Andy Duffy

Leading investors weigh in on the key issues shaping the REIT industry

As 2003 approached, Real Estate Portfolio brought together a group of leading investment professionals to discuss the key issues facing the commercial real estate industry. The session, which took place Oct. 29, 2002, was moderated by J.E. "Hoke" Slaughter, managing director at Morgan Stanley. The panel featured: Jamie Behar, portfolio manager at General Motors Asset Management; Ted Bigman, managing director and portfolio manager at Morgan Stanley Investment Management; Steve Buller, portfolio manager at Fidelity Management & Research Co.; Marty Cohen, president of Cohen & Steers Capital Management; and Andy Duffy, managing director and portfolio manager at TIAA-CREF.

Hoke Slaughter: The first question is which has been the bigger driver of REIT valuations over the past 12 months, fund flows in the capital markets or fundamentals in the local real estate markets?

Andy Duffy: I'll start by dissecting that 12 months into two different stories. Until the late spring or early summer of 2002 it was fund flows that were lifting the market. After that, as exemplified by the sell-off that we saw in July, I think the fundamentals started to sink in.

From left, NAREIT president and CEO Steven A. Wechsler and Marty Cohen

Steve Buller: I'd agree with that. I would add that the characteristics of the fund flows are a by-product of what has been going in the broader market, where on a short-term period and on a three-, five- or 10-year basis, real securities have outperformed the broader market as defined by the S&P 500. And so there is some of that subtle fund flow, whether it's the retail investor searching for, in many cases, income or the diversified fund manager, now that REITs are included on the S&P 500, are looking real estate securities.

And then lastly is the obvious one, is whether it's in the closed end or the open fund or in real estate-dedicated funds-fund flows that have supported the real estate securities industry. It's somewhat of a by-product of what's going on in the broader market, but I actually think that fund flows have been very important.

And even a little bit more recently, [fund flows] have been driving real estate securities, or at least have provided a floor for them.

Ted Bigman

Marty Cohen: Can I disagree with that? I've been a student of fund flows and manager of mutual funds, and I think fund flows are not a cause, but they are a result. And what happened, I believe, is that the market has remained very efficient, fund flows aside.

What happened was that most people, and I will include myself and my firm, expected a second half 2002 recovery in the economy that would start a real estate recovery as well. By the time July came around, it was clear that wasn't going to happen. So, lo and behold, you've got a correction in REITs and what do you find? Third quarter earnings reports are dismal.

It had nothing to do with fund flows. It was all a matter of fundamentals and the loss of hope that a recovery was about to begin. A recovery was, depending on the property type, put out 12 to 18 months into the future. That required the market to mark down the stocks in order to discount a later recovery rather than a sooner recovery. It's as simple as that.

You want to buy lodging the day guns start to fire. That will be the bottom. —Steve Buller

Buller: You are, to some extent, ignoring the fact that on a year-to-date basis the real estate securities world is roughly flat, which is a huge out-performance and really not that bad, especially given what's been going on (in the broader market). That is supported by a lot of the fund flows going in.

I don't disagree that we went into the first half of the year with many people thinking of an economic recovery. The top of the REIT market this year (June 30), when REITs were up an average 14 percent to 15 percent for year-to-date six months, we've corrected there. We've still gone down even less than the broader markets since that time period-just given fund flows or a support from a lot of cash looking to come into the market.

Cohen: Bear in mind that there has not been a very strong correlation between the stock market and the REIT market. So, whether REITs outperform or under-perform, there isn't really strong information with respect to fundamentals in the REIT industry. They simply behave differently from stocks and bonds.

I think that, over the long term, the more pension funds allocate to REITs, especially as part of their real estate allocation, the better off this sector is going to be. —Jamie Behar

Slaughter: That's a perfect segue to my next question, which is that there's been a lot written about the relatively low and decreasing correlation between REIT stocks and the bond market, and REIT stocks and the broader equity market-both large CAP and small CAP. I'm curious as to how the behavior of the fixed income and the broader equity markets affects your outlook for REITs generally and your investment decisions specifically?

