The Chicago Teachers’ Pension Fund expects like-minded institutions to take a more conservative approach by increasing their exposure to lower risk investments in real estate debt during 2019.
This continuing trend towards real estate debt will provide more downside protection and steadier, more predictable cashflows as market conditions look increasingly cloudy, according to Chicago Teachers’ Pension Fund portfolio manager John Freihammer. He views real estate debt as one way to maintain allocations to real estate and capture the upside of the asset class while lowering the risk profile.
Public markets performance is probably the number one cause of institutions – including the Chicago Teachers’ Pension Fund – over-allocating to real estate when market conditions are good and under-allocating when conditions are bad, according to Freihammer. However, staying in the real estate market and following a consistent plan, even when market conditions are less than favorable, is important, he said. Timing the market is difficult and academic research and past experiences have shown that some of the best vintages have transpired when markets are in a down cycle. Real estate debt allows investors to hedge bets without pulling out of the market.
Within real estate debt, Freihammer said his own pension fund tries to stay away from distressed or opportunistic investment strategies because timing exits correctly is difficult. His investment team gives their investment managers some flexibility to take on risk with placement in the capital stack, but they favor senior-secured debt and core-type properties.
“If there’s a downturn, that is your protection, even on the debt side – that you’re in a well-located, high quality property and you have a good credit in there,” Freihammer told PERE.
In the event the debt needs to be re-structured, he believes having a good investment manager and a borrower with solid credit will ensure that the two can negotiate a deal that will not materially impair the fund. The quality of the asset will also act as downside protection for the public pension fund’s more than 63,000 members and administrators.
Real estate debt, which has a special designation in the portfolio, acts almost like a fixed income alternative, he added. The real estate-backing gives it a premium and the strategy becomes an income generator.
Some investment managers may stretch for yield as the market slows and take on more risk, even within the real estate debt strategy, which is why investors must do their due diligence, Freihammer said. Studying the investment strategy, setting quantifiable guidelines, choosing the right investment manager and maintaining regular communication will help mitigate risk.
Real estate debt fundraising peaked in 2017 with 53 funds closed and a record $34.68 billion raised, according to PERE data. Interest in the strategy had been steadily increasing since its low in 2011, during which 30 funds closed on a total of $8.14 billion.
Along with favoring real estate debt strategies, the Chicago Teachers Pension Fund also actively looks for minority, women, and disabled owned managers in all asset classes, including real estate. The inclusion of diverse managers into the overall portfolio has been beneficial, and it has also been one way to identify more niche or boutique strategies, he added.