Facing $1T Shortfall, Pensions Scale Up Real Estate Investments In Search Of Returns

Public pension funds constitute some of the largest scaffolds in the commercial real estate market, with an estimated $6 trillion invested in real estate assets worldwide, and as economic and investment patterns change over time, these institutions face growing uncertainties with growing implications for CRE.

A volatile stock market, the retirement of the large demographic of baby boomers and even geopolitics contributed to what is expected to be the largest single-year drop in funding rates for retirement systems since the Great Recession, according to a report by the Equal Institute.


Pension funds hold an estimated $6 trillion in commercial property worldwide.

The gap between pension fund assets and the money they need to meet their obligations is estimated at more than $1 trillion this year, and while experts say the funds are stable and meet self-determined expectations of return, they predict that these funds will pour even more money into the real estate market to cover their shortfalls.

“More money is being invested in real estate today than a decade ago, in part because state pension funds are trying to match their returns and they know that stocks and government bonds are not the way to do it,” the Equable Institute director said. executive Anthony Randazzo. “Because the funding gap persists, there is more pension fund money flowing into real estate in general, to try to fill the funding gap.”

Commercial real estate record in 2021, in which the sales volume of commercial properties in the first three quarters of the year exceeded $462 billion, increased property values to new heights and helped close the funding gap for pension funds as a group.

Unfunded liabilities for state and local pension plans were $933 billion in 2021, down from $1.7 billion in 2020, according to the State of Pensions Report 2022 by the Equality Institute. The decline was due to “a single year of exceptional investment returns,” according to Equable.

But in 2022, as back-to-office delays dampened the office market and interest rate hikes and recession fears have kept a cap on transaction volume, that trend is likely to reverse. Equable estimates that unfunded liabilities will reach $1.4 trillion in 2022 “due to poor market performance.”

There are a number of ways that pension funds can make up for these shortfalls, including increasing contributions from members or from the governments where they are located. But getting a government boost is often an unpopular request and comes at the expense of other programs and services that people depend on.

The average annual contributions of state and local governments to their pensions have grown at a rate of 8% per year for a decade, Pew Charitable Trusts Said the Director of Public Retirement Systems, Greg Mennis.

Those contributions were significant for the funds they bolstered, Mennis said, propelling five funds that had been struggling financially into a more stable position, as measured by Pew. But they come with a cost.

“The flip side of that is that it has taken a bite out of government budgets and crowded out services,” Mennis said. “And so how do state and local governments navigate the very uncertain economy and if [they] it can bend the pension cost curve; I think those are interesting questions to focus on going forward.”

For example, in New York City, five pension funds posted a loss of 8.65% in the most recent fiscal year, Pensions and Investments reported last month. The loss, which was the worst for funds since the Great Recession, meant the public will be on the hook for fund contributions of $861 million in fiscal 2024, $1.97 billion in 2025, and $3.02 thousand million in 2026 to shore up pensions, P&I reported.


Position marker

1900 Aldrich St. in Mueller, Texas, outside of Austin, was recently purchased by the Teachers Retirement System of Texas.

Overall, state contributions to pension funds since 2010 have more than tripled, according to the Equable report, as a result of states making up ongoing funding shortfalls, but even with those increased contributions, the report’s authors They say the money coming in from employees and employers hasn’t been enough to offset steadily rising benefit payments to retirees.

So pensioners are increasingly turning to real estate, even though it can be seen as risky, Mennis said, because it diversifies portfolios and returns are typically higher than less risky investments.

Pension fund assets under management nearly doubled in the past decade, from $30 billion in 2010 to $56 billion in 2020, said Donald Hall, Americas director of research for Nuveen Real Estate. During that same period, pension funds increased their allocations to real estate by about 2%. Hall estimates, then, that pension fund capital in real estate globally is $6 trillion, up from $3 trillion a decade ago.

“What you get is actually a little more than the doubling of pension fund capital in the industry over the last decade,” Hall said.

Public pensions have an average allocation of 12.3% to real estate, which is the highest allocation of any institution, according to the 2021 Real Estate Allocation Monitor from global equity advisory firm Hodes Weill in conjunction with the Baker Program in Real Estate at Cornell University.

The company is still conducting its next survey, but all signs point to a continued rise in targeted allocations to real estate, Hodes Weill deputy managing partner Doug Weill said.

In the last year, the Indiana Public Retirement System increased its allocation to real estate from 7% to 10%; the Texas Municipal Retirement System has gone from 10% to 12%; and the California State Teachers Retirement System, the second-largest pension fund in the US, increased its allocations from 13.5% to 15%, Hall said.

Pensions are investing in everything from basic to value-added to opportunistic, Weill said, giving them the “broader investment objectives or set of objectives of all institutions.”

In an average of five years, real estate has returned 8.4% to pension funds, according to the 2021 report by Hodes Weill. Real estate has been “a shining star” in institutional portfolios, Weill said.

“The performance of asset classes has changed over the last decade and pension funds are continually increasing real estate allocations as a way to help them achieve required rates of return,” said Nuveen’s Hall.

But as the CRE market has changed, so have the tastes of pension funds within the real estate market. Persistent uncertainty about offices has affected how pension funds view the type of property. Many have also moved away from retail properties.

Private real estate funds have 23% of their investments in offices, down from 34% in 2019, The Wall Street Journal reported, citing data from the National Association of Real Estate Investment Trustees. Its holdings in commercial space have fallen from 17% to 10% during that time, but investments in industrial real estate have risen from 18% to 31% during the same period.

In an email to great snowA CalSTRS spokesperson said the pension fund, which supports teachers throughout California, is “actively increasing its exposure to industrial, residential and specialty product types such as life sciences buildings,” attributing the change to the “shifting consumer demand” driven by e-commerce and housing supply shortages.

“Institutional capital has been gravitating for some time toward industrial multifamily, especially Sun Belt multifamily, and alternatives, including life sciences, data center, medical office, senior housing, and housing. for students,” said Kevin, co-head of US Capital Markets at Newmark. Shannon said.

In a July presentation to the board, Teachers Retirement Systems of Texas Senior Director of Real Estate Grant Walker told board members that prior to the pandemic, the pension fund had begun to strategically “overweight” industrial and residential sectors in its portfolio and “low weight” offices, shops and hotels.

“When the pandemic started, the shock of that really worked in our favor,” Walker said. The pension fund had also jumped early into life sciences and studio real estate, something Walker said was relatively new to big institutional investors. But those were worth it too, earning a 7.6% return in the first three months of the year.

The TRST did buy an office building this year, a new property sold by Shorenstein where the pension fund will have its offices.

Real estate’s ability to generate returns when other investments struggle has helped bolster its position in pension fund portfolios, but with fears of a recession and their impacts on real estate markets still very much at the forefront, there may be further changes to the types of property they are looking to invest in.

Despite the outsized 2021 performance, a number of factors have slowed pension allocations in real estate in recent months, Weill said, including market volatility and concerns about rising interest rates and cap rates. . He anticipates that once market volatility subsides, perhaps in the fall, that will pass.

“At a time like now, even though medium- to long-term institutions are quite bullish on real estate and adding to their portfolios, right now their sentiment is negative or at least cautious,” Weill said. “Sentiment changes pretty quickly.”

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