Jamie Behar: I look to the impact of fund flows. The REIT market was up about 13 percent through June 30, 2002, and then there was a very sharp correction in July. And while I agree with Marty that fundamentals look lousy and the third quarter earnings reports bear that out, I look at the relative sharpness of the move. It occurred within a two to three-week timeframe. And, again, I think general mutual fund managers—growth and income fund managers as opposed to REIT—dedicated managers—were looking for holdings to liquidate which could be accomplished without too much pricing impact. That seemed to be the real theme being played out in the REIT market.

The good news is that the REIT market is now liquid enough that they could get out, but I think it was activity in the broader equity market that caused that kind of correction for REITs, not a sudden revelation about fundamentals.

J.E. Hoke Slaughter

Cohen: The same circumstances that affected the timing of the broader stock market recovery and profit recovery were affecting the REIT market as well. I've been a believer that REITs do not correlate well with bonds; and that REITs are not interest rate sensitive. Most people intuitively find that difficult to accept, but if you look at the statistical evidence it bears that out completely.

This year I changed my view, and for the first time in a number of years, I believe interest rates have had a dramatic effect on REITs for two reasons. One is their cost of capital is lowered to an all—time record low, and that would have to be positively reflected in equity prices. If the cost of capital debt is low, that would have to enhance equity returns and improve equity prices.

The second thing is that we have never lived in a period of 1 percent interest rates. And the exasperation of savers, investors, my mother—in–law, you name it, to find a place to put their money has never been as difficult as it is now. So, anything that appears to have a good yield and that's safe becomes a haven, which is what happened this year

It always intrigues me that here is an asset class that really requires the longest-term thinking, and it attracts the shortest-term thinkers. —Marty Cohen

Slaughter: Ted, paint me a picture for an upside scenario for REITs in 2003 and what all the underlying factors might be, or, conversely, give me the downside scenario. First you have to express whether you're a bull or a bear in 2003, and then take one of those two sides.

Ted Bigman: I will present both sides. On the downside scenario, I agree that REITs are not very well correlated to stocks or bonds but are very well correlated to real estate fundamentals. So the big question is where are real estate fundamentals going? A double dip in the economy would be very bad for real estate—not just for real estate fundamentals and earnings, but would also put pressure on dividends.

And dividends, to many investors, are a crucial part of REITs. I think the reduction of dividends would require companies to give investors quite a good education to understand why dividends were being cut. So, I think a weak economy clearly brings it down to that scenario.

In a favorable economic scenario, the broad equity market may rally so well that these non-dedicated investors decide to continue to sell their REIT shares in favor of other equity securities. That would continue to put pressure on REITs, despite the fact that the fundamentals are improving. I would say that's a downside scenario versus the broader market, but I think REITs will still have favorable returns because the fundamentals would be favorable.

I think the upside case for REITs continues to be that they trade at modest premiums and discounts to underlying real estate value, depending on what day it is. Underlying real estate value continues to be an investment that should be a preferred investment.

Slaughter: In terms of outperformance or under-performance relative to the broader market, where do you think REITs stack up?

Bigman: I think that's a harder question. From March 2000 to the end of the third quarter 2002, the out-performance of REITs was phenomenal. Although we said REITs are not correlated to the equity market, we're not going to advocate that they have inverse correlation to the equity market.

Going forward, at least in the near term, it may be a little bit tougher for REITs to outperform the broader equity markets. With the view that the equity market has bottomed here—then REITs will probably lag recovery in the equity market.

The scenario in which REITs outperform in the near term is a less happy one. In a weak economy, where the broad market continues to fail, REITs will outperform the broader markets. But I don't think their absolute return will be very exciting.

Duffy: I just wonder, to the extent that the stock market is a forward-looking indicator that discounts some semblance of the future, how much of what you were describing as a potential upside or downside scenario may already be in the market. Perhaps the market is already giving us its best guess of what that future looks like.

