CalPERS’ investment committee on Monday will discuss whether to increase leverage to 50% in its $8 billion core real estate portfolio, a move that could boost returns by 100 to 125 basis points a year while adding significant risk. The loan-to-value ratio for the core portfolio was increased to 40% in August, from 25%.
Staff at the $149 billion California Public Employees’ Retirement System, Sacramento, said low interest rates make using debt attractive. For example, a 10% internal rate of return for unleveraged investment would increase to 12.33% at 40% leverage and 13.5% at 50% leverage, the staff noted in a memo. Use of higher leverage also would free up about $3.2 billion in additional core investment capacity.
But higher leverage would make the portfolio more volatile and could reduce cash flows and increase refinancing risk, the staff noted. Consultant Nori Gerardo Lietz of PCA/E&Y Kenneth Leventhal Real Estate Group notes a 50% leverage policy would be out of line with other pension funds, would boost the leverage ratio of the entire real estate portfolio to 55% to 60%, and would create unknown correlation effects with other major asset classes.
