Friday Letter Ain't no stopping us now

As if in response to a growing chorus of GPs worried about capital sources drying up, news from CalPERS indicates that the supply of capital for real estate private equity is only expanding. 

This week, the investment board of the California Public Employees’ Retirement System considered a plan to increase its investment in real estate from eight percent to 10 percent over the next five years, a bump that would increase the fund’s property equity stake from its current $20 billion to $35 billion.

Coming from the largest public pension fund in the US, the increase could be a major shot of confidence for the global property marketplace, and may stifle some recent warnings from GPs that the fundraising environment is going to be more difficult going forward. The proposal, the first strategic review of the pension fund’s real estate assets since the mid 1990’s, would also allocate at least 50 percent of future real estate investment to foreign markets, targeting more high-risk and high-yield funds. PCA Real Estate Advisors, the fund’s real estate investment consultant, presented the plan, which can be viewed online here.

Industry observers expect the investment committee to approve the proposal, and since the large US pension funds often act as a bellwether for pensions as a whole, the CalPERS increase could convince smaller pensions to increase their real estate allotments as well, particularly when it comes to foreign assets.

The potential increase bucks the conventional wisdom currently being floated by a number of GPs that capital flows to real estate may be slowing down. At a real estate conference in New York City in June, John Kukral, the head of Northwood Investors and former head of Blackstone Real Estate Partners, said he was anticipating investor capital constricting going forward, arguing that the days of raising easy money have peaked and capital would be increasingly difficult to find. Earlier this year, a report from property consultancy Kingsley Associates came to a similar conclusion, predicting that real estate fundraising was going to slow down as large LPs hit their target allocations. The firm noted that the difference between target real estate holdings and actual holdings had dropped from 150 basis points in 2005 to 40 basis points in 2007.

Yet what wasn’t posited was that perhaps the LPs would respond to the fast approaching targets by increasing their allocations. CalPERS certainly has good reason to think this would be a good bet. In July the pension revealed that its real estate portfolio returned 20.2 percent for the 12 months ending March 31, 2007, topping its benchmark of 12.5 percent.

CalSTRS, whose real estate investments posted a 32.9 percent return for the past fiscal year, has increased its real estate allocation from 7.4 percent of the total portfolio in June 2006 to 10 percent in June 2007. The California funds aren’t alone. A JPMorgan Asset Management Survey released at the beginning of this year reported that only 1 percent of corporate funds and 2 percent of public funds plan to decrease their allocations to real estate, while 11 percent and 28 percent will increase their commitments, respectively.

The lesson from CalPERS potential strategy change may be that, instead of cutting back on real estate investments as they approach their target allocations, LPs may raise those targets with an eye on foreign investment. As the US economy undergoes economic turbulence, and as other global markets encounter construction booms and high growth, CalPERS will likely not be the only LP looking to ratchet up its international exposure.