With the average REIT trading at around a 5 percent to 10 percent discount to NAV (net asset value), maybe the market is telling us that NAVs are going to come down. Maybe it is the private market, the real estate market, that moves to where stocks are?

Slaughter: Clearly there's a big disconnect between where properties are trading in the real estate capital markets and the underlying supply—demand fundamentals. You have a lot of REIT CEOs and CFOs that say, "I would be a very active seller in this market if there were a predictable, accretive way to reinvest."

And you can argue in a lot of cases, REITs are getting to the point where buying back their stock is a good, accretive investment. But absent that, let's take a company with only a modest 2 percent to 3 percent discount to NAV, and the CEO is saying, "I'm not a seller because I don't want the cash proceeds sitting on my balance sheet and having that dilutive effect. I think the market's going to crush me for that."

Do you think that's too short-sighted a view? Is that CEO or CFO thinking about business the right way at this point in the cycle-being afraid to sell property?

Buller: We won't know until 12, 18, 36 months in the future, when we can look back at what both public securities and the private real estate world pricing does there. Your hypothetical 2 percent to 3 percent discount is a rounding error. To me, it's at plus or minus 10 percent that it starts to make sense to issue stock or buy back stock.

You always get in trouble when you think "this time" is different, but we're in the midst of a very subtle change of cap rates or the discount rate applied to real estate cash flows going down. Land is getting scarcer, and land prices in this downturn haven't really gone down that much for a lot of markets.

And land is the biggest variable as far as real estate values—not the physical structure on it. If land prices aren't going down, can we live in a lower cap-rate world? Possibly.

Behar: I want to go back to something Marty said earlier that even his mother-in-law can't find places to invest. It's true of his mother-in-law, and it's true of billion dollar pension funds. There are not great alternatives, and real estate looks pretty good as an asset class right now.

I actually see downward pressure on cap rates continuing. This may be a simplistic approach, but if you've got two markets and they're each valuing the same thing differently, why wouldn't a CEO sell assets into a strong market and buy back the company's stock?

Slaughter: Steve is right that 2 percent or 3 percent is a rounding error. But let's say a company is trading at NAV level, not a price where it's compelling to buy back stock. The CEO says, "I've got a lot of non-core assets and a hot market for them. I'm going to sell. I'm going to take a big number—$500 million—of net proceeds onto my balance sheet. And I'm going to hold it for six to 12 months, until I can ferret out the reinvestment opportunities."

The portfolio effect from a strategic standpoint is going to be great, and the CEO feels like a good market timer. However, that CEO is concerned that the market is going to whack him or her upside the head for taking that approach.

Duffy: The right thing to do in that example is to sell the properties and then buy back the stock—even if you're buying it back at NAV because you're getting a better return on the stock buy back than you would in cash on the balance sheet. You almost have to have those extremes to make it mathematically compelling.

Slaughter: Typically, a non-core property is sold at a higher cap rate than the overall average and, therefore, if you buy it back at NAV, it's likely to be a dilutive trade from an earnings standpoint. However, the remaining portfolio may be a higher-growth portfolio. That seems to be a difficult thing for the market to accept.

Duffy: The other factor you didn't mention is that CEO could use the cash to pay down debt. However, that raises the question of what is the company's capital structure? Is the company at its optimal leverage or not? If the company is over-leveraged, then obviously paying down debt is the right thing to do. If it is under-leveraged, then it is back in that same box.

Bigman: One of those factors that Andy raises is private markets and public markets trading at different prices. In order for a company to sell assets, the CEO and board have to have a firm belief that cap rates are going to pull back. The idea to accelerate a program to sell non-strategic assets in this market seems like a no-brainer.

I think all of us hope that cap rates are going through a bit of a secular change, nominally downwards. Which seems to make sense as people have rediscovered the asset class, and part of it has to do with interest rates and part of it has to do with the level of new money. We've been in front of so many boards in the last couple of years that avoided investing in real estate because some time in the 1970s or 1980s they were badly burned. Now they're finally willing to take the last handful of years of statistics and look at real estate again.

