With the global financial crisis now in the rearview mirror and markets around the globe back on the upswing, investing in quality real estate is becoming increasingly more difficult. Intense competition, higher prices and lower cap rates are just some of the challenges facing both GPs and LPs alike. And if you have a large amount of capital to deploy in a short time, those challenges are amplified.
Such is the situation facing the California Public Employees Retirement System (CalPERS), which is considering an asset allocation implementation plan that will bring the pension plan to its new 11 percent real estate target by July 1, 2015. Based on its current size of $287.2 billion, that means CalPERS may need to deploy as much as $5.7 billion into the asset class in less than 15 months – a significant amount for such a short period of time.
According to investment committee documents, CalPERS’ actual real estate allocation as of March 25 was only 8.5 percent, even lower than the 9 percent weighting it reported when it increased its allocation in February. Despite this underweighting, the pension still plans to reach a 10 percent allocation by mid-year and an 11 percent allocation by the middle of next year.
The investment committee will discuss the proposed investment pace at its meeting on Monday, and there is no doubt that the senior folks at CalPERS will be weighing the merits of the plan ahead of a scheduled vote at its May meeting. With its two consultants – Pension Consulting Alliance (PCA) and Wilshire Associates – expressing concern over the accelerated pace, it is worth considering the argument for and against.
Although CalPERS did not provide a comment as of press time, PERE understands that the giant pension has looked at the current real estate environment and decided that good opportunities meeting its investment criteria only will become more expensive as competition continues to increase. That is particularly true given its current strategy, which focuses primarily on core assets. As one other large global investor put it: “If you don’t like pricing now, you are really not going to like it next year.” Therefore, the sooner that CalPERS can put its money to work, the better off it should be.
As for the argument against, PCA stated in a letter to CalPERS that it “does not believe that ‘filling an asset allocation bucket’ just to meet a long-term goal makes sense.” The consultant noted that pricing is making it difficult for managers to meet capital commitments at expected income-oriented return levels and that CalPERS should be “very cautious and patient in pacing its growth of the real estate asset class to the target levels.” PCA recommended adding a minimum of one more year to the schedule.
Similarly, Wilshire advised against the pace of the plan and questioned whether CalPERS, which previously had difficulty achieving a higher allocation, “actually can reach its new target in an expedient fashion.” The consultant recommended “a slower phase-in or the development of a contingency plan for a persistently low real estate allocation.”
In its supporting documentation, CalPERS’ investment committee itself has expressed a preference to not ‘force’ investments into illiquid asset classes at unfavorable valuations simply to meet an allocation target – even if the reality is they are mandated to meet these targets. Still, perhaps CalPERS should heed its consultants and proceed at a more deliberate pace, lest it find itself with a portfolio full of regrets. That is good advice for anyone investing in property these days.