This week, the California Public Employees’ Retirement System (CalPERS) publicly disclosed its plans to earmark $6.6 billion in real estate during its new fiscal year. The figure was staggering by any measure, topping the pension plan’s already outsized allocations of $5.7 billion and $4 billion to its real managers in fiscal years 2013-14 and 2012-13, respectively.
At first glance, the planned commitments would appear to give CalPERS a major leg up in meeting its new 11 percent target in real estate by July 1, 2015, as part of a new asset allocation plan that was adopted in February. The institution, which currently is approximately $300 billion in size, had an 8.5 percent allocation to property as of June 30.
There’s a good chance, however, that CalPERS won’t hit its new target on time. PERE understands that the pension plan’s real estate managers haven’t all been able to deploy all of the capital that CalPERS had allocated to them in previous fiscal years, as a result of a highly competitive property market that has made it more difficult to find assets with appropriate pricing and returns to meet CalPERS’ investment thresholds. “You can get a respectable return, but it’s a tighter return than it was a couple of years ago,” one manager said.
It is true that many institutional investors have been unable to put as much money to work in real estate as they intended, as properties continue to be fully priced. Retirement systems like CalPERS, however, face a particular disadvantage in that they typically are held to fixed return targets, which often don’t apply to other property buyers like sovereign wealth funds, insurance companies and real estate investment trusts. This makes it even harder for them to source good deals.
Given current market conditions, CalPERS consultants Wilshire Associates and the Pension Consulting Alliance both have advised their client to remain disciplined in its underwriting and avoid unnecessary risks as it seeks to increase its allocation in real estate. Indeed, CalPERS and the managers are said to have avoided pursuing transactions that are not consistent with underwriting standards for risk and return. “We’ve got certain guidelines and if the market doesn’t provide the product that meets the guidelines, we probably won’t invest all the capital in a given year,” one manager said.
PERE understands that despite the failure to invest all of the $5.7 billion from its previous fiscal year, CalPERS has nonetheless increased its planned commitments for fiscal year 2014-15 to comply with its new asset allocation plan, which covers the next three to four years. In doing so, the pension plan is thinking more of its longer term goals, which is to reduce its risk in the equities markets by moving more capital into real estate and other real assets. With their lower correlation to equities, real assets also would provide diversification benefits and current income to CalPERS.
Because of this long-term perspective, coming up short on its real estate allocation matters less to the pension plan in the short term. For one thing, if the institution does miss its target next July, it still will be within the five percent allocation range for the asset class. More importantly, however, because real estate is cyclical, the pension plan could encounter more favorable buying conditions over the next three to four years than it does currently.
So despite appearances to the contrary, CalPERS and its real estate managers are not under pressure to invest billions into the asset class in the coming months. With regards to its asset allocation plan, CalPERS isn’t focused on any particular fiscal year. It’s looking at the big picture.