U.S. pension funds are preparing to take their biggest plunge into international real estate since a decade ago, when some lost money on ill-fated investment properties.
Trustees for the $130 billion California Public Employees' Retirement System, Sacramento, approved a $100 million investment in Luxembourg-based Security Capital Global Realty Co. The fund is expected to have $1.6 billion in investment capital. It will seek controlling interests in Asian, European and Latin American real estate operating companies or start companies from scratch.
Also investing in the fund is the $27.2 billion Virginia Retirement System, Richmond, Va., which approved a $50 million investment in Security Capital Global in February.
The $21 billion Colorado Public Employees' Retirement Association, Denver, also invested an undisclosed amount in the fund. State pension funds in Utah and Wisconsin also have invested, CalPERS officials said. Officials from Utah and Wisconsin did not return phone calls.
Some $1 billion of Security Capital Global Realty's money is expected to come from pension funds.
Security Capital Group Inc. has successfully used a similar investment strategy for real estate investment in the United States.
Seeking enhanced returns
International real estate investment has again piqued the interest of a number of other pension funds. Such investors are looking outside the U.S. real estate market for enhanced investment returns, said Karl Smith, director of real estate consulting at Frank Russell Co., Tacoma, Wash.
Russell's clients -- its roster includes a high number of corporate pension funds -- have "more interest" in international real estate, Mr. Smith said. Frank Russell is preparing a white paper on international real estate.
CalPERS' real estate consultant, Pension Consulting Alliance/E & Y Kenneth Leventhal Real Estate Group, Studio City, Calif., warns that not investing internationally in real estate could mean passing up a major investment opportunity for U.S. pension funds.
That position was strongly backed by David Gilbert, CalPERS's senior real estate officer.
"The U.S. (real estate) markets are quite clearly fully priced in many respects today. We view this as a higher risk and higher opportunity," Mr. Gilbert said.
Security Capital Global Real Estate is expected to realize an internal rate of return between 15% and 20% Those returns would be higher than investors normally can expect from stocks.
Investors in international real estate could expect significant diversification benefits, PCA consultants say. Statistical evidence shows meaningful noncorrelation between U.S. real estate returns and international returns.
The U.S. real estate market has stabilized, consultants say. It means U.S. investors probably won't be getting the same high returns they have in the recent past.
Others move aggressively
In contrast to the strong U.S. economy, Asia is in economic turmoil and property prices have fallen. The consultants expect some significant investment opportunities there.
Investment banking firms Goldman Sachs & Co. and Morgan Stanley & Co. Inc., both based in New York, already have moved "aggressively into both the European and Asian markets" looking for real estate opportunities, according to CalPERS' consultants.
Goldman Sachs, they say, has sent more than 50 people to various Asian markets to scout out real estate investments.
More investors are expected in Asian and European real estate markets. PCA consultants expect a new wave of U.S.-based investors in real estate to follow opportunity investment funds already interested in off-shore markets.
Consultants, with some exceptions, say the outlook for European real estate markets is positive. Property markets there are on the upswing, providing investors with potentially significant investment returns.
Realization of the European Monetary Union is likely to mean greater cross-border investing, the consultants predict. The EMU also will integrate real estate markets there.
And Europe is moving toward securitization of real estate, which would provide investors with greater liquidity for investments.
Same old story?
But some U.S. pension funds have heard about enormous opportunities in international real estate before, with less-than-stellar results. For example:
* Dozens of pension funds invested in the $425 million Randsworth Trust PLC, a portfolio of United Kingdom properties, in 1989. It was then called the most significant entry of American institutional money in the European real estate market. But by late 1991, Randsworth, battered by high interest rates in the United Kingdom, was troubled. One investor, the Massachusetts Pension Reserve Investment Management Board, Boston, wrote down its $25 million investment to zero value. Other investors included AT&T Co., New York, and Ameritech Corp., Chicago.
* Pension funds also invested in Cadillac Fairview, a $1.5 billion portfolio of Canadian properties, in 1987. By 1994, sources reported, investors were buying subordinated debt in Cadillac Fairview Inc. at 20 to 22 cents on the dollar. (Pensions & Investments, June 13, 1994.) Investors in Cadillac Fairview included Ameritech; State of Connecticut Trust and Retirement Funds, Hartford; Iowa Public Employees Retirement System, Des Moines; and CalPERS.
Consultants with PCA/E&YKL say they have concerns about Security Capital Global:
* The firm's investment strategy hasn't been used outside the United States.
* Security Capital's U.S. team hasn't invested outside the United States. Rapid expansion might spread senior management too thin.
* Investments will be exposed to addition currency and political risks. But, the consultants say, Security Capital is offering an attractive offshore investment opportunity. The firm has a clear strategy, similar to the one it has used successfully in the United States.
Global Realty also has a large staff with extensive experience and substantial resources.
Security Capital, meanwhile, is expected to invest $600 million of its own money in the fund, giving it aligned interests with its investors.
The consultants also say the investment fees -- 1.25%per annum of the market value of invested capital, and operating and administrative expenses of less than 35 basis points -- are reasonable.
Furthermore, the consultants say, what so hampered previous investments in international real estate -- the inability to get out of them -- might not be a problem here. Security Capital Global has filed for a listing on the Luxembourg Exchange, so investors could sell their interests.
The fund's approach to international real estate investment is different, Mr. Gilbert said.
Pension fund investments in Europe in the late 1980s sought to buy properties, build value and get out. Security Capital Global Realty, he said, will buy controlling interests in existing public and private real estate operating companies or build them from scratch for long-term investment.