Pensions Taking on Riskiest Real Estate Bets
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What are U.S. pension funds doing to close massive funding gaps?
With your money briefing, I'm J.R. Whalen at The Wall Street Journal in New York. Some U.S. pension funds are taking on extra risky real estate bets to close funding gaps. In some cases, their betting on real estate doesn't even exist yet. We'll explain in a moment. First, these money and market stories you should know. Home price gains slowed in September for the sixth consecutive month. That's further evidence that rising mortgage rates are helping to slow the momentum out of the housing market. The S&P CoreLogic Case-Shiller National Home Price Index that measures average home prices in major metropolitan areas across the country rose 5.5 percent in the year ending in September. That's down from the 5.7 percent year-over-year increase reported in August.
And after price gains accelerated for most of the last two years, in recent months price growth has been steadily slowing as interest rates have risen and inventory in some markets has been growing. And the tax law sharply reduced the number of people who get deductions for contributions to non-profit groups. And that has many charities bracing for a reduction in donations. The tax law pushed millions of upper-middle-class households from itemizing deductions into a larger standard deduction. And so in 2018, 15 million households, that's fewer than 1 in 10, will benefit from the charitable deduction. That's down from 36 million in 2017. Plus, a relatively small number of high-income people are responsible for an increasing share of charitable deductions.
The Tax Policy Center says those changes are expected to reduce charitable giving by about 5 percent, or $15 billion, compared with what would have happened under the old tax law.
Pension funds are making efforts to close funding gaps.
What short market updates set the context for pension risk-taking?
That's not unusual. But many are taking unusual and risky action to do so. And Wall Street Journal reporter Heather Gillers has the story. Hey, Heather, thanks for stopping by.
Thanks for having me.
So many of the largest U.S. public pension funds have turned to real estate investments to generate funding. But it's a particular kind known as opportunistic investments that are very risky.
We cited in our story some research from CEM Benchmarking that showed a lot of detail, more detail than we're usually able to see in terms of how pensions invest in real estate and what types of real estates they invest in. This data showed that over the 10-year period from 2006 to 2016, investment in opportunistic real estate increased sixfold.
What is 'opportunistic real estate' and why is it considered risky?
It's six times higher than it was in 2006. Opportunistic real estate typically means building a building from scratch or taking a really troubled building and overhauling it. You might turn sort of decrepit multifamily rental apartments into condos, but basically you're putting in a pretty significant investment before you get any income out of it. A more typical traditional real estate investment, sometimes called a core real estate investment, would throw off income because rent would be collected from the tenants or maybe parking fees if it were a parking structure. So the day the pension fund buys it, it's throwing off a steady stream of income. Hard to go wrong. With an opportunistic real estate investment, you may put millions of dollars, tens of millions of dollars into building a building.
And, you know, 10 minutes after it goes up, the housing market crashes and you're out that money and the value of your building is much less than the amount you've put in.
Now, the reasons some of these funds are going for these opportunistic type investments is because, as you say in your story, cheap real estate is harder and harder to find.
Many pension funds are underfunded for a number of reasons. One reason is that governments have often solved their budget crises on the backs of pension funds. You know, we got to pave the roads. We got to pay our police officers. But
How much have pension investments in opportunistic real estate grown recently?
maybe this year we'll put off contributing to the pension fund. Year upon year of that leads to a badly underfunded pension fund. Another problem many pensions face is that for years they've made over-optimistic assumptions about how much they can earn on their investments.
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Chapters
6 chapters
1
What are U.S. pension funds doing to close massive funding gaps?
0:05–1:56
2
What short market updates set the context for pension risk-taking?
1:56–2:42
3
What is 'opportunistic real estate' and why is it considered risky?
2:42–4:00
4
How much have pension investments in opportunistic real estate grown recently?
4:00–6:01
5
Why are underfunding and optimistic return assumptions pushing pensions toward risky bets?
6:01–8:10
6
Which pension funds and real-estate deals illustrate this trend (Blackstone, CalPERS, Dallas example)?
8:10–8:12
Speakers
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