New Sources of Capital from Target Date Funds Steven Chudnow Prudential Real Estate Investors Steven Kapiloff UBS Realty Investors John Noell Mayer Brown Lennine Occhino October 17, 2012 National Association of Real Estate Investment Managers

What is a defined contribution (“DC”) plan? Participants fund contributions Risks of investment return on participants Participants direct investment of their own accounts

DC Terminology 401(k) – Internal Revenue Code § 401(k) 404(c) – Internal Revenue Code § 404(c) CIT – bank collective investment trust DB – defined benefit DC – defined contribution ISA – insurance company separate account QDIA – qualified default investment alternative RIC – registered investment company

Pension Trends and Drivers DB plans maturing and cash flow increasingly negative DB underfunding Disincentives to funding Investment losses Maturing participant population Accounting rule changes requiring pension liabilities to be reflected on corporate balance sheet

DB  DC Migration of Pension Assets DOL statistics indicate that between 1978 - 1997: Total private pension assets grew from $377 billion to $3.5 trillion The percentage attributable to DC plan assets increased from 27% to 51% Investment Company Institute: DC assets grew 6,100 percent over a ten-year period

2006 Pension Protection Act 2006 change in law to facilitate auto enrollment of employees in DC plan Established new fiduciary safe harbor for “QDIAs” as 401(k) default option QDIAs must be appropriately diversified (typically target date, balanced or lifestyle funds) QDIA managers include: External management firms Internal management professionals

Projected Growth of Target Date Funds in DC Plans Investment Company Institute: By the end of 2015, 35% of all DC assets in a target date type product Cerulli Associates: Target date funds in DC plans will grow from $426 billion in 2011 to $1.5 trillion in 2015 Casey, Quirk & Associates: Target date funds will swell to $2.6 trillion by 2018 from $311 billion in 2008

DC Real Estate Opportunity Through target date strategy, DC portfolios aligning with DB portfolios Callan Associates 2009 survey: 73% of target date fund managers had a dedicated real estate allocation PIMCO 2009 Defined Contribution Trends Survey: U.S. consulting firms promoting diversification and inflation hedging in DC plans Casey, Quirk DC plan sponsors concerned that current target date asset classes insufficient to address longevity, market volatility and inflation risks

DC Investor Categories Plan participant On behalf of 401(k) account Internally-managed portfolio On behalf of plan Externally-managed portfolio Externally-managed fund RIC CIT ISA Private DC fund of funds

Traditional DC Investment Vehicles Bank CITs JPMorgan Insurance company separate accounts Principal Life TIAA Public REITs Registered investment companies Limited to liquid assets

New Twist on DC Investment Vehicles DC Friendly Fund Investors RICs REITs CITs ISAs Externally-managed plan accounts Internally-managed plan accounts DC fund of funds GP Manager (RIA) Features Open-end Daily valuation Daily liquidity for participants Quarterly liquidity for plan LP Core funds Liquidity Cash Credit line Public REIT stocks Specialty funds Direct real estate

New Twist on DC Investment Vehicles DC Eligible Fund Investors CITs ISAs Externally-managed plan accounts Internally-managed plan accounts Participants Bank Trustee or Insurance Co Manager (RIA) Features Open-end Daily valuation Daily liquidity for participants Daily liquidity for plans CIT or ISA Core funds Liquidity Cash Credit line Public REIT stocks Specialty funds Direct real estate

New Twist on DC Investment Vehicles Parallel DC Friendly/DC Eligible GP Manager (RIA) Bank Trustee LP CIT Liquidity Cash Credit line Public REIT stocks Core funds Specialty funds Direct real estate

Limited Partnership Bank CIT Insurance Co. Separate Account Unlisted REIT Tax Status Partnership/flow-through 501(a) tax exempt bad income blocker Annuity converts bad income REIT ERISA Status ERISA plan assets Not ERISA plan assets Securities Law Exceptions Reg D under ‘33 Act 3(c)(7) ‘40 Act 3(a)(2) ‘33 Act 3(c)(11) ‘40 Act ‘33 Act/‘34 Act registered Falls outside definition Registration/Approvals None Must be approved by state insurance regulator Registered Investor Eligibility Externally-managed plan portfolios Internally-managed plan portfolios RIC CIT ISA DC fund of funds Plan participants Externally-managed portfolios Internally-managed portfolios Other Considerations Unit not transferrable – only redemption permitted Bank trustee must maintain overall investment control SEC focus on abuse Very inexpensive and easy to establish OCC mandates redemption payout within one year Investors hold annuity contract rather than direct fund interest Insurance company remains as intermediary with investors No parallel vehicles for other investor categories No “investor control” Expenses high due to registration Ongoing public reporting

DC Investment Issues Liquidity Daily pricing Plan participant driven – daily Event driven – reasonable accommodation RIFs Corporate transactions Plan design changes Plan fiduciary driven – quarterly Investment option changes Daily pricing

What to ask a Real Estate Manager Liquidity Management Managing cash flows and liquidity needs of TDF Managers and Plan Sponsors Plan TDF 15% to 40% of Plan Assets Real Estate 5% to 15% Allocation Private Direct Property 60-100% Cash/REITs 0-40% Credit Line 5-15% Factors to Consider TDF Cash Flow Rebalance methodology Events that may trigger a material change in cash flows; i.e., reenrollment, new participant enrollment, plan design changes What to ask a Real Estate Manager Are there liquidity queues to get in and/or out of private real estate? Does the manager deploy a multi- fund approach or single strategy? Utilize line of credit or back stop to guarantee liquidity

Liquidity Versus Optimal Allocations Liquidity Range 100% Publically Traded REITs 0% Private Direct Property Cash/REITs 20-40% Direct Private Property 60-80% Optimal allocation to produce desired outcome in TDF Trade off between liquidity and optimal allocation What is the real liquidity risk?

Daily Valuation: “30,000 Foot View” Record keeper determines NAV C-TDF DC RE Fund Overall Fund NAV determined by custodian NAV determined by RE Manager and/or 3rd Party NAV determined by fund(s) Private Real Estate Fund(s): 60-100% Liquidity Components: 0-40% (REITs and/or cash) +

Valuation Methodologies Range of Approaches Valued In-house Partially outsourced to 3rd Parties Valued by 3rd Parties Individual property appraisals Appraiser review process at Fund level Intra-quarter changes; capital deployed, extra-ordinary revenue/ expenses Net operating income and changes thereto Transparency Integrity of the internal model Frequency of change Conflicts of interest Organizational confidence in change notification process Materiality levels Frequency of change Strength of market database Organizational confidence in change notification process Access to accounting records of manager

DC Sponsor Considerations Liability for plan participant investment decisions 404(c) QDIA Participant education Fees/costs New participant-level disclosures of fees and expenses DOL, Congressional focus on excessive DC costs Zero UBTI tolerance Recordkeepers must add fund to platform DC Real Estate Council