By Bernard Winograd

This year marks an important milestone for the U.S. retirement system. In 2007, the oldest baby boomers, the roughly 76 million Americans born between 1946 and 1964, first became eligible to collect Social Security and other retirement benefits. The ticking of America's demographic clock will get noticeably louder. Providing retirement benefits for an aging population will require progress and innovation along many dimensions, particularly as increasing numbers from that generation move closer toward retirement.

However, at least one solution is gaining traction in the retirement marketplace today. Target date funds may provide an opportunity to extend the acceptance that real estate has achieved in the defined benefit (DB) segment of the retirement market to the defined contribution (DC) segment.

To date, real estate has made moderate progress in the DC retirement market, despite the success of the asset class in DB plans and the availability of dedicated REIT mutual funds for DC plans. However, the increasing popularity of target date funds, also known as "life cycle" or "asset allocation" funds, has created an opportunity for real estate to play a much bigger role in DC plans.

According to the Investment Company Institute, the assets of life cycle funds held in individual retirement accounts and employer-sponsored DC plans, mostly 401(k) plans, have increased more than five-fold since 2003 to nearly $120 billion as of the first quarter of 2007. Their popularity stems from the fact that target date funds offer a relatively simple DB-like investment alternative that expands participants' investment options, while simultaneously simplifying the decision-making process and, at least in theory, improving investment performance.

Although the asset mix and allocations of target date funds vary, these funds have the discretion to invest in a broad range of alternatives to achieve the desired risk-return profile for the fund's investors over a relatively long time horizon, much like a traditional DB plan. With its low correlations with stocks and bonds and relatively high, stable cash yields, commercial real estate can help meet these objectives, just as it has in many DB plans for decades.

A few target date fund managers have already recognized the benefits that commercial real estate can offer in the context of a mixed-asset portfolio and have included an allocation to REITs and private real estate in their funds. However, if the experience in the DB market is any indication, the demand for real estate products, particularly funds that offer access to public and private real estate, should increase dramatically as target date funds continue to grow.

Private real estate and REIT performance will always be subject to capital and property market cycles. However, over the long term, they enhance risk-adjusted returns for retirement portfolios while providing predictable cash flows and a hedge against inflation. This will be as true for life cycle funds as it has been for defined benefit plans.