Pension Funds Love Real Estate. (Cover Report: Commercial)

Article excerpt

With an estimated $200 billion of pension fund investment already in commercial U.S. real estate, some funds are planning to bump up annual allocations for real estate by another 2 percent or more, pension officials say.

THERE HASN'T BEEN A BETTER TIME FOR PENSION FUNDS TO INVEST IN REAL ESTATE (versus domestic stocks or bonds) since the 1960s, in relative current yield terms, according to Ronald W. Kaiser, a principal of Bailard, Biehi & Kaiser Inc. (BBK), Foster City, California, an investment management practice he co-founded nearly 30 years ago.

* "We believe that real estate allocations definitely should be moved up to at least 5 percent to 10 percent of the total fund, in order to keep pace with the potentially high returns from this portion of the benchmark," Kaiser wrote for an industry publication--nearly five years ago.

Nothing has changed, essentially, in the interval. As BBK's third-quarter 2001 newsletter noted: "In times of uncertainty, many investors tend to prefer hard assets [like real estate and gold]. With bonds yielding under percent and stocks having a price-to-earnings ratio of over 20 times for an earnings yield of less than 5 percent, we believe real estate remains an attractive investment alternative."

* It makes sense, if for no other reason than real estate returns are a solid 7 percent to 7.5 percent cash-yield vehicle, Youguo Laing, managing director, research at Prudential Insurance Real Estate Investors, Parsippany, New Jersey, told Mortgage Banking in April.

"We're hearing that quite a few large pension funds have increased their allocation for real estate by 2 or 3 percent--but that's anecdotal, not statistical, evidence," Laing says.

More pensioners, more earnings

Apart from the satisfaction of achieving decent returns on brick-and-mortar-type investments, public and private pension funds will need higher yields to pay ballooning benefits to a rapidly expanding retirement population--including a huge wave of baby boomers--that will retire over the next 10 years, Laing explains. Pension funds have been pumping up their investment earnings by rebalancing their accounts to squeeze more yield out of investments to be able to honor those looming financial obligations.

Timing is becoming critical. John McMahan, executive director of the nonprofit Center for Real Estate Enterprise Management (Centerprise), San Francisco, says pension funds are "starting to move into a cash-outflow position, in which liabilities exceed incoming contributions. Public plans' retirement ages are often 55 or 62, so they are experiencing cash outflow earlier than the corporations."

Much of the higher yield is coming from public- and private-sector pension fund investment in U.S. real estate, worth an estimated (as of mid-April) $200 billion, according to Jack Nowakowski, director of research, Pension Real Estate Association (PREA), Hartford, Connecticut. With as many as 30,000 pension plans in the United States, it is impossible to precisely measure the swing in allocations for real estate, Nowakowski says. Historically it is about 7 percent, but it can be as low as 2 percent, zero for the smaller plans and, in some cases, as high as 9 percent or 10 percent.

What allocations for real estate are planned by pension-fund superstar Teachers Insurance and Annuity Association--College Retirement Equities Fund (TIAACREF), New York?

Richard Coppola, managing director, West Coast region, TIAA-CREF's mortgage and real estate division, which manages a $27 billion international portfolio (out of $280 billion in total assets under management), told Mortgage Banking in an interview last December, "We expect to continue investing $6 billion to $7 billion a year in conventional and securitized commercial mortgages and property acquisitions. We also expect to purchase about $800 million a year in new commercial real estate. …