Institutional investors - overinvested in CRE?

This is something I've read about before, but it bears repeating.

The "denominator effect" looms as the next force that could pressure the slumping real-estate market.

Falling stock prices are leaving institutional investors overexposed to real estate, which could trigger further declines in property values as some of the market's most-active players move to the sidelines to recalibrate their portfolios.

Big pension funds, college endowments and insurance companies typically allocate most of their investment dollars to stocks and bonds and sometimes a smaller amount -- about 6% to 10% for pension funds and as much as 30% for other institutions -- to real estate. In the past decade, as real-estate values rose rapidly, many institutional investors expanded their real-estate holdings and in many cases became fully invested in the sector or close to it, bumping up against their preferred allocations.

Now that stock values are beaten down, and because real estate is typically appraised only once a year and not daily like stocks, the relative size of the real-estate portfolio has grown and in many cases is now higher than the funds' guidelines. This is known as the denominator effect.

So, because your other assets have tanked, you have to dump dirt to retain the allocation ratios. Of course, doing so at crazy low prices...well, you get the picture. It'll be interesting to see how the big guys deal with this issue.

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So where do the bailouts end? You tell me.

I honestly don't know the answer to the question. But the deal is done for the Feds to bail out AIG, just like it did with Bear and Fannie and Freddie but not with Lehman or Merrill. At least the loan, once again made under the "unusual and exigent" clause of Section 13(3) of the Federal Reserve Act, is at 850 bps above LIBOR.

Where do you draw the line? Is Ford or GM a "national treasure," too? (Those are Hank Greenberg's words, not mine.) What about the airlines (again)? Or some other distressed company? The line was drawn in the sand and then changed. Why bail out the bondholders? Certitude would be nice. But again, even though I am a free-marketer at heart, maybe this one had to happen too. Unlike Fannie and Freddie, I don't know. Some say it had to be done to prevent a collapse, but others say that the Fed should have let the market take its course.

Apparently Steven Udvar-Hazy wants to buy back ILFC, the aircraft leasing unit he founded eons ago. He's got the team so that deal makes sense of the money's there to do it.

Yes, AIG did home mortgages and insured lenders on defaults as well. They did do some CMBS work, too, I guess. (Someone correct me if I am wrong.) But they sure have real estate holdings.

But the effect of all these deals, especially Lehman, will be more write-downs and hopefully some much needed portfolio transparency. Interestingly, the big fear seems to be home builders more than commercial property. (Lehman was known, however, for doing risky dirt deals.) And I think that's right. Another interesting development is that B-piece buyers in the few CMBS issuances out there are negotiating heavily to throw out any loan they think is a loser.

P.S. Check out the huge spreads right now -- wow.

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All in all, it's still about the dirt

Here's a story about pension and endowment and other institutional investors looking toward so-called "next generation" investments. In short,

Investors already experienced with the traditional alternatives — private equity, real estate and hedge funds — are now open to newer alternatives such as real assets, infrastructure and 130/30 strategies, said John Garibaldi, managing director, heading the alternative strategies group at JPMorgan Asset Management, New York.

Yeah, let's take advantage of market disconnects and make lots of money. Sound like something you've heard before?

In short, what goes around comes around. And as catchy as some investments are, don't forget that there's no more dirt being manufactured in the world, unless you count land created by dikes.

Now, if you've gotten this far in the post, you'll find that I buried the lede, which is exactly what this story did imo. Get this:

Overall, 94% of all investors stated that real estate is meeting performance expectations compared to 92% for absolute-return strategies, 88% for private equity and 87% for hedge funds.

Is that because of low expectations, or misplaced expectations for other investments or because -- wait for it -- real estate is a fundamentally sound investment? Ding, ding, ding...good answer! I knew you'd get it right or you'd probably not be reading this post.

Hope you all had good holiday weekends. I did.

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Politics and the Fed? A recipe for disaster

It's funny. I always assumed that, by this time in my life I would be involved heavily in the political process. But, other than my non-partisan position as a government official and enjoying reading about and watching the world, I'm not involved. And I expect I'll be staying that way.

I had the chance to see the Illinois legislature in (in)action on May 31 (yes, a Saturday -- the last day a budget can be passed without requiring a super-majority and it reminded me of how much politics and how little statesmanship is involved in government these days.

Now I read in The Economist that Congress is holding up not just judicial appointments but nominees for the Board of Governors of the Federal Reserve. Why?

No one doubts Mr Bush's candidates are qualified. The hold-up is ideological. Democrats want to wait until after November's election so that a new president can, as one senator put it, “remake the Fed” by appointing a clutch of new people at once. That is reckless on several counts.

In the short term, the central bank will be starved of talent and leadership at an extremely tricky time. Power in monetary policy will also shift.

The piece goes on to say:

The real danger, however, lies further ahead. Mr Bernanke's term as Fed chairman expires in 2010. With lots of governors to appoint at once, and the prospect of a new chairman within two years, the next president will have unprecedented power to reshape the Fed. Governors are appointed for overlapping 14-year terms precisely to avoid this concentration of power.

The governors already have to make tough choices about fiscal and regulatory policy. Politicizing this process only makes things worse. And, yes, I think this is a bad idea regardless of who wins the election. And to the extent the current or previous presidents have politicized the process, shame on them. Not everything is or should be political. And our lives and livelihoods should not be among them. Imagine the potential impact on the real estate market with a politicized Fed.

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