CalPERS Recommits to Real Estate

By Jon Peterson

CalPERS could invest as much as $1.5 billion in commercial real estate next year, up from a fraction of that sum in the previous 12 months as the largest U.S. public pension fund has absorbed massive losses and reconsidered its investment approach.

The California Public Employees’ Retirement System is to begin discussion of its first real estate strategic investment plan in nearly three and a half years after tallying $8 billion in real estate losses during the recent economic downtown.

The last time the pension fund discussed a new real estate plan was the fall of 2007. Many large U.S. pension funds have a new real estate investment plan every year. CalPERS is expected to take action on its plan at its Feb. 14 board meeting.

The CalPERS board is expected to approve a substantial reduction in the risk profile of the properties it wants to own. According to a staff report, the fund should shift its real estate portfolio largely to core, or lower-risk, assets with no less than 75 percent of its holdings in that class going forward. The existing investment plan splits the portfolio evenly between core, value-add and opportunistic, or high-risk, real estate.

Clark McKinley, information officer for the CalPERS office of public affairs, said the pension fund took a beating during the real estate bust mainly because of over-leveraged investments in non-core properties. Its losses represented half of its real-property portfolio value, McKinley wrote in an email message. This includes the devaluation of properties in the downturn and debt that the pension fund was responsible for repaying.

It currently has a large non-core portfolio with numbers of assets still locked in commingled funds. It will take many months to unwind those commitments and place the capital elsewhere.

The pension fund wants income-generating properties rather than opportunistic real estate such as development land where it took major hits in the financial crisis and recession.

Other than a $190 million commitment to a joint venture with global office landlord Hines, CalPERS made no other significant commitments last year.

Allison Yager, a principal with Atlanta-based Mercer Investment Consulting, said buying core properties will be no cake walk. “There is a tremendous amount of core capital waiting on the sidelines seeking to buy properties,” she said. “We have a non-U.S. pension fund client that is of similar size to CalPERS, and we are recommending that they pursue a value-added strategy.”

The CalPERS board is also expected to discuss designating separate accounts as its favored investment structure. In a separate account, CalPERS would invest alongside the manager, in contrast to a commingled investment fund where CalPERS’ capital is committed alongside that of other investors, including the manager’s. The pension fund staff believes the separate-account approach allows CalPERS’ interests to be better aligned with those of the manager and gives the pension fund greater control and flexibility in making changes.

The pension fund now has the vast majority of its real estate investments in commingled funds that are value-added or opportunistic. But on the core side, its capital has been invested through separate accounts. It has a total of six separate-account managers for its core holding. That number has been winnowed in the last year as the pension fund reviewed manager performance. Its core managers today are General Investment & Development Cos. for apartments; RREEF LLC and GI Partners for industrial; CommonWealth Partners LLC for office and Miller Capital Advisory Inc. and First Washington Realty Inc. for retail.

GID has a regional office in Larkspur. RREEF has a regional office in San Francisco. GI Partners has its corporate headquarters in Menlo Park.

CalPERS’ real estate portfolio was valued at $16.5 billion through the end of September, the most recent report available. At that level, the pension fund has invested just less than 8 percent of its $228 billion of total plan assets in real estate. The targeted allocation for the asset class is 10 percent.