The Employees Retirement System (ERS) of Texas expects to commit as much as $1.13 billion to private real estate through the end of its fiscal year 2017, with the bulk of capital to be invested in value-added and opportunistic real estate investments, according to documents from its board meeting last week.
Texas ERS projects to commit $345 million to three to 14 deals in fiscal year 2014, which begins on September 1. Of that amount, $75 million will be allocated to core strategies; $150 million to value-added; and $120 million to opportunistic.
“Opportunities to target non-core real estate will be the most attractive area to focus on,” the pension system stated in its fiscal year 2014 tactical plan for private real estate. ERS noted that it has proposed over-allocating capital to value-added and opportunistic investments to “take advantage of better pricing opportunities in the non-core real estate markets” and also to achieve its overall real estate target allocation of 10 percent, which consists of seven percent to private real estate and three percent to public real estate.
With the proposed commitment for fiscal year 2014, ERS will be on pace to reach its full real estate allocation by fiscal year 2015, during which the system is projected to allocate an additional $285 million to three to 13 private real estate investments, including $75 million to core; $150 million to value-added; and $60 million to opportunistic.
In both fiscal years, ERS will be targeting value-add and opportunistic managers that have had successful strategies employing lower leverage to achieve return targets and that do not have legacy issues with prior funds. The system also said it will be focusing on strategies and managers “where the portion of return derived from income, as opposed to capital appreciation, is significant relative to the respective risk return strategy.”
As for core investments, the pension plan said it was likely to concentrate on alternative core investments such as timber, medical office or core investments in international markets that would have lower correlations to its existing core portfolio. Additionally, ERS expressed a preference for direct operators over capital allocators, focusing on managers with specialized competitive advantages and the infrastructure to manage institutional capital.
The pension plan also expects to continue diversifying its private real estate portfolio geographically, particularly in Asia. “Focus on Asian investment opportunities with managers that can achieve returns utilizing lower leverage and taking on less risk than competitors may be an opportunity in the coming years,” the system said. In fact, ERS is exploring the implementation of a customized fund of funds program for Asian real estate, similar to one that it already has established for European real estate investments.
After fiscal years 2014 and 2015, ERS expects to commit capital at a somewhat slower pace to maintain its 10 percent target real estate allocation. Its funding level for private real estate is $300 million in fiscal 2016 and $200 million in fiscal 2017.
As of March 31, private real estate represented $780.4 million, or 3.3 percent, of ERS’ total portfolio. The pension plan had committed $207 million of its targeted $285 million fiscal year 2013 allocation to private real estate at the end of the first quarter and said it was probable that it could commit an additional $100 million to $150 million before the end of the current fiscal year.