Target-Date Funds Make Real Estate a Viable Option for DC Plans

Liquidity and valuation concerns for real estate within savings plans are dwindling, paving the way to greater adoption.


Defined-contribution-plan sponsors are constantly looking at new products and investments to aid participants wanting to grow their retirement asset base. One area of growth has been real estate. Although it can be difficult for individual investors with smaller portfolios to enter that asset class, more and more funds are being offered within DC plans that provide real estate exposure.

Plan sponsors, however, are not adopting these plans in great numbers — although that may be changing. “We are starting to see a small shift, but I don’t think it’s anything that is huge right now,” says Michelle Reuter, principal in the real estate boutique and head of research for North America with Mercer Investments in Chicago. “We’ve seen a couple of products come to market, like a daily valued fund of funds,” she says. “We would not recommend REITs [real estate investment trusts] or stand-alone investments. We think real estate is most appropriate in target-date or diversified inflation-hedged strategies.”

She notes that whereas the trend is in its infancy, plan sponsors have been looking to provide fewer options for participants, thus lessening the confusion over available choices. Real estate within target-date funds “allows them to come up with more creative solutions so that they still have broad diversification” but, for example, “not have to choose a commodities, TIPS [Treasury Inflation-Protected Securities] or real estate product,” Reuter says.

Given market concerns over liquidity, plan sponsors should make private real estate allocations a priority, says David Skinner, co-president of the nonprofit Defined Contribution Real Estate Council (DCREC) and the DC practice leader for Prudential Real Estate Investors in Parsippany, New Jersey.

A report published last month by the DCREC recommended that DC plan sponsors give strong consideration to allocating listed and unlisted real estate investments, generally through target-date funds. The report goes on to say that the allocation should be a relatively modest 10 percent, which would provide less risk and volatility than a conventional portfolio without such a real estate component.

To do this, notes Skinner, the DCREC is proposing a three-pronged approach to get plan sponsors to consider options with real estate exposure. First, plan sponsors and consultants, simply by reading the study, can familiarize themselves with the potential for better returns that come with investing in real estate. A second element is to educate the DC marketplace about the mechanics of daily valuation, liquidity and execution. Says Skinner: “As an industry, we are looking at how to come up with common practices on how real estate can be implemented in a multiasset class structure.” Third, let plan sponsors and consultants know such products exist, he adds.

The Utah Retirement Systems is among the plan sponsors that have gotten into real estate as part of diversification efforts. Craige Stone is director of the network’s $4.5 billion DC savings plan. Utah is currently going through the process of mapping older asset allocation funds and rolling out target-date funds to replace them. Stone says Utah has been monitoring real estate as an option since 2006. However, he says, the fund managers “didn’t feel the industry had developed enough yet to address concerns about daily valuation and liquidity.” Now, he says, the models are developed well enough to offer private real estate within the portfolio.

At the same time, Utah has relied on the research and advice of its consultants and its defined benefit real estate staff, which has suggested that if real estate “is good for the DB plan, it should also be good enough for the DC plan.” Stone says the newer target-date funds will be rolled out in 2015. But the fund is not sitting still in terms of the real estate portfolios it will offer. “The DC real estate space is evolving,” notes Dan Larsen, senior real estate investment analyst with Utah’s defined benefits plan. “We started looking at these investments in 2012. They’ve changed so much in terms of options, flexibility and concerns. We anticipate it is going to continue to change, so we continually want to monitor the DC private real estate industry.”

DCREC’s Skinner agrees and adds that most sponsors that run a defined benefits plan understand the positives of investing in private real estate and want to mirror that model in their DC plans. “Early adopters are those plan sponsors that had real estate in their DB plans and are bringing them over to DC,” he says.

Skinner says estimates show that target-date funds will account for about 60 percent of all DC assets in the next five to ten years. Says Skinner: “Ultimately, it’s in the target-date space that most of these sponsors are going to implement a real estate solution, so we really looked at the study not just as a series of outcomes but in the context of the structures that exist in DC plans and how real estate could improve plan participant outcomes.”

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