The Los Angeles City Employees’ Retirement System (LACERS) is expected to commit $225 million to real estate over the next three years, beginning with $85 million in proposed investments in 2013. LACERS also is expected to make real estate commitments of $85 million in 2014 and $55 million in 2015 to help the pension plan achieve or maintain a 5 percent allocation to the asset class, assuming 5 percent growth for its overall portfolio.
The majority of the new real estate capital will be earmarked for non-core investments, including a commitment of $28 million to $30 million to a single value-added manager and $30 million to $32 million to a single opportunistic manager this year. The focus on higher-risk investments is being driven partly by the large distributions expected to be returned within the value-added and opportunistic components of the pension plan’s real estate portfolio over the next three years.
In addition, “the best risk/return profile within the real estate asset class can be found in the value space of the market,” consultant Courtland Partners advised in LACERS’ 2013 real estate strategy plan. “Such opportunities provide for core equity-like current cash flow and capital appreciation potential, due to assets being purchased at a discount to replacement value.”
Meanwhile, opportunistic investments, including distressed debt, land, non-traditional property types and development projects, “would enable LACERS to take advantage of mispricing in the credit markets and take advantage of market illiquidity in financial instruments,” Courtland stated. However, the pension plan is expected to be more selective in making higher-risk investments, given its desire to reduce its exposure to development-focused managers following the market turmoil of 2008 to 2010 and subsequent valuation declines.
The real estate strategy for 2013 also includes potential commitments of $20 million or more to international investments, which may account for a portion of the prospective value-added and opportunistic allocations. LACERS’ largest international investment, through Prologis’ Asia fund, is expected to fully liquidate by the end of the year, which is projected to lead to a significant drop in the pension plan’s international allocation by year-end 2016. Consequently, LACERS is anticipated to increase allocations to Asian markets, boost exposure to emerging growth markets and seek distressed opportunities in Europe.
Lastly, LACERS is anticipated to commit $25 million to core funds in 2013, although Courtland has recommended that the pension system pursue opportunities in core debt, which is perceived as providing more attractive risk-adjusted returns than core equity with a significant income component. Indeed, the consultant has advised LACERS to pursue opportunities in private real estate debt – to which the pension plan has a 10 percent to 20 percent allocation target – across all risk/return strategies in order to take advantage of capital markets illiquidity.