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    Guest Interview:


    101 California Street 26th Floor
    San Francisco,CA 94111

    Telephone: 415-781-3300
    Fax: 415-986-6248


    Interview Quarter: 4Q2002

 Steve Steppe

 Partner in Charge & Client Relations

Q: Steve, this is the first interview in our 16 years with a manger specializing in real estate. What is the history of RREEF?

A: RREEF was founded in 1975. The U.S. Department of Labor, which regulates pension plans, had just passed new guidelines encouraging pension funds to diversify their investment portfolios. Prior to this period, pension plans had most of their assets in fixed income or stocks. The new ERISA rules (as they are referred to) encouraged pension plans to consider placing some of their assets in real estate. Claude Rosenberg, one of the founders of RREEF and the first “R” in the RREEF name, had a successful investment advisory business at the time which managed stock and bond portfolios. Claude was instrumental in getting RREEF started by introducing the idea of real estate investing to some of his existing pension fund clients.

Prior to 1975, there were very few real estate investments tailored specifically for pension funds. Most were open ended funds offered by large insurance companies. Investors would buy or sell interests in these funds based on the most recent appraised values of their property portfolios. RREEF introduced a new concept for the pension real estate business—the closed end fund. Investment and returns were tied to actual market prices for the properties, not appraisals. The funds were blind pools. Pension funds would commit to invest a block of capital in a fund. This capital would be drawn down as properties were purchased. RREEF would manage the properties, returning distributable income to the investors each quarter. At the end of 10 years (the life of the fund), properties were sold and the sales proceeds distributed to the investor.

For its first 10 years, RREEF’s business consisted exclusively of a series of closed end funds of this type. The funds were unleveraged and invested in all four basic property types. RREEF’s products and services have expanded over the years to meet the investment goals and objectives of our clients. In the mid-1980s we began offering individually managed accounts to larger corporate and public pension plans. Around that time RREEF also undertook its first portfolio takeover—where assets are assigned to RREEF from another advisor, often with a work-out or liquidation strategy. This has become an important component of our overall business and we’ve taken over more than 300 properties to date totaling over $6 billion on behalf of nearly 30 different clients.

Another important new line of business was added in 1993, when a sole proprietorship was reorganized as RREEF Real Estate Securities Advisors, L.P., in order to offer management of publicly-traded REIT portfolios to our clients. Today RREEF Securities is a dedicated group of eleven professionals operating out of our Chicago office and managing more than $3.4 billion in real estate securities assets.

Q: What makes real estate an attractive investment for pension fund investors?

A: Over the last three years the leading stock indices have declined by more than 24% with some indexes losing more than half of their value. Over the same period, private equity and public real estate have turned in positive performances, reporting cumulative gains of 39% on the private side and 42% for public companies. Why the divergence? Real estate is not immune to the economic conditions that have pummeled stocks – but the unique characteristics of real estate investment allow for lower volatility, conservative valuations and a return cycle that is typically out-of-phase with other asset classes. These factors are the key attributes of real estate’s diversification capabilities. Over the long-term, real estate returns will typically trail those achieved by other asset classes. But in times of distress in the capital markets, commercial real estate has the ability to mitigate risk in a diversified investment portfolio.
Both public and private forms of commercial real estate investment provide attractive returns with favorable diversification benefits. Each type of real estate investment, however, provides a very distinct set of benefits and costs. As separate investments, their specific risk and return characteristics are best suited for different types of investors. But their benefits are very complementary to one another and mixed strategies provide investors with attractive investment options.

Q: You describe RREEF as a full service real estate investment advisor. Tell us about the various ways you invest in real estate.

A: On the private side, we are active buyers, sellers, developers, and manager/operators of institutional-grade real estate, and we utilize modest financing on certain owned assets to enhance performance. These activities are carried out as a fiduciary on behalf of our investment clients. In terms of investment vehicles, RREEF offers its direct real estate services through separate accounts, as well as core and value-added commingled funds.

As I mentioned earlier, we also have devote considerable resources to the public real estate market. Our real estate securities team manages portfolios of publicly-traded REITs and REOCs for separate account clients, as well as a core mutual fund and commingled fund.

Q: Please tell us about how your operations are structured. In which parts of the country are your offices located and what are their functions in regard to managing your portfolios.

A: RREEF has corporate offices in San Francisco, Chicago, and New York. Our operations are structured around key operating groups, including Acquisitions, Client Relations, Dispositions, Portfolio Management, Property Management, Real Estate Securities, and Research..

At RREEF, we believe in direct ownership of real estate so that we can control its operations and destiny on behalf of our clients. To this end we have developed a network of more than 115 property management offices throughout the country so that we can manage our clients’ properties with RREEF personnel.

Q: Who are the members of RREEF’s management team and how is it structured?

A: As RREEF’s funds under management have grown to nearly $19 billion, we have worked hard to preserve an entrepreneurial approach. A small team of partners still makes all investment decisions (portfolio management, acquisitions, and dispositions). These partners average over 23 years of real estate experience and are led by Donald A. King, Jr., RREEF’s managing partner. An eight-member Policy Committee, two of whom are from DB Real Estate, is responsible for developing and approving both firm and departmental strategies, and monitoring the performance of the partners responsible for the firm’s various functional areas.

