IIJournals JPM-Special Real Estate Article Collection | Page 30

A third practical implication holds mainly for US
pension funds. Our study clearly shows that US funds
have significantly higher costs than their global peers
in any size group. This seems to be caused by their
greater reliance on external managers, and Andonov
et al. [2013] show that these external managers are more
costly in the United States than elsewhere, especially
in direct real estate. Cost-cutting and tougher negotiations with external managers should be a priority for US
pension funds if satisfactory performance on their real
estate investments is to be attained.
Last, and maybe most fundamentally, pension
funds would be well advised to consider the practical
implementation issues of real estate investment when
deciding whether to invest in real estate in the first place.
Our results suggest that a pension fund that is not able to
opt for the internal approach and not willing to invest
indirectly should seriously reconsider any allocation to
real estate at all, given the relatively poor net returns
generated by external managers and fund-of-funds, even
if the theoretical return–risk trade-off for real estate
seems favorable.
ENDNOTES
We thank CEM Benchmarking Inc. in Toronto for
providing us with the CEM database. The authors thank the
Real Estate Research Institute (RERI) and the University
of Toronto’s International Centre for Pension Management
(ICPM) for financial support. Kok is supported by a grant
from the Dutch National Science Foundation (NWO).
1
REIT investments are reported separately in the CEM
database. CEM explicitly asks pension funds to split REIT
investments from the (small-cap) equity mandate. In the
case of passive index investments, some pension funds may
not be able to filter out REITs, and our results may thus
slightly understate actual allocations to REITs. But small-cap
investments do not account for a very large part of pension
fund portfolios, and passive investments in small-cap equity
represent less than 15% of the total small-cap equity assets,
so any underestimation is likely to be small.
2
In the CEM database, internal management means
that the buy–sell decisions for the individual properties are
made within the organization (including wholly-owned
subsidiaries). When outsourcing the investment decision,
institutional investors can directly select the external managers (funds) or invest via fund-of-funds. External investing
also incorporates real estate limited partnerships. Separate

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accounts at the external managers are classified as external
management.
3
In the CEM database, pension funds declare their
benchmarks, which are usually market indexes (for example,
the NCREIF Index or the FTSE/NAREIT Index for US
real estate investments). Benchmark returns can also be a
combination of multiple indices, weighted by the asset allocation. The advantage of using self-declared benchmarks is
that these benchmarks more precisely ref lect the allocation
and risk exposure of the real estate allocations. For example,
if a fund is exposed to office buildings in the United States,
benchmarking its returns against the NCREIF Office Index
is more appropriate than using the broader NCREIF Property Index.
4
In addition to the transaction costs involved in the
properties, internal investment costs include compensation
and benefits of employees managing internal portfolios and
support staff, related research expenses, and allocated overhead costs.
5
CEM’s definition of external investment costs capture the management fees paid to investment consultants and
external money managers. The performance fees, carried
interest (fees that are a portion of returns exceeding a hurdle
rate), and rebates (the limited partners’ share of certain fee
income realized by the general partner in connection with
the fund, such as break-up, monitoring [