SACRAMENTO, Calif. - The $50 billion California State Teachers' Retirement System has taken a first step toward a major change in its real estate policy.
The fund's real estate staff is recommending a new policy that calls for securitizing all or part of its $1.6 billion realty portfolio.
Securitizing even part of the portfolio could lead to some changes in the real estate manager lineup, agreed James Mossman, chief executive officer. But no decision has been made on how much, if any, of the portfolio will be securitized.
As an important player in real estate, the fund's new policy could give an important boost to the $40 billion public real estate market. The change might influence other pension funds to change their policies or accelerate their moves to the public real estate markets.
The retirement system's board told its staff to prepare a request for proposal for an adviser or manager that can implement the securitization policy, but withheld final approval of a policy change pending further examination.
In a separate action, the board also approved developing an RFP for an emerging markets index fund manager. That RFP probably will be ready for approval in November.
Mr. Mossman said the real estate securitization RFP could be ready in January.
Mr. Mossman said he has no reason to think the board won't adopt the RFP for the real estate adviser. Still, he said, "it's not a done deal."
"A fairly arduous process" is ahead before any change could be implemented, he said.
A staff proposal suggested shifting the focus from traditional private equity investments that are the mainstay of most pension funds. The proposed policy instead would favor the public real estate markets.
The fund's staff suggested several different tactics to securitize the real estate portfolio. One proposal calls for trading the pension fund's existing properties for common shares in real estate investment trusts and investing additional new capital in the REITs.
The fund would continue to invest in the private real estate market, but there would be new qualifications on such investments. The fund would move away from individual property transactions except for value-added opportunities that increase the attractiveness of its existing assets, improve the ability of the fund to securitize portfolios or create higher investment returns.
The fund would move toward a greater percentage of non-traditional, higher-yield real estate assets.
Currently, only 15% of the fund's real estate assets are publicly traded real estate securities.
New investments also could include making private placements in, or buying shares of, undervalued real estate companies.
Pension funds have shown interest in securitization partly because securitized real estate is more liquid than traditional property investments. Many pension fund executives complain about the trouble they had withdrawing from open-end commingled real estate funds.
Mr. Mossman said if the policy is adopted, the staff would have the option to use the securitization strategy.
"The board essentially did go ahead with the staff recommendation to proceed with the RFP proces....but I think they also want to look closely as to what is going to be asked of this adviser," Mr. Mossman said.
"I think the board is still a little unclear of what the role of the adviser would be, so they want to see that in RFP-type language," he said.
Mr. Mossman said the fund doesn't have the in-house expertise or experts among its current real estate advisers or consultants to execute the strategy.
"All they (the board) did is to say, 'We are willing to explore the notion of getting some expertise in here to advise us on what we might do relative to securitization of some portion of the real estate portfolio,'" said Mr. Mossman.
The recommendation for the policy shift came from the fund's real estate staff and its real estate consultant, Institutional Property Consultants Inc., San Diego.
Officials for the pension fund see the new strategy as offering some advantages:
They expect real estate yield to be enhanced, the real estate portfolio to be more liquid and the staff to have the ability to make changes in real estate holdings faster.
They expect the new policy to increase overall portfolio investment returns.
They believe they will have the ability to create real estate structures and garner higher investment returns by adjusting to market conditions.
Many pension funds moved toward some securitization after the recent real estate downturn. "Like any other large institutional investor, we suffered (in real estate investment returns) for several years. Our portfolio has stabilized and we are doing OK now, but we took a fairly large hit a couple of years ago when the properties were appraised," said Mr. Mossman.
The pension fund also is expected to search for a money manager to invest passively in emerging market equities. The new strategy is needed, according to the pension fund staff and its general consultant, Pension Consulting Alliance, because the fund's active international managers have invested less than 5% of its international equity exposure in emerging markets, and the previously adopted strategic target of 10% of international equity exposure for emerging markets is unlikely to be reached.