RREEF’s Investment Committee makes all decisions for the firm’s private market investment activities, including the acquisition, financing, and disposition of properties. This Investment Committee is comprised of 11 of RREEF’s most senior real estate professionals plus the portfolio managers for the account.

On the public side, sector allocations are established on a quarterly basis by our Strategic Investment Committee, whose membership consists of five senior members from the acquisitions, client relations, portfolio management, and research areas of RREEF, as well has the portfolio management team from the securities area. In addition, Claude Rosenberg, Chairman Emeritus of RCM Capital Management, provides an overview of the factors influencing movements in debt and equity markets, and relating those influences to potential moves in the REIT market.

Q: The stock market has gone through a difficult period for the past three years. Why do you think real estate has been able to buck the trend?

A: We think real estate returns have held up for three reasons: First, they missed the 1997-2000 bubble—they were never as inflated as other equity values Second, cash flow adjustments lag the economic cycle due to lags in both market rates and vacancy and lease expirations. Real estate is on a different cycle than other assets as well; i.e. the diversification argument for holding real estate in a multi-asset portfolio. And third, record cash allocations to both real estate debt and equity have buoyed the asset values despite declining cash flows (see Chart 1on next page).

The important question is will this continue? And I believe the answer is yes. Values should hold up as there is anecdotal evidence that there is unspent cash available, by some estimates there is about 3 years of unspent cash.

Q: If inflation were to return and interest rates were to rise, what impact would it have on the value of your real estate portfolios?

A: Long term, “anticipated” inflation is a wash for real estate (the long-term hedge argument). In the near-term, however, rising rates would increase mortgage costs and cause some deterioration in values. We don’t anticipate this to be that large. As the leveraged total return accounts (the opportunity funds) back off, the traditional core equity funds could potentially step up as buyers. One can argue that current market values appear to be defensively priced
against both rising rates and declining cash flows. The current spread between NCREIF income (or REIT dividend yield in the public markets) and the 10-year treasury is high by historic standards (see Chart 2 on next page).

Q: What percentage or your portfolio consists of properties you own and manage versus liquid real estate securities such as REITs?

A: Currently real estate securities comprise approximately 20 percent of our total assets under management. The remaining assets are held for our private real estate investors through separate accounts, and our various core and value-added commingled fund products.

Q: What differentiates your firm in its approach to direct real estate management?

A: For 27 years RREEF has been a leader in the real estate industry. RREEF has been at the forefront of:

* Designing new investment vehicles.
* Dedicating significant resources to applied research.
* Establishing a process to ensure realistic property valuations.
* Demonstrating a dispositions discipline and returning over $8 billion to our investors.
* Establishing trust and aligning interests with our investors.
* Exceeding industry performance benchmarks.

Although we have expanded the products and services we offer over the past 27 years to meet the changing needs of our clients, we have always maintained our conservative client driven approach to our investments. Our senior professionals have been working together as a cohesive team for more than two decades and have been through the ups and downs of the real estate cycle. We are known as a firm with the utmost integrity in everything we do and we are very proud of that reputation.

Q: What differentiates your firm in its approach to REIT securities management?

A: Drawing on RREEF’s 27 years of experience as an investor, manager, and operator of U.S. real estate, our RREEF Securities group stresses the importance of real estate fundamentals in its approach to the analysis and selection of REIT securities. The complete integration of RREEF’s extensive real estate resources into the securities investment decision-making process is our most significant source of value added capability and best distinguishes RREEF from other advisors. Our nationwide network of real estate professionals in nearly 500 properties gives our securities analysts first hand data on what’s happening in the markets where the public companies own properties.

Two key aspects of the investment process that utilize and rely on this distinction are sector weighting and stock selection.

Sector Weighting - The efforts of RREEF Securities are fully integrated with all other RREEF functions and rely on the real estate expertise of several senior RREEF partners to set investment guidelines. The Strategic Investment Committee is responsible for setting guidelines for the RREEF Securities model portfolio with respect to property type weightings.

Stock Selection - Stock selection is the result of our company modeling plus our valuation work, which leads to a forecast of total return for each individual company in our investment universe. In completing this detailed analysis, RREEF Securities analysts take advantage of their access to real time property market information provided through RREEF’s property investment activities, which include research, acquisitions, dispositions, portfolio management, property management, and capital markets expertise.

Q: Demographics are often used to access the strength of local real estate markets. How do you go about tracking changes in each of the locales in which you are active?

A: We established an internal research department at RREEF in 1986 in order to integrate more systematic research into our approach to institutional real estate investing. Today RREEF Research has eighteen professionals and operates out of RREEF’s San Francisco and New York offices and is led by Asieh Mansour, our Partner in Charge of Research.
Our Research Department performs a number of key roles for RREEF. These include analyzing the performance characteristics of equity real estate at both property and portfolio levels and using this information to advise on investment strategy and portfolio structure. This is done for publicly traded REIT securities as well as for privately held property. Other functions include:
Identifying long-term trends and changes to real estate capital markets, demographics, regional economics, lifestyles, technology, transportation, and other factors that will affect fundamental supply and demand for different property types and their investment potential.

