U.S. public pension funds have started to scale back on their investments into the commercial real estate industry, The Wall Street Journal reports. The reversal comes after these funds had invested money into CRE at a record rate during the first half of 2022.
The retirement funds made $32.6 billion of new financial commitments to offices, buildings, warehouses and other CRE properties in the first half of this year—an approximate 40 percent increase from the same time frame in 2021, according to Ferguson Partners, a professional services firm that tracks the CRE industry.
The high demand for CRE property during the first half of this year was in part due to investors coming back to the market following the start of the COVID-19 pandemic, Ferguson director Scott McIntosh told The Wall Street Journal.
“Real estate was generating strong returns,” McIntosh said. “We were seeing strong rental growth and strong transaction volume through 2021 and a lot of that momentum flowed into the first half of 2022.”
Unfortunately, increased borrowing rates are not a good sign for an interest-rate sensitive industry like CRE. Plus, building owners haven’t been in the best position to raise rents because of increased concerns about a recession.
Ferguson Partners is still calculating potential third-quarter pension fund investments, but they are most certainly going to drop during the back half of 2022, according to McIntosh. He pointed to inflation, labor costs and supply-chain disruptions, which have made building more expensive, as reasons there could be fewer pension-fund commitments during the third quarter.
CRE fundraising also on the decline
Private equity funds and other CRE investors that look to pensions when they raise money for their new funds have also noticed a difference, according to The Wall Street Journal. Private equity firm managed CRE funds raised $112.8 billion from pension funds and other investors worldwide as of October 20. The time last year, almost $160 billion was raised, according to data firm Preqin. Market experts are projecting fourth quarter fundraising could fall well below the record $80 billion raised during the final three months of 2021.
“(At this time last year) we were coming out of COVID; inflation wasn’t going to last too long and interest rates were probably going to be manageable,” Dave Lowery, Preqin’s head of research insights, told The Wall Street Journal. “A lot has changed since then.”
CRE sales are also down—the $171.2 billion worth of commercial property acquired during the third quarter is a 21-percent drop off from the same time period in 2021, per MSCI data. Decreased sales have made pension funds and other investors hesitant to put more money into CRE because it’s uncertain if property values will continue to fall.
A lot of pensions have now scaled back on future CRE investments because of what’s known as the “denominator effect,” The Wall Street Journal reports. They want their property holdings to only make up a certain percentage of their entire portfolio.
Meanwhile, some pensions are focusing on potential opportunities with troubled properties during an economic downturn. For example, the Connecticut Retirement Plans and Trust Funds is looking to “take advantage of the lack of capital in certain areas” as well as “distress in the market,” a spokeswoman said.