CalPERS is discovering that some of the leverage in its now $13.7 billion real estate portfolio falls outside its investment policy limits.
Drawing back the curtain a little more on what went wrong in what had been a $20 billion portfolio, executives at the $209.3 billion California Public Employees' Retirement System, Sacramento, have revealed that it was not only massive amounts of leverage, but also the kind of debt and the type of investments the system took on, that ended up cutting the value of its real estate portfolio by almost half.
The real estate portfolio's one-year return fell to -47.08% as of Feb. 28. Net total real estate returns have underperformed the customized benchmark in all time periods, according to the system's most recent staff investment report.
As part of the restructuring and soul-searching process that began when the fund's value collapsed, CalPERS last June adopted a more conservative real estate investment policy that includes various elements of risk and leverage not counted before. It also reduced the amount of leverage the real estate portfolio can take on.
System officials since have recalculated just how much risk the real estate portfolio had taken on — viewed under the new investment guidelines.
And indeed, the real estate portfolio is outside those investment policy limits. For example, the 65.2% loan-to-value calculation of the total portfolio, which reflects the amount of debt on a parcel compared with its property value, is 5.2 percentage points above the policy limit, according to CalPERS' last quarterly report, issued Feb. 10. The 55.6% loan-to-value calculation of its core portfolio is 10.6 percentage points above the policy limit.
System officials estimate it will take three to five years to bring the portfolio in line with the new limits.
What's more, CalPERS took on the wrong kind of debt. Close to 40% is recourse debt — that is, debt not backed by the property — that exposed the system's portfolio to risks beyond the specific properties, according to a memo prepared by the system's real estate consultant, Pension Consulting Alliance Inc., for the investment committee's April 19 meeting. CalPERS' recourse debt is 29 percentage points above the current policy limit. It is also 14 percentage points above the old policy limit, the investment committee agenda materials reveal.
Some $45 million of this recourse debt was in the apartment/residential subsector, $811 million in housing, $1.5 billion in its opportunistic investments and $1.2 billion in urban subsectors that would not have been counted under the old method. In all, CalPERS had about $5.4 billion in recourse debt as of Sept. 30. The total permitted amount of recourse debt is about $1.4 billion.