Monday, January 19, 2015

Why CRE? Ask California and Ohio, For Starters...

Why Commercial Real Estate? Ask California, for starters. Or Ohio, for that matter.

But I’m getting ahead of myself.

In October, the largest U.S. pension fund, The California Public Employees’ Retirement System (CalPERS), announced it was increasing its investments in real estate by $6 billion within the next year. Not surprisingly, apartment owners and investors read that news with great interest and not just because it could mean more money flowing into core markets.  

 “You’re seeing real estate become a bonafide asset class and an alternative to bonds and equities,” says Bobby Lee, president and COO of Los Angeles-based JRK Property Holdings.

Beyond the symbolism, CalPERS' increased allocation to real estate is a sizable chunk of change. Bloomberg reported that “the $295 billion fund had 8.7 percent in real estate as of July 31.” The allocation then rose to 9.9 percent on its ways toward a target of 11 percent in 2016. And 11 percent of $295 billion is $32.4 billion. The news came on the heels of an announcement by CalPERS last September, where the giant pension fund decided to pull the $4 billion it had invested in hedge funds, because they “were too complex and too expensive,” according to Bloomberg.  

 Market-watchers quoted in a number of publications indicated they wouldn’t be surprised to see other pension funds back away from hedge funds and look at other investment options.

While not all of this money will be earmarked for apartments, the firm has been an active investor in the space space and many multifamily housing owners expect CalPERS to increase its stake in apartments. “It’s logical that the first place that these large gatekeepers will start will be in the core space, not in the higher return and risk spaces,” Lee says.

And that could have a big impact on today's already low cap rates.

“I expect to see more compression long term in the core space,” Lee says. “We’re seeing stuff [cap rates] in two’s and three’s. I expect things to be just as crowded as it has been or frankly even more crowded for that product.” This also is good news for owners of institutional real estate in other parts of the U.S. with higher capitalization rates. In fact, CalPERS – like other investment funds – invests where returns are strongest, and safe.

Widespread pension fund interest is expected to affect the valuation of land, apartment assets, and even entire companies. In 2012, CalPERS paid approximately $100 million for a one-third stake of Bentall Kennedy, a real estate development and investment firm with properties in the United States and Canada. That same year, the California State Teachers' Retirement System (CalSTRS) spent more than $800 million to acquire a 90-percent interest in the Berwyn, Penn.-based multifamily builder LCOR. Real Capital Analytics even went so far to project that some funds to similarly focus on construction. “I would expect some of these pension funds to be interested in development more than buying,” he says.

And that includes value-add plays, which are becoming a more popular investment option as the upturn matures.

“As core has been priced to perfection, we’re seeing pension fund advisers and other institutional-type investors pursue a strategy of value-add to core where they’ll buy an old building in a really good location and reposition it into a core-plus asset,” says David Schwartz, CEO of Chicago-based Wateron Associates.

Remember how I mentioned earlier that Ohio was a bellwether in addition to California? California’s announcement that it is ditching hedge funds for institutional real estate reminded me of a news release from Ohio's State Teachers' Retirement System -- another of the biggies -- fund a few years back that it was actively hiring a number of real estate experts.

The giant Ohio pension fund’s announcement was met with derision by many of its members, who didn’t understand that commercial/investment real estate routinely throws off far higher investment returns than the markets. They said, “Why real estate? Why?”  Hmmm….

California knows.

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