I think there has been a permanent shift within institutional investors' allocations where they now have a permanent allocation to real estate, which means a permanent level of demand for the asset class. This may mean a re-pricing for the asset class and, frankly, probably shows that the risks they had been implicitly or explicitly assigning to the asset class were too high. Investors are taking the risk down—put money in the asset class and cap rates will come down a little bit.

Slaughter: Every year there are hot and cold REIT sectors. Last year, mall, health care and triple net lease REITs were the hot sectors—up around 15 percent. On the cold side, office, apartments and hotel REITs were down 10 percent or more—which is a big spread. What are your prognostications as to the hot and cold sectors in 2003, and why?

Cohen: There is going to be a rotation in recovery. It's not a recovery that's going to be monolithic and take up everybody at once. It wasn't that way in the 1990s. Office was the last to recover and apartment was the first. You could have practiced sector rotation during the '90s and have done very well. I think the same thing is going to happen in 2003. We're restarting both a real estate and economic cycle, so that we can play the sector game.

If I was to speculate on what sectors recover, it looks like industrial might be a good candidate at first. Office might be a recovery candidate in late 2003 and into 2004. I'm not sure apartments are ever going to recover—and there are structural issues that give me that feeling.

Slaughter: The apartment sector seems like the bottomless pit, but if you remember Atlanta in 1991 they were saying the same thing.

Cohen: In that period though there was no construction.

Slaughter: Well, they were coming off huge supply.

Cohen: Now, however, we've had no abatement in the supply. Whether it's a secular or cyclical shift, I don't know. But certainly there has been a propensity toward home ownership, which is very strong today. Also, the low interest rate environment, to the extent that it persists, not only promotes home ownership but also promotes multifamily development because developers' hurdle rates are lower. I think there is going to be a chronic oversupply situation in the months ahead.

Slaughter: So that's the structural reason that you were pointing to. Let's say the economy picks up sharply, which will put more people in position to afford a house, but likely there would be some increase in interest rates that should work to the benefit of multifamily REITs from an affordability standpoint because that's been a major driver.

Cohen: You've got a long way to go before interest rates rise to the extent that it chokes off affordability. Plus, builders can make it very easy for you to buy a house regardless of the interest rate environment. I suspect that they'll do that because builders are geared up for a higher level of ongoing demand.

Behar: I agree with Marty's supply picture—it's pretty abysmal in the apartment sector. It's abysmal for office as well. But there are strong demand—side factors that work to support the multifamily sector longer term. One is a very strong demographic picture, with echo boomers chomping at the bit to "get out from under mom and dad." Another increasing source of demand comes from empty nesters.

Cohen: And immigration.

Behar: Immigration is a big one.

Slaughter: Any other observations on subsectors?

Bigman: The hotel sector, given daily pricing, could be the most leveraged to recover with the economy. As long as corporate America comes back in any strength and the individual business traveler comes back, that sector seems to have the wind at its back. With very little new supply getting added and stocks trading at big discounts to underlying value and underlying replacement values, it seems like it's a matter of when rather than if for that sector. But you can hold your breath for a long time to find the when.

Duffy: With consumer confidence down to a nine-year low (in October 2002), we may see more than just a rotation out of the retail REIT sector simply because they've had their run and people are sector hopping looking for the next move. We may actually see a deterioration in retail fundamentals if this consumer confidence engine that's been driving consumer spending results in less buying in the holiday season followed by more retailer bankruptcies.

And then you have a potential war in Iraq. If you overlay a war on top, we could see consumer confidence decline even further, consumer spending goes down with it, and you could have a recipe for a disappointment in retail in 2003.

Slaughter: If there is a war with Iraq, do you think that REITs will relatively under-perform or outperform the broader market? What about specific subsectors?

