STATESIDE: Core complex

After pulling back from international investments during the global financial crisis, US pensions are starting to look offshore again. This time around, however, some of those institutions are seeking to lower their risk when making property bets abroad.

In a July interview with PERE, Mike DiRé, director of real estate at the California State Teachers Retirement System (CalSTRS), said the pension plan expected to begin developing a strategy for increasing its non-US property investments during its new fiscal year. A key part of this expansion would involve CalSTRS pursuing more core and value-added opportunities overseas.

CalSTRS isn’t the only US pension system interested in core real estate investments abroad. In December, the Los Angeles County Employees Retirement System (LACERA) approved its first core-focused international real estate commitment when it agreed to invest $100 million in Invesco Real Estate’s Invesco Real Estate Asia Fund. Meanwhile, the New Jersey Division of Investment made a rare non-US core real estate investment with its $185 million commitment to Prologis’ open-ended Prologis European Properties Fund II in July. 

“There’s a growing demand for core real estate outside of the US,” said Edward Schwartz, co-founder of ORG Portfolio Management. While US pensions making overseas real estate investments previously did so primarily for higher returns, “the movement overseas now is more of a diversification play,” he added. “People are looking at lower risk.”

Historically, most non-US real estate investments overwhelmingly have been considered opportunistic because of the higher perceived risk involved with investing in a foreign country. However, the concept of core real estate overseas has gained support among investors because of the lower perceived risk of investing in high-quality, stabilized properties in top international markets, as compared to the higher perceived risk of developing and leasing assets in those markets or in emerging economies.

In his December recommendation to the board, John McClelland, principal investment officer for real estate at LACERA, noted that one of the reasons that the pension system previously had not committed to core properties outside of the US was because of “an under-appreciation for the quality of properties available internationally. Staff has become increasingly impressed with the institutional quality of core properties in the [Asia-Pacific] region.”

Some investors and consultants, however, contend that such investments, regardless of how high quality or stable the asset in question, cannot be core given the risks of investing in overseas real estate. “We certainly do not view anything international as being core, even if it is a core office building in London,” said Steve Spook, senior investment officer of real estate at the Florida State Board of Administration (SBA). The $161.8 billion pension plan is exploring its first commitments to dedicated non-US property funds, but the vast majority of those investments would be opportunistic (see Foreign policy, opposite page).

The difference between US pension systems that are seeking core investments abroad and those that are not appears to be their historical risk profile in real estate. For example, CalSTRS and California Public Employees Retirement System (CalPERS) traditionally invested primarily in opportunistic and value-added investments but, after suffering heavy losses during the global financial crisis, have strived to move the majority of their real estate capital to core strategies, both at home and abroad. 

Florida SBA, on the other hand, historically has had an almost entirely core real estate portfolio in the US and therefore exhibits less risk aversion internationally. “We feel we have plenty of core exposure here in the US,” said Spook. “We think that with the greater risks overseas, we need to be compensated for it.” 

Schwartz added that those risks extend far beyond just the real estate to include sovereign, currency, repatriation and structural risks. Because of those issues, the concept of core real estate overseas “is almost an oxymoron,” he said. “I really don’t see how that could be considered low risk.”

DiRé, meanwhile, has acknowledged the difficulty of finding open-ended core funds outside of established markets such as Europe and Australia, despite the increase in the number of such vehicles. “There are not a lot of choices for us to invest into core open-ended funds,” he said.

Another issue is the lack of clarity surrounding core real estate abroad. In the US, the concept of ‘core’ real estate has well-defined characteristics: high-quality properties, lower risk-return profile and gateway markets. When applied overseas, the concept becomes murkier. 

“Does it mean there has to be a certain return?” asked Paige Mueller, director of institutional real estate advisory services at RCLCO. “We don’t have a standard, agreed-upon definition for what the term ‘core’ means in terms of property characteristics or country.”

While it’s safe to say that international core real estate investments may be riskier than US core investments, they are nonetheless less risky than other types of property plays abroad. So, for US investors that desire lower-risk property investments but still want geographic diversification in their property portfolio, this may be the best solution. That said, it isn’t an easy solution, nor is it a solution for every investor.