Mutual funds targeting commercial real estate.

During the booming 1980s, there were few if any mutual funds investing in real estate. But that is changing in a big way, mutual fund and real estate industry sources say. The REITs explosion, securitization of commercial real estate, and an uptick in property values and rents have mutual funds flocking to invest in real estate, industry insiders say.

"The attractiveness of real estate is being evidenced by new funds that are coming to the market," says Steven M. Graziano, senior vice president and director of marketing at Pioneer Funds Distributor Inc., a Boston-based mutual fund company. He adds that the number of real estate-related mutual funds has grown to 24 nationwide from just one in 1985. The 24 account for more than $1.3 billion in assets. Eight of the funds were established during the first six months of 1994 and nine in 1993.

Boston-based mutual fund giant Fidelity Investments Co., with more than $250 billion under management, set up a special new real estate department last year to explore real estate investment opportunities. Fidelity's real estate fund has more than $500 million in assets, mostly in REITs, and the staff at the firm's newly created real estate department has already grown to at least six people.

Analysts say more real estate-related mutual funds are on the docket and should be hitting the market in the near future, while some of the large mutual funds are still out of the arena.

"I would not be surprised if more funds come in. I would not be excited, though. I don't want more competition," says Graziano. "We are very bullish on real estate. It should be a component of everyone's portfolio. Real estate is going to be an important investment objective." In 1993, Pioneer Funds teamed up with Winthrop Financial Associates to establish a real estate mutual fund -- Pioneer Winthrop Real Estate Investment Fund -- that invests largely in REITs.

Ronald Borod, who heads the Public and Structured Finance Group of the Boston-based law firm Brown, Rudnick, Freed & Gesmer, attributes the mutual funds' growing interest to a moderate turnaround in the market and the securitization of commercial real estate.

"Mutual funds will become a very large buyer of commercial mortgage securities," Borod says. "They are coming into a greater volume." He added that the recent rush of securitization of commercial real estate has made the area very attractive to mutual fund managers.

Through securitization, which was virtually non-existent a few years ago, ownership of a single property or a group of properties is converted into securities. After purchasing the pool of properties and loans, the buyers weed out the properties, put together a portfolio of good assets and then go to a rating agency and come up with a rated security. After the securitization, they are sold in the form of debt, zero coupon bonds, and bonds with varying maturities and ratings through institutional trading desks on Wall Street.

"As funds become more and more comfortable with the rating structures and continue to complement their internal real estate expertise, they will invest more into real estate," says Mark Hall, a senior vice president at Hunneman Commercial Co., a Boston-based real estate brokerage firm. "More and more mutual funds are getting into commercial real estate. They're buying various tranches." He adds that securitization has created a lot of options for mutual funds because now they are able to pinpoint what they want rather than buying the whole piece of real estate.

"Liquidity is the key. They can move in and out quickly. In the 1980s, you did not have a lot of liquidity," Hall says. "There is more of a selection and broader property type that is being securitized."

He recommended, however, that mutual funds carefully look at collateral, especially for lower tranches. "You have to really look at collateral," Hall says. "Criteria to rate securities have become more formed and structured than in the 1980s. A mutual fund purchaser has a little bit more of a comfort level."

Borod adds that the law firm says that most mutual funds have been picking REITs, and it was unlikely that they would become traditional real estate owners. Traditionally, real estate investments were made either through a loan or purchase of a building.

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