Buller: You want to buy lodging the day guns start to fire.

Duffy: Because that will be the bottom?

Buller: That will be the bottom. The uncertainty principle of whether we're going to war will have lifted, and you still obviously have the uncertainty principle of how the war will go or what will happen. It's been proven that you always buy lodging when everybody thinks nobody's going to travel or that the airlines are going to go down. Lodging stocks already trade at discounts, and they could even trade at further discounts.

Slaughter: In the event of an extended war, is real estate a sector that's going to continue to offer those defensive elements that investors have been attracted to?

Behar: I think the industry is going to outperform because of the continuing disconnect between the private market and the public market. Even though the public market is usually a predictor of private market performance, we have a situation now where you have discounts to NAV in the 30 percent to 40 percent range for hotels, 12 percent for apartments—which is unprecedented—and about 20 percent for office. I know those numbers move daily, depending on where cap rates are, but I think that gap may close. I don't see cap rates going back up, which will provide a floor for publicly traded real estate despite the fact that fundamentals are not great.

Cohen: We talk about war, but this is not like the U.S. and England fighting the Axis powers. I don't think there's any question that this is not going to be a war in the traditional sense. This is a battle that we're going to win. It's just a matter of when we want to wage it. I don't think war is an issue at all in any of the financial markets.

If anything, a conflict that liberates or changes Iraq's position in that region is going to cause oil prices to go down dramatically. And I think that's going to have a very positive effect on worldwide economies.

Slaughter: Let's talk about the continuing deterioration of dividend coverage. How big an issue is this going to be in your view? How widespread are the dividend cuts going to be? Because once you see the threatening of the income and yield characteristics, certainly from a retail standpoint, I would think that's going to have a jolting effect.

Buller: In my opinion, the sell side and the popular press are going to give it more headlines than are warranted. I'm sure all of us could list five companies that should, or will have to, cut their dividends in the next six months. If we look out six or 12 months and we're talking about serious dividend cuts across the entire industry, it will be a pretty ugly world out there because we don't live in a vacuum. However, perception will be a bigger ax than actual reality and will hurt more than the actual economic impact.

Bigman: Part of the reason that REITs have gotten into this trouble is that while times were good and we had record levels of rents and occupancy rates in the apartment, hotel and office sectors, REITs raised their dividends. Those companies that are bumping up against dividend—pay out ratio issues are not the ones that had to raise their dividends because of legal limits. They raised their dividends either to satisfy shareholders or because they thought it was the right thing to do.

The positive thing that the REIT industry has learned is that growing your dividend is fine, but during rapidly increasing times, the idea of growing the dividend at too rapid a rate may come back to bite you.

There have been a couple of companies that have paid a dividend, and then at the end of the year, saw where they were and paid a special dividend to make sure they retained REIT status. And, perhaps, that might be less needed in certain sectors. But, for example, in the hotel sector, when those companies start initiating a new dividend—given the volatility of their cash flow—you can imagine a couple of more sophisticated CEOs saying, "perhaps we set ourselves a dividend we know we can meet, come war or terrorism or anything else. And at the end of the fourth quarter we worry about whether or not to pay a special dividend."

When times get good again, which they will, I think the idea of being a little bit more disciplined about increasing your dividend may be the good thing that comes out of a little bit of pain we're going through right here.

Cohen: My reading of history on dividends is that management teams will do whatever they can to maintain their dividend. When they've cut their dividends it has been because the banks have forced them to do it, it's not because the boards or shareholders forced them to do it. You are talking about a covenant companies are very reluctant to break.

Today, because of the great health of the industry, there are very few companies that are bumping up against bank covenants—the hotels were last year, and that's what caused them to do what they did. But I don't know of any companies that have bank covenants that they're potentially violating that would force them to cut their dividends.

Slaughter: I was wondering if those five names Steve discussed weren't really the tip of a bigger iceberg, where we could see more wholesale dividend cuts. Does anybody think that those five names could become 50?

Buller: I hope not.

