The Employees Retirement System (ERS) of Texas has proposed committing nearly $600 million to private real estate during fiscal years 2013 and 2014, with a focus on value-added and opportunistic investments. For fiscal year 2013, which will begin on 1 September, ERS is targeting $285 million in commitments, including $240 million for three to six investments in value-added real estate and $45 million for one to three deals in opportunistic real estate.
In addition, the pension system has proposed $305 million in private real estate investments for fiscal year 2014, which will include $100 million to core real estate, $160 million to value-added and $45 million to opportunistic. ERS’ private real estate portfolio was valued at $650 million as of 30 June, with an additional $475 million committed but not yet invested.
“Significant capital commitments during fiscal years 2013 and 2014 are proposed to take advantage of what should be a favorable pricing environment for value-added and opportunistic strategies,” the pension’s real estate staff and real estate consultant, RV Kuhns & Associates, stated in ERS’ fiscal year 2013 private real estate tactical plan, which was released this week. “Real estate staff and the real estate consultant believe that 2013 and 2014 will be attractive vintage years for real estate investment.”
ERS, however, expects that its private real estate investment activity will slow substantially after the next two fiscal years. It has proposed $90 million for one to three core investments for fiscal year 2015, and $180 million for two to six value-added investments in fiscal year 2016. The pension system is on track to achieve its full real estate allocation – 5.6 percent of the total ERS portfolio for private real estate and 2.4 percent for public real estate – by the end of fiscal year 2015.
In fiscal years 2010 through 2012, ERS had an accelerated investment pace to take advantage of opportunities in core real estate and the debt markets. Total private real estate commitments were $136 million in fiscal year 2010, $606 million in fiscal year 2011 and $385 million in fiscal year 2012 through 30 June, with the expectation of allocating an additional $100 million before fiscal year-end.
Within its overall real estate portfolio, ERS is lowering its core private real estate allocation from 35 percent to 30 percent and does not have an allocation to core strategies in the coming fiscal year. In its tactical plan, the pension system cited a “substantial run-up in core real estate market values, as well as emerging concern about high pricing in those values,” as the reasons for that shift.
Instead, “there is a notable bifurcation within the market with well-leased, core-assets in Tier 1 locations receiving considerable interest, while properties with near-term leasing risks and those in secondary locations receive much less interest,” ERS real estate staff and RV Kuhns noted in the tactical plan. “The lack of focus on non-core assets by incremental real estate purchasers may provide attractive opportunities for ERS.”
The parties recommended that ERS seek value-added and opportunistic managers that do not have legacy issues relating to prior funds and have been successful using lower leverage to achieve return targets. Preferred managers will have solid track records through different market cycles and the ability to achieve value from growth in net operating income rather than from capital appreciation.
Furthermore, real estate staff and RV Kuhns advised that ERS explore core-like real estate opportunities outside of traditional commingled funds, given concerns over valuation and the substantial amount of capital waiting to get into such funds. Such opportunities could include those in timber, which has seen a decline in valuations because of lower demand from homebuilders and other end-users of lumber, as well as hybrid types of assets such as student housing and medical offices.
Additionally, ERS may consider opportunities in subordinated real estate debt, both in the US and Europe, during fiscal year 2013 and focus on investing with direct operators rather than capital allocators. The pension system also intends to continue the global diversification of its real estate portfolio and pursue select non-US investments, particularly in Asia.