How CalSTRS Plans to Avoid Selling CRE Assets in a Down Market
The giant pension could borrow 10% of its $318 billion portfolio value and change its long-term CRE asset allocation by a third.
Commercial real estate valuations have been hit over the last 18 months. Inflation, the Federal Reserve’s response of interest rates hikes, growing operating expenses, previously swollen values, and a lack of transactions undermining price discovery have all done their part to down prices.
That puts investors into a barrel of pickle brine. They may be holding CRE assets that have plummeted in value while refinancing options are tighter, demanding higher interest rates and lower LTV ratios. Selling in a down market could lead to fire sale prices when markets might eventually recover, especially if the Fed cuts interest rates.
One enormous investor, the California State Teachers’ Retirement System, or CalSTRS, is considering a new policy of borrowing up to 10% of its $318 billion portfolio value to preserve liquidity without dumping assets, as Bloomberg first reported. It also would allow for the temporary rebalancing of asset allocations that would enable opportunistic purchases of more properties. For CRE, that would be plus or minus 5% against a long-term target allocation of 15%.
An investment committee policy document, slated for consideration on January 11, states, “Market shifts often require the investment team to actively rebalance an increasingly complex CalSTRS portfolio. This complexity stems from our growing private markets portfolio, as well as cash flow streams that vary over time with the business cycle.”
“Enhanced portfolio and liquidity management helps to manage risk and complexity, and continue to meet our objectives including: (1) Paying benefits; (2) Avoiding selling assets at discounted prices; (3) Taking advantage of market opportunities; and (4) Rebalancing the portfolio,” the document continued.
Using temporary leverage through borrowing against the portfolio, CalSTRS could tap more than $30 billion if it needed. According to Bloomberg, CalSTRS already leverages 4% of its portfolio. Meketa Investment Group, a consultant to the pension fund, supported the idea in a memo.
“A number of risks were considered by Staff, and discussed with Meketa,” the firm wrote. “Meketa would like to highlight that one important risk of both these changes is that they create the potential for larger losses and tracking error relative to benchmarks. Staff highlighted the risk that expanding target ranges could potentially increase the active risk in the portfolio, if/when the portfolio deviates more substantially from targets. Staff conducted analysis that showed a relatively small change in the funding risk to the plan over time, and also highlights the RAC Committee, and other oversight by Meketa and risk managers, to keep these risks in check.”
As of September 30, 2023, the pension fund’s annualized one-year return was 7.7%. Over a 10-year period, it was 7.9%.