Cambridge Associates: ‘Favor opportunistic over core’

In both the US and Asia, the investment consultancy cautioned against core property.

Cambridge Associates, the Boston-based investment consultancy, has advised the San Francisco Employees’ Retirement System to opt for investing in the opportunistic – rather than core – real estate space.

“Favor opportunistic over core mandates,” the firm recommended in an annual overview of SFERS’ real assets program, to be presented at the pension system’s board meeting on Wednesday.

In the US, the consultancy noted that core real estate’s valuations remain high, driven by strong interest from both domestic and foreign buyers. “Current exposures should be monitored, as this segment of the real estate market is most susceptible to interest rates,” Craig Beach, Marc Cardillo and Dwight Keysor of Cambridge wrote. They cautioned that rising interest rates will likely result in cap rate expansion for core property, which could be partially mitigated by increases in net operating income fueled by a strong economy.

Going forward, more international investors may be drawn to core US real estate, which will increase competition if more ex-US pensions enter the US market as a result of changes to the Foreign Investment in Real Property Tax Act (FIRPTA) made in December 2015. The UK’s June vote to leave the European Union may also drive more investors toward the US as they seek safe havens for capital. However, Cambridge wrote that the UK continues to provide opportunities for certain investors, including in opportunistic urban real estate and niche sectors such as student and senior housing.

In the US, “value-add and opportunistic real estate strategies continue to be more interesting than core, given relative valuations,” Cambridge said in its overview. However, investors should expect lower future returns because of the lack of distressed sellers, increased competition for properties and weaker future growth expectations. The consultancy noted that new development will become a “more meaningful component” of opportunistic funds, which increases their risk profile.

In Asia, the consultancy found more downside risk than upside potential in core real estate. Predicting low cap rates for the long term in core real estate, Cambridge recommended short-term, opportunistic and value-added strategies of “manufacturing core assets” to sell to core investors.

SFERS managed about 74 percent of its real estate portfolio in core, as of September 30, with the remainder split between value-added and opportunistic real estate. The pension system invested 88 percent of its real estate portfolio domestically, with 4 percent each in Asia, Europe and emerging markets.

SFERS’ real estate portfolio returned 7.2 percent in its fiscal year ending September 30, lagging behind its 10.1 percent return benchmark, according to the meeting materials. The pension system managed $2.5 billion of real assets as of September 30, with 83 percent of the portfolio in real estate.