What CalSTRS’ $500M Bet on REITs means for Pension Funds
The $500 million wager by the California State Teachers’ Retirement System on publicly-traded REITs could spur an influx of investment by other pension funds and institutional investors into the REIT sector, experts say.
The California State Teachers’ Retirement System (CalSTRS) is the second largest U.S. pension fund, boasting an investment portfolio valued at $246 billion as of Oct. 31. When it makes portfolio moves, other investors take note. So CalSTRS’ bet on publicly-traded REITS could be a catalyst for other pension funds, says Meredith Despins, senior vice president of investment affairs and investor education at trade group Nareit.
“There is significantly more receptivity among those [funds] to hearing how REITs fit into the real estate investment equation than there has been in the 13 years I’ve been with Nareit,” Despins says.
She adds that pension funds are drawn to the REIT sector because it enables exposure to traditional property types, including office and retail, as well as to non-traditional property types like data centers. However, she adds, any shift by pension funds toward REITs won’t be swift.
“It’s not a market where tomorrow the floodgates are going to open and you’re going to see everyone piling in,” Despins says. “But it’s going to happen.”
As highlighted in a November 2019 memo from Los Angeles-based RCLCO, the real estate adviser for CalSTRS, the pension fund traditionally hasn’t embraced a REIT allocation strategy. But earlier this year, the pension fund’s staff earmarked up to $500 million for investment in publicly-traded REITs. CalSTRS split management of its REIT portfolio between Plymouth Meeting, Pa.-based CenterSquare Investment Management and Des Moines, Iowa-based Principal Real Estate Investors.
Nancy Cox is a partner at The Bonadio Group, a professional services firm based in Pittsford, N.Y. She specializes in real estate and employee benefit plans. Cox says she’s noticed an uptick over the past several years in employee benefit plans, such as pension funds, turning to REITs and other alternative investments.
“I don’t see this trend changing,” Cox says, “and I would anticipate more and more plans exploring these options going forward.
“REITs give plan participants the option to be involved in the real estate industry in a more secure and less risky environment,” she adds. “They also give plan fiduciaries the option to include alternative investments in the plan portfolio, without as much risk as other alternative investments.”
In early November, CalSTRS bumped up its long-term real estate allocation target from 13 percent to 15 percent to help accommodate its REIT strategy. As of Oct. 31, real estate accounted for 13.9 percent, or nearly $34.2 billion, of CalSTRS’ investment portfolio.
The RCLCO memo says CalSTRS is making “selective investments” in publicly-traded REITs that are viewed as undervalued—meaning their intrinsic value exceeds their market price. REITs historically have produced a higher return than private real estate investments, the memo notes, but also have experienced more volatility due to their liquidity.
CalSTRS envisions the 15 percent allocation target for real estate being achieved within two to three years. Officials with the pension fund weren’t available for comment about their REIT investment approach.
“REITs are the best way that institutional investors can benefit from the real estate market without having the operational challenges that go into actually owning the property on a fee basis,” says Craig Ganz, who frequently works with REITs as a partner in the Phoenix office of law firm Ballard Spahr LLP. “In a sense, they are letting the professionals handle the minutiae.”
Ganz says CalSTRS’ REIT outlays demonstrate growing comfort in the REIT sector on the part of institutional investors.
“It shows that despite certain headwinds, institutional investors are confident in the current economic climate and what the future holds, as these investment types are usually long positions and not ones that are moved quickly through multiple asset classes,” Ganz says.
According to data published by Nareit, pension, endowment and foundation funds control more than $9 trillion in total assets, with nearly $800 billion of that invested in real estate. Nareit suggests these funds aim for a 15 percent to 20 percent allocation in real estate. At the average pension fund, the real estate allocation is 7 percent, Nareit points out.
“Institutional investors are continuing to deepen their understanding of the mechanics related to exactly how REITs operate,” Ganz says. “Traditionally, it was common to hold the belief that REITs performed as well as the broader market performs, and this is not necessarily true.”
A study sponsored by Nareit found that from 1998 to 2017, REITs outperformed all 12 asset classes held by public and private pension funds except one—private equity. The study measured performance by average annual net returns, with private equity at 11.8 percent during the 20-year period and REITs at 10.9 percent.
“We have seen tremendous growth in the REIT sector as a whole,” Ganz says, “and the yields associated with these REITs far outpace what investors will find in the Treasury market.”
John Traynor, chief investment officer at People’s United Advisors Inc., an investment advisory firm based in Bridgeport, Conn., says he’d like to see more liquidity in institutional portfolios through investment vehicles like REITs.
“At this point in the real estate cycle, when cap rates are approaching cyclical lows, we believe liquidity should be valued very highly by investors,” Traynor says. “Investors may sacrifice some of the ‘alpha’ potential in private real estate funds by investing a portion of their real estate allocation in REITs to gain flexibility.”