Core Funds, Accounts Slipped in 4th Quarter

Even though they invest conservatively, core funds and separate accounts are also taking their lumps in the market meltdown.

Many core funds posted double-digit declines during the disastrous fourth quarter, according to fund reports that have started reaching investors. Among them: Prudential Real Estate Investors' PRISA 2 fund (down 17.8%) and PRISA 1 fund (down 14.7%); ING Clarion Partners' Lion Properties Fund (down 15.8%) and Lion Industrial Trust (down 11.7%); BlackRock Realty Advisors' Granite Fund (down 16.8%); RREEF's RREEF America 2 (down 12.8%); and Cornerstone Real Estate Advisors' Patriot Fund (down 10.9%).

Separate accounts, which also pursue conservative investments, fared somewhat better, especially if they use little or no leverage.

Core funds by definition are the most conservative in the industry. They gravitate toward trophy assets and other high-end properties, and use significantly less leverage than value-added or opportunistic vehicles. As a result, their return targets - generally 6-8% - are much lower than those pursued by higher-risk funds.

Still, core vehicles couldn't escape the carnage of the fourth quarter, when the economy nosedived. All investors are being hurt by "significant weakening in underlying property fundamentals," one consultant noted.

To be sure, core vehicles are suffering much less than value-added and opportunistic funds, which have been battered by losses on high-risk investments such as condominium conversions, development projects and mezzanine loans. High-yield funds that invested heavily as the market was peaking in 2006 and 2007 typically had posted cumulative declines of 10-35% through the third quarter. Investors are bracing for heavy additional writedowns when the fourth-quarter numbers are released in the weeks ahead.

Nevertheless, core funds and separate accounts are also being dragged down. Most core separate accounts peg their returns to an index compiled by the National Council of Real Estate Investment Fiduciaries that posted an 11.7% annual gain over the past five years, but was down 8.3% in the fourth quarter and dropped 6.5% for all of last year.

Core separate accounts generally outperformed core funds in the fourth quarter. Market players cited a variety of reasons. For one thing, funds are more likely to use leverage, which magnifies losses in a declining market. Some players also think that funds are marking down property values more aggressively. Another factor, albeit minor, is that core funds often carry higher fees than separate accounts.

Two unleveraged separate accounts of the $18.3 billion Nevada Public Employees nearly broke even for the quarter. Those accounts are managed by BlackRock Realty (down 3%) and Invesco (down 2.4%). Four unleveraged separate accounts of the $29.3 billion Alaska Permanent Fund also had declines in the single digits. Those accounts are managed by L&B Realty Advisors (down 8.8%), CB Richard Ellis Investors (down 8.7%), Sentinel Real Estate (down 4.7%) and LaSalle Investment Management (down 4.5%).

Among separate accounts that employ leverage, five accounts of the $18.1 billion Iowa Public Employees posted a combined 10.5% decline. Those accounts, which average 30% leverage, are managed by ING Clarion, Invesco Real Estate, RREEF, TA Associates Realty and UBS Realty. And two accounts of the $4.4 billion Sacramento County Employees that use about 20% leverage also had double-digit declines. The account managers are BlackRock (down 15.8%) and Cornerstone (down 12.5%).

One exception to the trend was four separate accounts of the $29.1 billion Illinois Teachers that eked out gains in the quarter. Those accounts, which average 33% leverage, are managed by Cornerstone (up 3.2%), Invesco (up 1.7%), Commonwealth Realty Advisors (up 1.6%) and Capri Capital (up 1.1%).

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