Real estate is hot, again.
One manager estimates as much as $75 billion in new capital could flow into real estate over the next 12 to 18 months if all institutions followed their consultants' recommendations for the asset class.
Consultants and managers expect the trend to continue because sponsors are searching for ways to boost returns, and real estate has been a top performer.
Said Michael Rosen, partner at consultant Angeles Investment Advisors, Santa Monica, Calif.: "Around 25% of our clients have made investments (in real estate) this year, up from 10% a year ago, and I expect it to move to 50% or more going forward."
In July, the $10.5 billion San Francisco City & County Employees' Retirement System raised its real estate target to 12% from 8% following an asset-liability study done by Angeles. Executive Director Clare Murphy said the study showed that increasing real estate would increase return slightly and reduce risk. Funding will come from reducing domestic and international equities. Most of the new commitment will be used to increase the system's stake in a co-investment with AMB Property Corp., San Francisco, to 80% from 50%.
Also in July, the $74 billion New York State Teachers' Retirement System, Albany, raised its target allocations to equity real estate and to mortgages to 8% of assets each, from 6%.
"Real estate's returns were more favorable compared to the other asset classes, so it was decided to increase the target allocations," said spokesman Dave Daly. The equity real estate allocation will be funded by reducing international equities; mortgages will be funded from fixed income.
Jay Kloepfer, senior vice president and director of the capital market research group at San Francisco-based Callan Associates Inc., NYSTRS' consultant, explained: "We did an asset allocation study for NYSTRS, and one of the conclusions was to increase alternatives; real estate was one of the potential alternatives. They're comfortable with real estate and have a program in place. Real estate has been their best-performing asset class in the last two years. The others (asset classes) had declined so much, NYSTRS had reached the upper end of its real estate target. After a lot of discussion, they concluded it was silly to sell assets they liked so much and figured why not go to 8%, and we had no problem with that."
For the year ended June 30, 2001, the most recent date for which NYSTRS returns were available, the system's domestic equities returned -10.5%; international equities, -24; and alternatives, -10%. Equity real estate, meanwhile, returned 13.5% for the period.
Mr. Kloepfer said the system considered equity real estate more attractive than bonds for income generation since bonds were yielding around 5% while real estate was yielding close to 8%.
Fitting the bill
The $22 billion Teachers' Retirement System of the State of Illinois, Springfield, last month approved raising its real estate target to 14% of assets from 10.6%. "Given where the bond market interest rates are, we're thrilled with the diversification that real estate can provide," said Charles Self, former chief investment officer. "We're not thrilled with the 5% return from bonds and wanted another way to diversify away from U.S. equities that wouldn't be too far below our actuarial assumptions. We thought real estate would fill the bill."
Added John Day, assistant executive director and interim CIO: "We've had a good track record and a large enough portfolio to develop expertise in real estate, and have done well with it. One of our strong points has been selecting managers." The system is starting a structural analysis to determine whether to add new managers or to increase the mandates of existing managers. Its current portfolio consists mainly of core separate accounts plus a few hotel properties and an agricultural allocation. The system's real estate portfolio returned an annualized 7.8% for the three years ended June 30 and 10.6% for the five-year period, Mr. Day said.
Other systems are just beginning to invest in real estate. For example, the Indiana State Teachers' Retirement Fund, Indianapolis, with $3 billion in defined benefit assets, will start to look for its first real estate managers shortly, said CIO Robert Newland. An asset allocation study showed 5% of assets should go into real estate for better yield, he said. The funding will come from fixed income. The system plans to issue RFPs for one manager to run 80% of the portfolio in a core strategy and another manager to run the remainder in an opportunistic strategy.
Among those returning to the asset class or coming to it new are the $300 million Kansas City (Mo.) Firefighters' Pension system, which is selecting a manager to run $15 million in a broad core open-end fund; the $200 million New Orleans Firemen's Retirement System, searching for a few managers with different strategies to invest its $10 million allocation; and the $300 million endowment of the University of Utah, Salt Lake City, which recently invested $15 million in Commonfund's real estate securities fund.
New asset class
The $850 million endowment of Smith College, Northampton, Mass., committed $8 million to TA Associates Realty's value-added fund, the endowment's first real estate investment in 14 years. Jay Yoder, director of investments at Smith, said the real estate investment is part of the endowment's new asset class, known as inflation hedges. That portfolio also includes a recent first-time timber investment of $8 million to the Forestland Group.
The $1 billion endowment of the University of North Carolina at Chapel Hill has been upping its real estate allocation during the past 18 months, taking it to 8% of assets from 5%, said Mark Yusko, president and chief executive officer at UNC Management Co., which manages the endowment. "We like real estate a lot and may increase it to 10%," Mr. Yusko said. "Compared to buyouts, it's the last leverageable asset, and it also offers consistent cash flow. But it's a little troubling that so many managers are selling now, because then we face the dilemma of redeploying the capital." Now the endowment is looking for more niche strategies, possibly involving local investment or development.
The $25 billion State Retirement and Pension System of Maryland, Baltimore, also is considering an increase to its real estate allocation. Spokesman Joe Coale said: "The target range is 2% to 7%, and we're now at 6.1% because the value of our properties has gone up. Some board members want increased exposure to real estate. A decision will be made after we get the results of an asset allocation study our consultant Ennis Knupp is doing for us."
Up to $75 billion
If all of these investors follow the recommendations, the tally for new capital into real estate could be as much as $75 billion, said Paul Saylor, chief executive officer C.S. Capital Management Atlanta. He noted that the firm's affiliate, Chadwick, Saylor & Co., this spring surveyed 300 pension and endowment funds in its database and found that almost 40% weren't meeting their real estate targets.
Mr. Saylor observed there has been so much interest in the asset class recently because of concerns that pension funds' actuarial assumptions of 9% are not going to be met without changing the investment mixes. "One answer has been real estate because it has done well. But if everyone starts to invest in real estate, returns will start to come down."