The high return of the overall real estate portfolio was achieved despite a downward trend in real estate returns, according to a staff report. Returns in most areas dropped by roughly three percentage points, to between 6% and 7.5% for core properties using up to 25% leverage, from 9.5% to 11% four years ago. Opportunistic fund returns dropped to 15% from 18% over the same time period, the report noted.
Other institutional investors earned sizable returns on their real estate portfolios, but none approached the CalPERS numbers. The $5.7 billion real estate portfolio of the California State Teachers' Retirement System, Sacramento, earned 35.1% gross and 30.4% net of fees for the same one-year period, said Sherry Reser, spokeswoman for the $133 billion system. CalSTRS' return was the result of the sale of several large properties and high lease income, she said.
The $4.7 billion real estate portfolio of the $59 billion State Teachers Retirement System of Ohio, Columbus, returned 21% for the same period. During the Ohio system's fiscal year ended June 30, officials sold real estate assets for rebalancing and to take advantage of the high prices, according to its 2005-'06 annual investment review. System officials were more selective with their purchases, because of projected lower returns for new purchases.
David W. Ziegler, partner in the real estate group of Ernst & Young LLC, New York, said institutional investors have been selling off direct investments, which are primarily core properties in separate accounts, and investing in commingled funds. Investors are broadening the risk spectrum of their real estate investments because they have been increasing their allocations to the asset class, giving them more money to invest.
"From what I see, investors are clearly looking to invest in non-core, but not to the exclusion of core," Mr. Ziegler said.
While the strategy of selling off core assets might be successful, investors who are moving into non-core might be losing sight of the reason they began investing in real estate in the first place — the income stream, Mr. Ziegler noted.
"As investors move out on the risk spectrum, are they achieving that objective?" he asked. He added that non-core investments are less steady and less predictable.