers drew almost $4 billion in net inflows; 81 percent came from institutional investors, which had gotten wise to the true cost of tying up their money in illiquid private real estate vehicles. “When you are illiquid, you need a superior return to compensate for the risks of a private investment,” says president Harvey.
Institutions still have about 80 percent of their real estate allocations in private funds, according to Seattle-based Russell Investments. But Cohen & Steers’ research shows that over the 30-year period ended January 31, listed REITs beat core private real estate funds by, on average, 498 basis points annually. They also did better over shorter time frames. In 2010 and 2011, Cohen & Steers raised a combined $13.5 billion; again institutions accounted for 81 percent of the total.
But over the past two years, the firm’s U.S. and global REIT strategies have lagged their benchmarks because of macroeconomic forces like European debt and U.S. fiscal issues. In 2012, Cohen & Steers, which relies on fundamental research, suffered $950 million in net outflows. Much of that has been in Japan, where the firm subadvises several mutual funds. Big REIT patrons for the past several years, Japanese investors have been fleeing as yields have dropped. To combat underperformance, Cohen & Steers has made changes that included promoting Jon Cheigh to global head of REITs last May. Since July the global REIT strategy has beaten its benchmark by 150 basis points.
In these difficult times, diversification has turned out to be a blessing. The Global Infrastructure Composite surpassed its index by 3.9 percentage points in 2012 and 2011, while U.S. Preferred Securities outstripped its hurdle by 5.9 percentage points last year and 1.8 percentage points in 2011.
With aging investors as well as pension funds and other institutions on a long-term hunt for yield, inflation protection and stability, Cohen & Steers thinks it has found the sweet spot. The three-decade-long bull market in bonds will eventually end, making real assets, with real estate at the core, more attractive, Cohen says. Thanks to accommodative monetary policy, central banks around the world have pumped a record amount of liquidity into the system. Eventually, this will lead to higher inflation, Cohen believes. Real assets tend to deliver the best returns in such environments.
Cohen & Steers’ Real Assets Fund exemplifies how the firm is looking ahead. The fledgling fund’s holdings encompass not only REITs but gold; currencies, through the use of short-duration fixed-income instruments; natural-resource equities; and commodity futures. Director of quantitative strategies and hedging Yigal Jhirad, who runs Real Assets, says it grew out of investors asking how real estate fared against inflation.
“We took that as an opportunity to look under the hood and ask whether real estate was the be-all and end-all to inflation, or are there other alternative asset classes that we should have,” explains Jhirad, who joined the firm in 2007 from Morgan Stanley, where he headed portfolio and derivatives strategies. After looking at various investment environments from the 1970s onward, Cohen & Steers realized that “inflation is complex, and no one asset class can provide a hedge to all types of inflation, whether energy-driven, labor-driven or driven by monetary policy,” he says.
When the firm launched Real Assets in January 2012, it took the unusual step of enlisting two outside subadvisers, which it calls the “Cohen & Steers of their asset classes,” to manage commodities and natural resources: New York’s Gresham Investment Management and London-based Investec Asset Management, respectively.
“We believe that ultimately there will be inflation, and even if there isn’t inflation in the traditional sense, we have a growing world population,” Cohen says, pointing to demand for natural resources, commodities, housing and food. “There should be good fundamentals for companies that are involved in these businesses.”
Real Assets is an inflation-fighting strategy with several levers. Cohen & Steers used real estate as the base, layering on natural-resource equities and commodity futures to provide a growth opportunity given increasing emerging-markets demand for the underlying assets as well as limited supply. These two components also offer inflation protection. The managers added gold to manage volatility and inflation, along with exposure to global currencies through short-duration fixed-income instruments.
Above all, Cohen & Steers sought to address investor concerns about committing to the fund by broadening its mandate to deliver long-term growth and diversification. “It’s not just a one-trick pony,” Jhirad says. “We wanted to also provide a smoother investment experience across economic environments and across inflation cycles.” If the firm could sell the fund as a diversifier and growth asset, clients wouldn’t just invest when they thought inflation was about to climb, which is hard to predict.
Real Assets was a test of how far Cohen and Steers were willing to push diversification. In the end, they left unfamiliar asset classes to the experts. “They’ve increased the size of their business substantially over the years, but they’ve pretty much remained focused on income-producing assets,” says Fairfax’s Swartz. “That’s what the board was attracted to at the beginning.”
Steers likes Real Assets’ chances — eventually, anyway. He compares the fund’s launch to when he and Cohen started their firm. “Will it take three years to catch on? We don’t know,” Steers says. “But we want to be there with a best-in-class fund when the world decides this is what they want.”