Opportunists come knocking

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Pension plans in the US began to move back into European strategies in 2013. Rachel Fixsen investigates the source of the transatlantic pull.

In a country as big as the US, pension funds hardly suffer from a lack of property investment opportunities. With no less than nine cities of over a million inhabitants, there are plenty of real estate deals to be had in all sectors.

Yet, many of the country’s pension funds are have been closing investment deals across the Atlantic in Europe. In January, the Illinois State Board of Investment announced its intention to make its first commitment to property funds targeting solely Europe or Asia, saying there were some strong investment opportunities to be had in both regions. The strategy would let the board increase the overall level of diversification of its portfolio, it said at the time.

Two months before, the Teacher Retirement System of Texas awarded a mandate to AXA Real Estate to build a €135m diversified European portfolio with a view to making value-added investments.

Last summer, a wave of US institutions made moves to start or increase their exposure to European real estate. San Diego City Employees’ Retirement System said it would invest $20m (€14.7m) in Europa Capital’s value-added fund, a pan-European strategy focusing on the UK, France and Germany. Other institutional moves towards European real estate came from New Jersey Division of Investment, New Mexico State Investment Council and the California State Teachers Retirement System.

They view Europe as emerging from a post-austerity recessionary period and beginning to be a store of value

Jay Morgan, Courtland Partners

Anthony Frammartino, partner at real estate consultancy the Townsend Group, says Europe does have a disproportionate appeal to US pension funds and institutions. “It’s probably perceived globally as somewhere where there’s still distress-value appeal,” he says. “Due to the state of the lenders in Europe, there’s still anticipated to be a feeling they’ll be net sellers. Global investors are contemplating more in the way of sales.”

The same level of upcoming opportunities is not expected in the US and Canada because lenders to real estate there are better capitalised than their counterparts across the Atlantic, Frammartino observes.

“Now, in the US from a relative standpoint, pricing is less favourable than in Europe,” he says. “The fact that [Europe] is an attractive opportunity to invest in will probably continue.”

This is not the only international comparison that makes Europe an appealing investment location for US institutions. “The other thing is there’s probably less interest in emerging markets now, with rising interest rates affecting those markets more,” Frammartino says.

US pension funds started looking at Europe partly because they have had their fill of invest- ment in core open-ended funds — vehicles they flocked to in the spirit of de-risking that followed the global financial crisis.

“They now find themselves full up on core, and they recognise the contribution queues going into these funds,” says Jay Morgan, senior consultant and director of research at Courtland Partners in Cleveland, Ohio.

These queues have hit the ability of the funds to put new money to work, which has meant that the pension funds investing in them now are having to wait up to six quarters before they can draw income from the fund. “At the same time, cap rates have compressed again because of all this buying activity, particularly on the core side,” Morgan notes.

“On the one hand this has led US pension funds to reassess their risk appetite and begin to become more comfortable taking risk and adding opportunistic funds, and at the same time they view Europe as emerging from a post-austerity recessionary period and beginning to be a store of value or a place for opportunistic investments.”

Not everyone sees the appeal of the European real estate market as a source of returns for US pension funds.

“I don’t see what Europe has to offer,” says Ted Leary, founder and president of Crosswater Realty Advisors in LA. “It’s a low-growth story with low yields. The non-performing loans side, the debt side, is an opportunity, but that’s not for everybody.”

Besides, Leary points out that the US has such a vast array of institutional investors with different goals and strategies that it is impossible to reach common conclusions about their behaviour. “For every advocate of, say, Europe, there is another that hates it,” he says.

However, there is a general trend apparent among some US pension funds in the way they are investing in real estate, Leary observes. “Most of the major funds are clearly shrinking the number of managers they use. That has two impacts: the big successful managers are getting bigger, and there’s less money to go around particularly for the emerging managers. People are not getting beaten to death on the streets but they’re just going to quietly disappear.”

The factors behind this are similar to the factors at play in Europe, but Leary says the big public pension funds in the US are simply being more assertive in their reaction to them than their European counterparts.

Morgan says the preference for larger firms is partly driven by pension funds’ reduced appetite for risk relating to the organisation of the manager. “We’ve seen managers get rejected for back-office due-diligence issues that wouldn’t have been that much of an issue five years ago,” he says, adding that the bigger firms have the skills to provide what is needed.

Pension fund’s now face more scrutiny and, as a result, are less willing to take organisational risk, Morgan says.

“A broad theme happening in the US for the past 18 months has been an increased interest in co-investments,” he says. “These structures are giving the investors more control in how and when their dollars are invested. They’re less interested in exposure to a blind-pool closed-end capital-call fund where they don’t know what will be invested and when.”

Co-investment gives pension funds the chance to approve or reject investments based on their current investments and their view of the market, Morgan says. 

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