Two years ago, the Massachusetts Pension Reserves Investment Management Board (MassPRIM) officially made its entry into non-core real estate. “We had a short-term view that we probably could enhance our returns based on where we thought we were in the market cycle,” said Timothy Schlitzer, senior investment officer for real estate and timber at MassPRIM, which currently has approximately $4.5 billion in its property portfolio. “But we also had more of a long-term view, in that we thought having a bit of non-core was really just part of a good asset allocation within the real estate portfolio.” 

Since then, the non-core real estate portfolio has grown to $213.4 million as of June 30. MassPRIM made its first non-core real estate fund investments in 2012 via commitments to The Carlyle Group’s Carlyle Real Estate Partners VI and to Divco-West’s DivcoWest Fund III. The historically core investor also executed two direct property investments through separate accounts with AEW Capital Management and JPMorgan Asset Management. Furthermore, the pension also has one pending direct investment with a cost of approximately $90 million.

MassPRIM, however, already is planning to increase its non-core exposure even further. In August, its board approved a doubling of its non-core target from five percent to 10 percent of its property portfolio, with the option to increase the allocation to 15 percent if more attractive opportunities become available. 

Schlitzer explained that the pension plan still has “a lot of conviction” in core real estate and will continue to invest in that area. However, in addition to being non-correlated to its core strategies, non-core investments give the portfolio an additional boost in returns. With a 10 percent to 15 percent non-core allocation, “we wouldn’t be meaningfully increasing the portfolio risk, but we could add some alpha over the long term,” he added. 

Indeed, the pension plan’s non-core real estate portfolio has generated a return of 26.4 percent over the past year, exceeding the NCREIF benchmark of 10.7 percent by a significant margin. In contrast, the core portfolio returned 11.7 percent over the past year, against a benchmark of 10.7 percent. “I don’t expect to do that well over the next couple of years,” said Schlitzer. “But we do think that there are opportunities to increase returns over what we’re getting from core.” 

In fact, MassPRIM has allowed for an even more aggressive pace of investment in non-core real estate. The pension has the ability to “over-commit” to non-core by 25 percent above its allocation during the current fiscal year, given that “the velocity of capital investment and distribution is much higher than core investments,” according to MassPRIM’s investment policy.

With a 10 percent allocation target, the pension plan, which has a long-term overall real estate target of about $5 billion, will have an additional $250 million of capital to invest in non-core real estate. It plans to deploy that capital through its existing managers, which also include LaSalle Investment Management, Invesco Real Estate and TA Associates Realty.

MassPRIM previously focused its non-core investments on existing apartment buildings, apartment development and office strategies in select markets. Going forward, however, the pension plan is likely to scale back on multifamily development in the face of growing supply hitting the market. 

Instead, Schlitzer anticipates that the pension plan potentially could begin making investments in specialty property types, such as senior housing and student housing. MassPRIM already has exposure to those niche strategies through its REIT portfolio, but it would seek to make direct investments through its non-core portfolio. 

Another new investment initiative that would fall partly within the non-core bucket would be international real estate. “We would be focused more on core markets in countries that we view as being more mature and more developed, as opposed to emerging markets,” said Schlitzer. Whether an overseas investment is classified as core or non-core would depend on the deal’s individual attributes and risk profile, he explained.

In markets such as the UK, Germany and potentially Singapore and Hong Kong, MassPRIM would seek to own properties outright through separate accounts. While he acknowledges the diversification benefits of investing in overseas real estate through funds, Schlitzer said that, “given the amount of assets under management that we have now, we already feel like we’re fairly well-diversified and feel like we can take more targeted bets outside the US.”

Overall, MassPRIM will be taking a ‘tactical’ approach to non-core real estate and will not have specific diversification targets. “We’ll look for themes that we think will play out in the near term and try to find ways to invest,” Schlitzer said.

MassPRIM does not anticipate increasing its non-core target further over the next couple of years, nor has it determined how much capital it will invest in higher-risk strategies in the near term. “We do think that there are opportunities out there, but we’re not going to force a certain amount of money out the door,” Schlitzer said.