Cohen: I don't see it—unless we have what Steve and Ted refer to as a disaster scenario—because earnings have to go down and stay down. I believe it's a beginning of a new cycle and it would be very foolish to cut your dividend when you look out six or 12 months and see better times. There are the companies—the "five" that I think we're referring to—that in the best case scenario can't cover their dividend for another three or four years, which might take them into another cycle.

Slaughter: Retail demand has been extremely strong. The closed—end funds have captured a lot of that retail demand. As the leading closed—end fund manager, Marty, I would love to hear your thoughts on why these funds are a good vehicle for the retail investor and whether you think the closed—end fund vehicle is good or bad for the industry?

Cohen: As in anything, it's not a matter of whether it's good or bad, but how it's executed. We've raised equity capital and then sold the preferred from that fund and gotten an AAA rating from Moody's and S&P. It's an auction—rate preferred with a rate of 1.8 percent. Now, it's great to borrow at 1.8 percent and invest at 8.8 percent, and there are a lot of people out there doing that. But what we've done is purchased interest rate swaps, so we've locked in our cost of borrowing for five years. And what we envision over the next five years is that we're going to see dividend growth again. So, no matter what interest rates do, our dividends are going to be safe.

The closed-end fund is a way to take advantage of money market yields that are very low and buying high yielding REITs, inserting a safety element by locking in the rate of borrowing. I think it's a neat idea. It's probably the reason that these funds have become popular. It's also the reason they sell at a premium to net asset values, which closed-end funds traditionally don't.

But again, if anybody that creates these gets a little aggressive in how they manage the funds, if they don't lock in their cost of borrowing and get squeezed by interest rates, it's going to hurt everybody, us included.

Slaughter: From the standpoint of dedicated REIT investors, the closed-end funds that might give me heartburn are those that invest via direct placements. Simply because you line up a whole series of direct placements that are, by definition, not broadly distributed and, therefore, ones that I couldn't participate in.

Cohen: I've heard concern voiced by our competitors, but not by our investors and our shareholders. My duty, as a fiduciary, is to serve my shareholders. If I can get my shareholders a good deal on stock, whether I buy directly so that I don't have to go into the open market or buy it at a discount, that is my first, second and third job. And I can't think about anything else. So, if I've delivered quality and value to my shareholders, then really nothing else matters to me.

Buller: We have issue with direct placement-direct meaning to one. We'd rather have secondary deals priced by the broader market-available to everybody, and if it's direct placement, fine. But it should set a premium, and that would be great.

It shouldn't be a direct placement at a discount without the same opportunity or the market pricing, and I think that's where we have issue. This is trying to do what's right for the REIT industry-respecting Marty's opinion to do what's right for his shareholders for those funds.

This doesn't seem to happen in other parts of the equity market. My diversified fund managers have said, "Once again, this clubby little REIT world, why should I go buy a REIT stock that trades everyday on the New York Stock Exchange when someone else is going to get it at a discount?"

Cohen: Why doesn't that fund manager go to the company and do the same thing that we do?

Buller: We buy shares that trade everyday on the New York Stock Exchange. We just think it's a bad practice not to do that.

Cohen: Bad for who?

Buller: Bad practice for the REIT industry.

Cohen: How does it detract?

Buller: You have to be an insider to get special deals. We've seen some of that. If you're not in it everyday, you don't know who needs capital or why or anything like that. It's not efficient. The market is not pricing that deal because some companies, in my opinion, shouldn't have access to capital and some of them continue to do so.

Duffy: Let me interject. I respect everything Marty said about his fiduciary obligation and his duty on behalf of shareholders. I also see your point, Steve. Let me try to de-personalize it and just quantify it. What if, Marty, you had a company whose stock was trading at $20, for example, and you were able to negotiate a price to buy "X" number of shares for your fund at $19.

But when the market gets wind of it, people like Steve and others that share his view vote with their feet and sell that company's stock. The stock price goes from $20 to $19 to $18.50. Hasn't the market mechanism worked in a way that's disadvantageous to your shareholders?