Forecasting prospects for regional and local real estate markets before these are fully reflected in market pricing. Research staff systematically tracks economic conditions and forecasts real estate market performance in more than 55 major metropolitan areas. Unlike most institutional advisors, RREEF is also known for its detailed, “bottom up” research, producing regular detailed market forecasts for RREEF’s various operating groups on each local submarket where RREEF has property or an active interest in investing.
Injecting this information and insight into day-to-day operating decisions and planning on both a formal and informal basis, Research is integral to investment decision-making throughout the organization. Members of the department also frequently consult with RREEF clients, consultants, and industry organizations on investment and management issues.

Q: What are the greatest dangers in real estate as an investment, and how do you minimize your risk exposure?

A: For private real estate, we believe that spreading risk across different real estate investments is prudent. Spreading risk across investments with different performance characteristics is also desirable because it reduces the volatility of portfolio-level returns. Equity real estate investments are, by nature, “lumpy”. Single assets take large commitments of capital to acquire. Compared to most portfolios of publicly traded stocks or bonds, real estate portfolios contain relatively few, relatively large, investments. Investors buy those individual assets more than “the market”. The performance of similar properties in the same market can differ widely from property to property and from any one property to the market average. As a result, asset selection and management usually matter more to portfolio performance than allocations made to different property types or to market locations. Good portfolio performance will never be squeezed out of mediocre individual investments, regardless of how well diversified the portfolio is.

Spreading risk successfully within an equity real estate portfolio does not require that all allocations be filled. Performance targets are more likely to be met through careful selection and underwriting of individual assets, within broad diversification guidelines, than by meeting all allocation targets. Long-term strategic allocation/diversification targets can be underweighted or overweighted when tactical considerations dictate. These may be driven by near-term performance expectations and risks for each type of asset, or by the relative attractiveness of specific opportunities provided by the market. It makes sense to be pragmatic!

As for public real estate securities, we believe the majority of company-specific risks are measured and controlled through detailed financial modeling. We maintain detailed bottom-up cash flow models of all companies in our universe. Core revenue from existing properties is broken down by market and property type. Company management inputs are incorporated as are RREEF proprietary inputs. Models are updated quarterly or as events warrant.

Portfolio risk for real estate securities comes in two forms: 1) systematic risk, i.e., the risk of investing in a particular sector (the account will bear the risk of investing in the REIT sector); and 2) non-systematic risk, i.e., the risk of each individual real estate security. We concentrate our portfolio-level risk reduction efforts on individual REIT securities. By maintaining close watch on changing investor sentiment, trends in property supply and demand, and the differential impacts of demographic and economic factors, we assess the sector and securities risks in a careful and rigorous way. This is only possible with the resources of a large, full-service real estate investment management firm with active property management in approximately 115 offices nationwide. We continually track market conditions that affect the performance of the portfolio and investment activity that occurs within the REIT to determine the likely growth rate of earnings. To control risk, we impose a rigorous sell discipline.

Finally, in terms of specific risks out there in today’s economic environment, clearly there could be a second leg down or a double dip recession, the impact of which would be much worse for the equity markets. This is again a very good reason to still own real estate. Once the war issue is resolved, I think recovery will take hold and will be sustained. At this stage of the business/economic cycle (mild recovery with much uncertainty), the decline in potential real estate revenue is mostly over. But, event risk remains high. For individual assets, you need to look at lease rates relative to the market and the credit history of the largest tenants. Weaker tenants, weaker secondary markets will experience a greater occurrence of negative shocks. Commercial mortgage defaults are still very low but rising as cash flows are negatively impacted. It is a time to buy quality and buy patiently. It is also a time to watch costs closely—rising energy costs, insurance and soon mortgage will all place further constraints on property income growth.

Q: You formulate an investment strategy for each of your clients. What types of clients do you have and how do their investment strategies differ?

A: RREEF has a varied client base comprised of more than 230 U.S. corporate and public pension plans, Taft-Hartley funds, foundation and endowment clients, as well as some private and non-U.S. investors. For those clients with direct separate accounts, we work with them to formulate an individualized investment strategy.

On an annual basis, we formally document the investment strategy for each separate account (as well as for each fund product) through a client-approved annual Investment Plan. This dynamic document serves as a guideline for all investment decision-making for the portfolio.

Paramount to the formulation of an industrial investment strategy is a clear identification of the client’s reasons for investing in real estate. This includes but is not limited to the establishment of a specific investment style (core, value added, opportunistic, combination) and average return parameters. Establishing an investment style and return hurdle implies a selected risk profile unique to each investor.

Developing an understanding of the client’s existing portfolio is of equal importance. We formulate investment approaches that complement existing portfolios by diversifying industrial investments by property location, type, sub-type, occupancy requirements, and tenancy.

Q: How can investors learn about your current outlook on the real estate market. Do you have a newsletter or Web posting and how would those interested be able to receive it?

A: RREEF’s web site ( includes a Research page where several of our widely-distributed publications are available for download.

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