What pension funds need to know about commercial real estate

I was at a dinner party recently where I had the opportunity to speak with a teacher from New York, who was monitoring the performance of her pension fund quite well. She worried about whether, when the time came, there would be enough to fund her retirement and asked me bluntly, “Where should we invest?”

Without hesitation, I said: “Commercial real estate”.

Historically, in order to protect assets, pension funds invested in safer and lower risk products. Yet recently, pension funds have been playing across the risk spectrum as returns compress in their traditional asset classes. We have noticed an increase in inquiries from pension fund advisors and asset managers regarding increased allocations in real estate. And the trend has only accelerated in the last 12 months.

A 2018 study by PREA, as reported by National Real Estate Investor, showed that over the next two years, 56% of global retirement investors plan to increase their real estate investments to around 10% of their total retirement allocation. capital. 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 take a step back and analyze investment risk tolerance, not just return. And they discovered that one asset class has proven to be the most resilient and valuable: real estate.

What I’ve noticed while discussing real estate investments with advisors across all asset classes is that there’s a common misconception that real estate sparked the downturn. In reality, it was the products allegedly securitized by real estate that were a factor in the market crash, not real estate itself.

The fact is that real estate has continued to outperform all other asset classes such as fixed income, stocks and venture capital ever since. However, the traditional core real estate assets that have provided steady returns and significant appreciation in hub cities like New York and San Francisco are no longer as readily available as they once were, nor do they guarantee solid returns.

So where should these pension funds look? Although a bit riskier, value-added transactions in primary markets and investment opportunities in secondary and tertiary markets could be just what repos need to place their capital and earn a return.

Secondary cities

Technological advances and the ability to tap into a pool of talented labor have changed the dynamics of secondary and tertiary markets. Talented people are actively looking for accommodation in these cities, which is driving market growth. The Canada Pension Plan Investment Board bought assets in Knoxville, Tennessee, and Orlando, Florida, while the Massachusetts Pension Reserves Investment Management Board bought an office building in Seattle, research shows. internal of Colliers.

Many of our clients have turned to secondary and tertiary cities with buoyant fundamentals. While the allure of expensive buildings does not exist in these markets, the dynamics of industrial and creative office and multi-family markets could offer healthy returns.

Added value

According to an investment intentions survey, as reported by National Real Estate Investor, value added has become the most popular investment strategy, with 55% of respondents saying it is their new strategy. This becomes an even more compelling argument if pension funds believe the market will continue to grow.

We have seen a number of recent examples in New York alone of value-added acquisitions and partnerships by some notable pension funds:

CalSTRS has provided $100 million of equity in a $900 million purchase of an existing 1.3 million square foot block building, which will be retrofitted and expanded by an additional 500,000 square feet . PGGM, a Dutch pension fund, and its local partner recently purchased an apartment building on Manhattan’s Upper West Side for $416 million. Given the base of the investment, the plan will be an upgrade of the asset to increase rents and yield.

Canadian pension funds Oxford and CPP have purchased one of the largest redevelopment projects available in New York. The two funds acquired a three-block 1.3 million square foot asset for $700 million with plans to develop a mixed-use residential and office rental asset.

There are still those pension funds that make traditional core real estate investments, like the Ohio State Teachers Retirement System which recently purchased a 20% stake in the newly developed 10 Hudson Yards for $432 million. PGGM bought a 30% stake in another newly developed multi-family building, valuing its position at $195 million.

Looking to 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 makes the most sense based on their portfolio.

3. Be open to exploring opportunities in secondary and tertiary markets, which may prove to have strong underlying fundamentals and the potential for higher returns.