The insider

This week, the California Public Employees’ Retirement System (CalPERS) said it acquired a one-third stake in Bentall Kennedy, a Toronto-based real estate investment advisor, for $100 million.

In terms of pricing, it wasn’t a very large real estate deal for the $228 billion pension fund. Just last month, for example, it announced a $500 million commitment to GI Partners for a separate account targeting technology-focused core real estate, and that was by no means the biggest cheque it has written.  The Bentall Kennedy transaction, however, may be one of CalPERS’ most significant real estate investments to date.

The purchase of the ownership interest is the first investment of its kind in the real estate sector for the pension fund, which called it “a unique opportunity in the market.” CalPERS and Bentall Kennedy have been real estate partners for the past 15 years through a number of investments, but as co-owners, they will take their relationship to a new level.

In one notable shift in the dynamic between the two groups, CalPERS will now sit on Bentall Kennedy’s board and have the ability to participate in the overall strategy and direction for the firm. In another, both parties plan to engage in a knowledge swap initiative. They also intend to cross-train staff and share best practices, particularly with respect to the environmental, social and corporate governance (ESG) aspects of property management and investing. ESG concerns, after all, are increasingly being included among the nonfinancial factors that figure into the valuation of real estate and other types of investments.

There’s obvious method behind this tie-up. Bentall Kennedy will become a better advisor and fiduciary if it understands its client better, while the CalPERS will become a more thoughtful and informed investor when making strategy and manager decisions.

Of course, while this active position in an investment management business is new to CalPERS, Bentall Kennedy has been here before. It is already one-third owned by British Columbia Investment Management Corporation, and until recently, Ivanhoé Cambridge. The latter, which is the real estate investment subsidiary of the Caisse de dépôt et placement du Québec, is bringing its real estate advisory operations in-house, thus providing CalPERS with the opportunity to buy in by snapping up its stake.

Bentall Kennedy now will have a major US pension fund as a part owner, and that will help the firm to continue expanding the US side of its business, following the merger of the Toronto-based Bentall and the Seattle-based Kennedy Associates in late 2010.

The impact on CalPERS, however, will be much more profound. Becoming a one-third owner in Bentall Kennedy could be interpreted as effectively a fee reduction for the pension fund, because while it may be paying fees on real estate assets that are managed by the firm, it also owns a piece of the manager, which is a fee collector. Subsequently, CalPERS will participate in the management fee profits, essentially offsetting the fees it is paying on assets.

Perhaps more significant, however, an ownership stake provides the pension fund with insight into the mechanics and economics of the investment management business – information that few, if any, other investors have at their disposal. Property management and investment certainly are areas of interests, but CalPERS will also garner further insight into how real estate investment managers approach the oft-disputed area of fees.

The pension fund is said to already have the most detailed fee information available on managers, but by owning a piece of a company, it would have a much deeper and more detailed understanding of the cost structure of an investment manager. Bentall Kennedy is just one manager, but nonetheless, this enhanced understanding could put CalPERS in a much stronger negotiating seat with other managers.

Of course, CalPERS may need to address potential conflicts of interest with the manager’s other clients, as well as exposure to other possible risks – such as personnel changes at the firm.

The CalPERS/Bentall Kennedy deal isn’t likely to spark a major trend in the private equity real estate industry, simply because of the limited number of large investors that have the wherewithal to acquire an ownership stake. That said, this investment seems certain to further drive the trend of managers seeking long-term strategic partnerships with their major clients and capital sources. How much more strategic can a partnership get?

And we at PERE hear that there are similar deals in the works. Stay tuned.