Spotlight On Pension Fund Investment in Real Estate

Public sector pension plans have increasingly turned to real estate to supplement lower yields from bonds and equities. According to a Preqin Real Estate Spotlight report issued in October 2016, public sector pension plans had $681 billion invested in real estate as of September 2016, the largest amount of any institutional investor category covered by the report. Private sector pension plans had allocated $340 billion to the asset class, though a slightly greater number of private plans participate in real estate markets. Preqin found that public pensions account for 15% of institutional real estate investors, second only to private pensions at 19%.

The report indicates that roughly nine in 10 domestic and international public pension funds currently hold some form of real estate. Domestic public pension funds CalPERS and CalSTRS ranked among the five largest global pension investors in the asset class, with holdings of $27 billion and $26 billion, respectively.

The Reason Foundation, a policy research organization, argues that real estate suits pension plans because of their long-term liabilities and the asset's long-term holding profile. It also notes that public plans are several steps removed from the taxpayers who ultimately bear investment losses, and that a multi-generational taxpayer base cannot have a clearly defined risk tolerance. As a result, the foundation contends there is a practical limit to diversification for public plans, and that less risky assets should carry significant weight in their portfolios.

The foundation identifies three risks: high-volatility global real estate can produce swings between high yields and substantial losses; overexposure to domestic real estate could expose plans to housing-cycle downturns that depress annual returns and increase unfunded liability amortization payments; and past performance does not guarantee future results, so plans must ensure investment staff can handle the complexity and illiquidity of the asset class. Morgan Stanley is quoted as saying there are no bulletproof deals, but portfolios can be monitored and managed for risk. Investors are advised to monitor property sector exposure across geography, risk classification, asset life cycle, investment structure, and external manager type.