Hike continues in real estate

Equity real estate investments by defined benefit plans in Pensions & Investments' top 200 employee benefit plans rose 29.8% to $150.1 billion in the 12 months ended Sept. 30, 2006, more than triple the growth rate from a year earlier.

When adjusted for the 17.62% gain by the NCREIF Property Index during the period, the increase was 10.4%. This is the first time in two years that real estate assets rose on a market-adjusted basis.

Investments in real estate investment trusts among the defined benefit plans in the top 200 increased 29% to $29.1 billion. When adjusted for the 24.01% return of the FTSE NAREIT U.S. Real Estate index, REIT investments gained 4.2%.

In other alternative classes, a sizable gain also was seen in venture capital. Defined benefit plans in the top 200 reported $23.7 billion in the asset class, a gain of 12.9% from a year earlier.

Overall, the aggregate asset mix of the defined benefit plans in the top 200 plans shows 4.1% of plan assets in both real estate equity and in private equity as of Sept. 30, up from 3.9% and 4% a year earlier.

While REITs are included in equities for the aggregate allocations, plans reporting REIT assets had about 1% of total assets in the trusts, a similar percentage to 2005, based on dollars reported.

For the defined benefit plan real estate equity investors, more than 90% of the assets reported were invested in domestic real estate, with 5% in international real estate and the remainder in timber.

The asset class remained popular despite concerns with rising real estate prices in some areas and sectors, with many pension funds increasing their allocations.

The largest defined benefit investor in real estate equity on P&I's Top 200 list continues to be the $228.4 billion California Public Employees' Retirement System, Sacramento. Its real estate portfolio grew 80% to $16.7 billion. The leap in assets is the result of CalPERS' strategy to sell its core, mainly domestic real estate investments and slowly reinvest the proceeds in non-core and global real estate, said Brad Pacheco, spokesman.

In September, the $156.1 billion California State Teachers' Retirement System, Sacramento, increased its real estate target by five percentage points to 11% of total assets from 6%. CalSTRS is second on the Top 200 list for real estate equity investments by defined benefit plans; its $11.6 billion portfolio is up 50% from a year earlier.

The Massachusetts Pension Reserves Investment Management board, Boston, saw a 62% increase in real estate equity assets to $4.9 billion. Despite selling 10 properties during its fiscal year ended June 30, the $45.5 billion fund was a percentage point over its 10% target because of appraisal and valuation, and the 24.61% return of its real estate portfolio in fiscal 2006, according to its annual report.

A driving factor among pension executives in raising their real estate investment is the large amount of capital available, said Stan Ross, chairman of the Lusk Center for Real Estate at the University of Southern California, Los Angeles.

Investors' portfolios have also reaped some of the profits from the sale of properties by their investment managers, which has given them even more capital to reinvest in real estate, Mr. Ross said.

The problem among real estate investors and money managers is where to invest all of the capital.

Much of it is going into foreign real estate, Mr. Ross said. For example, 20% of CalSTRS' real estate portfolio is allocated to predominantly opportunistic international strategies. The $14.9 billion Illinois State Universities Retirement System, Champaign, last month added a global mandate to two active real estate investment trusts run by RREEF, America and ING Clarion Partners and to a passive REIT run by Barclays Global Investors. Officials at MassPRIM are exploring investing in international real estate, although no allocation decisions have yet been made.

Although consultants do not expect overall real estate and REIT returns to continue at current levels, they could still beat stock and bond performance — or at least provide diversification.

Adding to the diversification argument, Mr. Ross noted investors were also interested in niche strategies such as development.

Last year, the majority of pension plans' interest was "and continues to be in core but they are heavily moving into value added and opportunistic strategies," said J. Michael Fried, chief executive officer of Phoenix Realty Group, a New York-based real estate firm investing in inner-city development projects.

High returns and some increased investment, including global REITs, caused an increase in REIT holdings by the largest pension funds. CalPERS' portfolio skyrocketed 452% to $2.2 billion as it parked about $1 billion of its uninvested real estate allocation in an internally managed, international REIT index fund pending a search for external active REIT managers.

Some pension funds and real estate consultants are also concerned with high REIT prices, said Monica Butler, managing director of U.S. consulting, Russell Investment Group, Tacoma, Wash. Higher prices could cause returns to suffer.

"But REITs still have a strategic place in a real estate portfolio," Ms. Butler said.

MassPRIM chipped away at its $1.34 billion REIT portfolio by funding a new $300 million allocation to RREEF America's value-added real estate strategy. Its consultant, Townsend Group, recommended the move, noting REITs' high-flying performance should slow this year. Instead, the fund is studying whether to add global REITs.

Still, equity REITs have outperformed the Standard & Poor's 500 stock index for 35 years, said Michael Grupe, senior vice president for research trade group, the National Association of Real Estate Investment Trusts, Even if REIT performance returns to the mean, that return might be higher than investors had anticipated, Mr. Grupe said.

Pensions & Investments added or altered several questions in private equity for the current survey, changing the subasset classes, so there are few comparison data. That said, however, venture capital investments increased 12.9% to $23.7 billion, after rising only a percentage point in the year-earlier survey.

A portion of the increase is due to the large number of funds that closed during the survey period, said Mark Heesen, president of the National Venture Capital Association, Washington.

"But we're coming toward the end of our fundraising cycle; Sept 30, 2005 was the high point," he said. "Pension funds have traditionally been the mainstay of venture capital commitments."

Pension funds have been loyal investors in venture capital, despite shaky short-term returns, he said.

But not all institutional investors are hanging tough with the asset class. MassPRIM recently reduced its overall allocation to between 10% and 20%, from 35%, but increased its target for buyout funds to between 60% and 70% of the allocation, from 45%.

Pension funds are investing in megafunds — with $10 billion or more — and the smaller funds with differentiated strategies, but staying out of the middle, said Steven Presser, partner in private equity firm Monomoy Capital Partners LLC, New York.

And while there has been a lot of conversation in board rooms about investing with new, so-called "emerging managers," only a few funds are interested in investing with newer firms, said Mr. Presser.

Monomoy Capital closed its first fund, the $280 million Monomoy Capital Partners LP distressed equity fund, on Jan. 9.

Defined benefit funds among the top 200 also reported $71 billion in buyout funds, $3.8 billion in commodities, $8.3 billion in distressed debt and $28.7 billion in other private equity.