The $222.5 billion pension, which managed $27.6 billion in real estate as of March 31, started working with Belay’s predecessor company in 2006 to identify smaller operating partners than CalSTRS would typically invest in. In 2016, CalSTRS committed $200 million to Belay’s ‘fund of joint ventures,’ Belay Partnership Ventures II, to invest in programmatic JVs across the US and across property types.
Now, the pension fund is earmarking an additional $100 million to Belay for follow-on investments with select operating partners the firm backed through the fund. The new capital will be invested subject to Belay’s discretion through a co-investment structure.
These include Los Angeles-based Arc Capital Partners, an urban California and Texas-focused company with which Belay formed a relationship in 2014 and which invested $50 million on behalf of CalSTRS in 2016.
Arc Capital deployed this capital in four projects ranging from $5 million-$15 million in equity–a tenth of the size of the equity investments CalSTRS makes with its typical operating partners.
“Arc has been an effective, profitable partner and a good fit for CalSTRS’ real estate portfolio,” said CalSTRS’ real estate investment officer Josh Kawaii-Bogue. “Over time, as these emerging managers produce their expected results, we have the ability to commit more capital to their efforts.”
On behalf of CalSTRS, Belay also invested $70 million with two other companies: Eagle Property Capital Investments, a Hispanic-focused workforce housing specialist, and L&L Investment Partners, a Portland, Oregon-focused mixed-use developer-operator targeting creative office and multifamily.
The pension fund began working with operating partners in 2001 and has since brought on several managers, including Belay, to oversee some of its smaller relationships. While Mike DiRé, CalSTRS’ director of real estate, said there is not a hard distinction between emerging operating partners and those large enough to work directly with CalSTRS, he differentiated the groups by noting that the Belay-linked groups are small enough that the partnership is not overweight to any individual operating partner.
Through the use of JVs, CalSTRS can attain better alignment of interests with its managers and partners, as well as proprietary dealflow, lower fees and control of major decisions, DiRé told PERE. CalSTRS’ 21-person real estate team is limited in its ability to manage small relationships internally.
“The staff at Belay is better positioned to perform due diligence with smaller size partners,” DiRé said. “CalSTRS’ partnership with Belay provides us access to emerging managers, which we wouldn’t normally have. Belay, using the JV model, gives us the opportunity to effectively compete on smaller transactions that – because of our staffing limitation – we would otherwise pass on.”
Kawaii-Bogue said the Belay program works well for CalSTRS because Belay acts as an investment committee to oversee investment and asset management-related decisions. Belay also serves as an institutional mentor to help the firms develop reporting and corporate governance processes.
“Emerging managers don’t have the back office to handle CalSTRS’ high information demands and the requests we might have for capital administration, which can be overwhelming for a small group,” he said.
CalSTRS has placed greater importance on operating partner relationships since the global financial crisis, as the pension fund’s commingled fund investments fared worse than its programmatic JVs.
“After the crash, the value of the JV model over closed-end funds became apparent as most leveraged and transitional assets were in crisis mode,” DiRé said. “During this period, closed-end funds often couldn’t protect their real estate investments. For example, if the fund was outside the investment period or out of capital, it was unable to act because the limited partner model necessitates all partners agree to the action. Thus, the funds’ ability to be nimble – when it was most crucial – to either save existing assets or buy down its own debt at a discount was unattainable.”
By contrast, in CalSTRS’ operating company investments, the pension fund could control leverage levels and negotiate with partners for debt discounts.
“Recognizing we had the ability to efficiently recapitalize assets in a profitable way on real estate we already owned – now that was a huge ‘aha!’ moment,” said DiRé.
After the GFC, CalSTRS studied options for emerging manager programs, concluding that a fund of funds’ double fee layer was a poor choice for the fee-conscious pension fund. Instead, a fund of JVs allowed CalSTRS to, as DiRé said, “Go for a test drive on an asset strategy.” At the end of the test drive, CalSTRS could commit more capital for future investments or walk away without being tied up in a closed-end fund with less control for years.
Now, about 35 percent of CalSTRS’ US real estate portfolio is overseen by emerging managers as of December 31, according to its most recent diversity report.
For others considering a similar program, DiRé and his team cautioned that a would-be investor needs significant private markets experience with operating partners, along with appropriate staffing and funding.
“Success demands a long-term view and enough capital to attract multiple operating companies to consider exclusive relationships,” said CalSTRS’ real estate portfolio manager Mitch Pleis. “Due to the size and long-term nature of the JV strategy, you must be ready to do more than just dip your toe in the space.”