In other words, if you acknowledge the reality that there is a segment of the market that looks with disdain on that practice-and some of those people who share that view may, in fact, vote with their feet—there may be an unintended consequence that could be disadvantageous to your shareholders.

Buller: One question for Marty. You mentioned the fiduciary duty, how do you get around the fiduciary duty of just putting these direct placements in closed-end funds and not in any of your other baskets of money?

Cohen: Because I put it in all the others.

Buller: That I did not know.

Cohen: We do not favor any account over any other. It just so happens that when you do a closed-end fund the money comes all at once, so you have a lot more clout and you have a lot more to buy, so you can do larger transactions.

Bigman: I think REIT management teams must be aware that if they accept to do this financing transaction on a one-off basis, they may have to pay the repercussions. They have to decide whether shareholders will vote with their feet. I think REIT managers have a serious choice as to whether they want to participate in these things, and I think they can't just say it's an interesting transaction. They do have to decide whether there are longer-term effects there.

Slaughter: Let me wrap this up with one final issue. Do you think this industry is going to be subject to the kind of volatility that we've seen in the last six months?

Cohen: It always intrigues me that here is an asset class that really requires the longest-term thinking, and it attracts the shortest-term thinkers. I go to conferences, and if REITs are up, the question is, "isn't it over?" Not, "is it over," but "isn't it over." And if REITs are down, the same question is asked—"isn't it over?" There's something that makes investors short-term oriented about these assets.

My advice: forget about the volatility; look at the fundamentals, take a long-term view, a long-term position and collect your dividends and reinvest those dividends. If you just bought an index and reinvested your dividends, you would have outperformed stocks, bonds, Nasdaq—you name it. And 77 percent of that return came from dividends and reinvesting those dividends. And when you collect a dividend, if the stocks are down, you reinvest into more shares. That's the simple math of this industry, which people lose sight of.

Behar: I think that, over the long term, the more pension funds allocate to REITs, especially as part of their real estate allocation, the better off this sector is going to be. I think it might have a dampening effect on the more fickle fund flows from the growth and income managers. They're huge and they do move our market, but I think over time pension funds represent one source of demand that is very stable.

And another source of stable demand would be 401(k) plans. Something that NAREIT is very actively working on is increasing the number of REIT-dedicated mutual fund investment options that people have in their 401(k) plans. At GM, we have two REIT investment options, and both have attracted a considerable amount of interest from plan participants. The Ibbotson Associates study (which was commissioned in 2001 by NAREIT) showed that if you include REIT securities in your portfolio it will increase the level of expected return and reduce the level of risk in an otherwise well-diversified portfolio. This would hold strong appeal for plan participants, especially at a time like this when they don't even want to open up their 401(k) statements. I think an increase in those two sources of demand will bode well for the sector going forward, in contrast to the more fickle demand from growth and income funds.

Bigman: I think there are a lot of benefits that investors get by virtue of the fact that REITs are liquid. One of the biggest drawbacks is that there is volatility in REIT stocks. If you look at REIT returns over any reasonable period, on an average basis the REITs provide better than a core return, better than NCREIF (National Council of Real Estate Investment Fiduciaries) returns.

We tell our clients that there will be some volatility in the returns because they are public vehicles being brought to market on a daily and moment basis. But over the medium and long-term, we think we'll get returns like private real estate. In fact, we think we'll get returns better than private real estate because it comes with a lot more value.

One issue that pension funds have is when they have to report the real estate being down 5 percent one year-even though it was up 20 percent the previous year. That has been the only difficulty we've had in conversations about getting pension funds and endowment foundations to put money into REITs.

I think there is volatility in the sector. And to raise money for a pension fund and pretend there's not going to be a year where they could have a negative return—which on average will get offset by a bunch of positive returns-is just disingenuous to them. They just have to realize they're going to face that volatility if they're investing in any public securities.