Pension-System Pledges Drop to 4-Year Low

The nation's largest public pension systems significantly pulled back on equity commitments to real estate investments last year.

Pledges to funds, separate accounts and joint ventures plummeted to $16.7 billion, down more than 50% from a revised $35.8 billion in 2007, according to Real Estate Alert's annual survey of the 50 largest systems (see tables on Pages 6-13).

That ended a 3-year run of increases and was the lowest total since 2004, when $9.9 billion was pledged.

The survey found that the tide turned sharply in the fourth quarter. Commitments were relatively strong through the first nine months, totaling more than $17 billion. Although that was down from the pace during the peak years of 2006 and 2007, it nonetheless suggested that pensions remained reasonably bullish about real estate.

But the bottom dropped out following the sharp September plunge in the stock and bond markets. Nearly all major players, including Calpers, California State Teachers and New York Common Fund, steered clear of new commitments. In fact, there was actually a net decline in commitments because Pennsylvania Public School Employees and New Jersey State Investment withdrew a combined $1.2 billion of pledges - more than double the amount of new commitments. That was the first quarterly net decline in commitments in the survey's 12-year history.

The pullback has continued in the first quarter, with only one notable commitment disclosed so far - New York Common's $300 million pledge for a multi-manager account.

The plunge in commitments doesn't reflect declining interest in real estate investments. Indeed, many pension investment officers say they would like to commit fresh capital to funds targeting distressed properties and debt, because they think those vehicles offer the potential for outsized returns.

But their hands are largely tied because losses in all categories of investments last year ravaged their asset bases, curbing the capacity for new commitments. Asset declines for a large sampling of the funds averaged 27.2%.

Pensions typically set a target allocation for real estate investments equal to 5-10% of total assets. But stock and bond losses last year generally exceeded the drop in real estate values, which typically take much more time to be recognized. That helped fuel a huge jump in the proportion of real estate investments. The Top 50 pension systems had 8.8% of their total assets invested in real estate at yearend, up from a revised 6.2% in 2007. When unfunded commitments are included, investments surged to 12.3% of total assets, up from a revised 9.1%. That sharp increase caused many pensions to bump up to or surpass their real estate targets, leaving little or no leeway for new investments.

A rebound in the value of stocks already parked in pension portfolios would go a long way toward restarting commitments. Pension executives say they have been following the stock market a lot more closely of late, especially after the recent rally took the Dow Jones index back over 8,000. "The stock market hitting 9,000 would make a lot of lives a lot easier," said one veteran player. "It would make commitments possible" for his system. Another veteran player said that if the index climbed from 7,500 to 9,000, most pension asset bases would increase by 7-10%.

The real estate slump has also slowed the liquidation of existing investments, further restricting cash available for new pledges. Pensions seeking to pull equity out of open-end funds are often being told there is a waiting list of 6-12 months. What's more, falling property prices have made fund operators reluctant to harvest investments, slowing the return of capital to pensions.

The turn of events has prompted several pension systems to increase the proportion of their assets that can be invested in real estate. A host of other pension systems have asked their consultants to review asset allocations - a likely precursor to increasing the investment ceiling.

Among the Top 50 public pension systems, total real estate investments climbed by a net 8.7% last year, to $166.1 billion from $152.9 billion. That means that new commitments and gains from existing investments exceeded losses. But about one-third of the funds posted a decline in real estate holdings, led by Florida State Board (down $1.3 billion, to $8 billion). The biggest increase was posted by the largest system, Calpers, whose holdings climbed by $3 billion, to $20.9 billion. Significant increases were also recorded by No. 2 California State Teachers (up $1.9 billion, to $20.3 billion) and No. 3 Washington State Investment Board (up $1.7 billion, to $9.5 billion).

Overall, the 50 systems, which primarily oversee the retirement benefits of state, county and municipal workers, made 168 commitments last year, barely half of the 326 in 2007.

Texas Teachers committed nearly $2.3 billion, more than any other pension. Pennsylvania Public Schools was close behind, with $2.2 billion of net pledges, after factoring in the withdrawal of $950 million of previously announced commitments. CalSTRS ($1.2 billion), Maryland State Investment ($790 million) and Wisconsin Investment ($775 million) followed.

Texas Teachers also had the most commitments by number, with 15, followed by Pennsylvania Public Schools (13), Los Angeles City Employees (11) and Arizona State Retirement (nine).

As in recent years, pensions were more likely to pledge money to fund operators than to joint ventures or newly formed separate accounts. Last year, 82.7% of the equity pledged to real estate went to commingled funds, primarily high-yield vehicles. Value-added vehicles attracted 59 commitments totaling $5.9 billion, followed by opportunistic vehicles (44 commitments totaling $3.8 billion), high-yield debt vehicles (27 commitments totaling $2.6 billion) and core-plus (24 commitments totaling $1.8 billion). The remaining fund commitments were made to core vehicles (nine commitments totaling $1.9 billion), funds of funds (three commitments totaling $315 million) and debt vehicles not seeking at least a 10% net return (two commitments totaling $400 million).

A Morgan Stanley vehicle, Morgan Stanley Real Estate Fund 7 Global, received the most money from the Top 50 - $850 million via three commitments. Blackstone Group's Blackstone Real Estate Partners Europe 3 attracted $761 million of commitments from five investors, while Starwood Capital received $700 million of commitments from four investors for its Starwood Capital Hospitality Fund 2.

Nine of the 10 funds attracting the most equity last year were value-added or opportunity funds. The exception was AEW Core Property Trust, a core vehicle managed by AEW Capital Management. It received three commitments totaling $350 million, but lost a planned $100 million commitment from New Jersey State Investment.

Real Estate Alert's survey also tracks the most-active advisors, based on total commitments from 2006 to 2008 to commingled fund-operators, joint ventures and separate-account managers. Blackstone topped the field with 39 mandates, followed by CB Richard Ellis Investors (33) and Prudential Real Estate Investors (31). Those same three shops led the way in commingled-fund mandates. For separate-account and joint-venture assignments, Hines ranked first with five mandates, while several other firms had two.

Townsend Group was again the top consultant, with 23 mandates, unchanged from 2007. Courtland Partners was second with six assignments, up one, while PCA Real Estate Advisors was third, with three assignments, down one.

Calpers continued to have the largest real estate portfolio, with $20.9 billion of investments at yearend, just ahead of CalSTRS, at $20.3 billion. Next came Washington State Investment Board ($9.5 billion), Florida State Board ($8 billion) and New York State Teachers ($7.5 billion).

The survey didn't include commitments to vehicles that invest in REIT stock, timber or agriculture. It also excluded investments in private equity, infrastructure or hedge funds that didn't put at least 50% of their equity into commercial real estate. Also excluded were fresh commitments to existing separate accounts, joint ventures or open-end funds.

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