For a few quarters running, several news outlets have reported precipitous declines in pension allocations to real estate fund managers. While succeeding in generating attention for their reporting, none of these articles reflect reality – the challenge facing institutional investors is placing enough capital into commercial real estate (Figure 1).
Source: Cornell University
CalPERS is the largest public pension plan in the United States outside the federal government. Citing statistics from an advisory concern, one outlet recently reported a 50 percent decline in the pension’s allocations to CRE. Contrary to the headline, CalPERS’s allocation remains 13 percent – one of the highest allocations to commercial real estate in the institutional world. However, their ability to fund investments to meet this allocation has been challenging.
Rolling 12-month transaction volumes have declined some 12 percent since peaking in the post-GFC cycle at $544 billion in 2015. Effectively removing approximately $70 billion in transaction velocity from the market place has stymied institutional investors’ ability to fund capital in a manner that meets its capital commitments.
Investment managers across the nation therefore hold a record amount of dry powder, referring to capital already committed to commercial real estate investments but not yet successfully funded (Figure 2). Totaling nearly $140 billion within closed-end funds alone, the amount of money seeking investments is a backstop for values in the aforementioned environment of lower transaction velocity.
We can therefore conclude capital is abundant for commercial real estate, but not desperate to deploy. Such a mentality is appropriate given the long-dated recovery cycle we are currently operating in. And while wire transfers to investment managers may have declined by 50 percent, it is in no way a negative reflection of investor interest in, or the attractive return performance of, commercial real estate assets compared to various asset classes (Figure 3).
Sources: HFF Research, Dow Jones Corporate Bond Index – equal weight investment grade corporate bonds, S&P Total Return Index – total return including capital appreciation, assumes dividend reinvestment, Bloomberg Commodity Index – annually rebalanced excess return index based on futures price fluctuation, Dow Jones CBOT Treasury Index – default-free returns available within the US, FTSE NAREIT Total Return Index – non-timber, non-infrastructure REITs total return including capital appreciation, assumes dividend reinvestment, Sharpe Ratio calculations assuming risk-free rate of 4.1 percent from UST CAGR
Investors are taking a measured approach to underwriting, valuation and investment strategy. This is a distinguishing element of the industry’s approach to risk and valuation. It is also a critical element of the asset class’ protracted influence in the composition of a balanced, diversified investment portfolio.