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I was recently at a dinner party where I had the opportunity to talk with a New York City teacher, who kept pretty good tabs on her pension fund’s performance. She was worried about if, when the time came, there would be enough to fund her retirement and asked me point blank, “Where should we be investing?”
Without hesitation I said, “Commercial real estate.”
Historically, in order to protect assets, pension funds would invest in safer, low-risk products. Yet recently, pension funds have played on the risk spectrum as yields compress in their traditional asset classes. We have noticed increased inquiries from both pension fund advisors and asset managers asking about increasing allocations into real estate. And the trend has only picked up in the last 12 months.
A 2018 study from PREA, as reported by National Real Estate Investor, showed that during the next two years, 56% of global pension investors expect to increase their real estate investments to about 10% of their total capital allocation. The study also found that pension fund investors intended to commit at least $60 billion to real estate globally in 2018.
Real Estate Is A Safe Bet
Coming out of the Great Recession, pension funds had to step back and analyze the risk tolerance of the investment, not just the return. And they found one asset class proved to be the most resilient and appreciable: real estate.
What I’ve noticed in discussing real estate investments with advisors across all asset classes is that there’s a common misconception that real estate triggered the downturn. In reality, it was the products supposedly securitized by the real estate that were a factor in the market collapse — not the real estate itself.
The fact is real estate continues to outperform all other asset classes such as fixed income, equities and venture capital since that time. However, the traditional core real estate assets that provided stable returns and significant appreciation in gateway cities like New York and San Francisco aren’t as readily available as they once were, nor do they guarantee robust returns.
So where should these pension funds look? Even though they are a bit higher on the risk spectrum, value-add deals in core markets and investment opportunities in secondary and tertiary markets could be just what pensions need to place their capital and recognize a return.
Secondary Cities
Technological advances and the ability to draw from a talented labor pool have changed the dynamic of secondary and tertiary markets. Talented people actively seek housing in these cities, leading to growth in the market. The Canadian Pension Plan Investment Board purchased assets in Knoxville, Tennessee, and Orlando, Florida, while the Massachusetts Pension Reserves Investment Management Board purchased an office building in Seattle, according to internal Colliers research.
Many of our clients have looked to secondary and tertiary cities with high-growth fundamentals. While the lure of the big-ticket buildings doesn’t exist in these markets, the dynamics of industrial and creative office and multifamily markets could provide healthy returns.
Value-Add
According to an Investment Intentions Survey, as reported by National Real Estate Investor, value-add has become the most popular investment strategy, with 55% of respondents saying this is their new strategy. This becomes an even more compelling argument if pension funds believe the market will continue to expand.
We’ve seen a number of recent examples in New York City alone of value-add acquisitions and partnerships by some notable pension funds:
CalSTRS provided $100 million of equity as part of a $900 million purchase in a 1.3 million-square-foot existing block-long building, which will be upgraded and expanded by an additional 500,000 square feet. PGGM, a Dutch pension fund, and its local partner recently purchased a rental apartment building on Manhattan’s Upper West Side for $416 million. Given the basis in the investment, the plan will be an upgrading of the asset in order to increase rents and yield.
Canadian pension funds Oxford and CPP purchased one of the largest redevelopment projects available in NYC. The two funds acquired a three-block-long, 1.3 million-square-foot asset for $700 million with plans to develop a mixed-use residential rental and office asset.
There are still those pension funds making traditional core real estate investments, such as Ohio State Teachers Retirement System recently purchasing a 20% interest in the newly developed 10 Hudson Yards for $432 million. PGGM purchased a 30% stake in another newly developed multifamily building, valuing their position at $195 million.
With an eye toward the future, here’s what pension funds need to do:
1. Review their real estate allocation to ensure they are positioned to take advantage of its growing market opportunities.
2. Identify the low-risk asset class and life cycle that make the most sense in accordance with their portfolio.
3. Be open to exploring opportunities in secondary and tertiary markets, which may prove to have strong underlying fundamentals and potential for higher yields.