Why CalPERS is sticking with regional malls

Retail’s difficult year weighed heavy on the California Public Employees’ Retirement System’s real estate holdings in 2020. Its portfolio, which is overexposed to regional malls, had a one-year net return of zero through the third quarter of last year.

However, the $450 billion pension is not running away from the embattled property type. During its semi-annual performance review on Monday, consultant Meketa Investment Group told the CalPERS investment committee that its retail holdings could withstand the market’s current harsh conditions.

“Enclosed shopping malls are a tale of two cities, and the difference is who has capital and who doesn’t have capital,” Meketa’s David Glickman told the committee. “The properties in your portfolio are of the very highest quality, and you and your joint venture partners have balance sheets that will provide for the preservation of the assets through this difficult time.”

Regional malls account for 18 percent of CalPERS’s $37 billion allocation to real estate. That is a significant overweight to the MSCI/PREA US ACOE index – one of two benchmarks used by the pension – which consisted of just 4.5 percent regional and super regional malls as of December 2020. The MSCI/PREA index’s exposure to all retail is just 15 percent.

Overall, CalPERS’s mall properties depreciated by 3.6 percent between July 1 and September 30, the final quarter captured by Meketa’s review. This is more than double the depreciation tracked by the NCREIF Property Index for the same period, which fell just 1.5 percent. The consultant attributed this decline in CalPERS’s mall values to mandated closures that were still in effect last summer to stop the spread of covid-19.

Following the report, California state controller Betty Yee asked Meketa about the feasibility of converting some of CalPERS’s mall assets into apartments or other uses. Glickman said the pension and its joint venture partners are looking for ways to enhance the value of their retail properties and have noted an uptick in redevelopment projects throughout the US. But, he said, those undertakings are best backed by opportunistic capital given the various costs and risk involved, whereas CalPERS is laser focused on core strategies – 84 percent of its real estate assets are considered core, according to Meketa’s report, up from just 55 percent four years ago.

Much of the retail repurposing underway today, Glickman added, is concentrated on malls that are not economically viable, and CalPERS’s high-quality investments do not fit that description. “There are approximately 1,000 enclosed retail malls in the United States, 200 of them are of very high quality, 400 of them are of very low economic driver potential, and there’s another 400 in between,” he said. “So, we get As, we get Bs and we get Cs. The places where the repurposing is happening is with the Cs, as their owners and lenders struggle to see how they can continue to generate rents from those properties to service the debt that’s attached to them.”

Other assets

In addition to the 18 percent allocation to malls, CalPERS has a 9 percent allocation to grocery-anchored shopping centers, according to Meketa’s report. This part of the portfolio performed moderately better during the third quarter, with a 0.6 percent net return, up from -4.2 percent the previous quarter. While grocery stores and other essential retailers have remained open during the pandemic, in-line tenants – particularly restaurants and small businesses – bore the brunt of closures, Meketa found.

Overall, with its net-zero return over the previous year, CalPERS trailed its benchmark by 0.4 percent. It has failed to hit its target over the three-, five- and 10-year periods as well.

Glickman acknowledged the swirling speculation about the possible demise of the office market, saying it is “very hard to try to draw inferences at this stage” about demand for the sector moving forward. He added, however, that CalPERS has seen strong collections from its office properties. And, market-wide, there has not been a noticeable uptick in available office space. Similarly, he said, income from the pension’s multifamily holdings has been largely unchanged by the pandemic.

Moving forward, Glickman expects demand, from both end users and investors, to increase for troubled property types such as hotels – to which CalPERS has little exposure – and retail. “You’re going to see, when it’s safe, very high turnout at retail facilities and therefore a bulge or surge in retail sales from pent-up demand,” he said. “[That has been] partially taken up by e-commerce but that doesn’t have the same kind of thrill as going and shopping in person.”