The Partner Perspective
Introduction:
For the May 2020 blog on the Partner Perspective, Alliance interviewed Limited Partners with cumulative real estate assets under management of over $39 billion and Consultants separately representing approximately $90 billion in real estate assets under management. We listened to Chief Investment Officer (“CIO”) reports and real estate reports delivered during April and May Board meetings to collect the viewpoints below.
Existing Portfolio Considerations
The Denominator Effect
The denominator effect influences the amount of capital available for investment. When values fall across every asset class (more rapidly in an equity portfolio), the risk of being overweight to a specific asset class rises, constraining the amount of capital available for investment at the “bottom” of the market. Preservation of capital and the importance of vintage year diversification were two valuable "lessons learned" following the global financial crisis.
As reported in the Wall Street Journal on May 12, 2020, “public pension plans lost a median of 13.2% in the three months ended March 31, according to Wilshire Trust Universe Comparison Service data released Tuesday, slightly more than in the fourth quarter of 2008. March’s stock market plummet led to the biggest one-quarter drop in the 40 years the firm has been tracking.”
Comparatively, the institutional investors Alliance interviewed for this piece lost, on average, approximately 10% of total plan assets in the first quarter of 2020. Real estate investment officers noted that private real estate valuation adjustments did not take place in the first quarter of 2020 reporting, but all expected valuation adjustments in the coming quarters.
Asset/Liability and Asset Allocation Considerations
Most CIOs agreed that the analysis of the financial impact of the COVID-19 pandemic is ongoing and that they take a long-term view. However, some changes to actuarial studies were mentioned in our conversations with Limited Partners. Though the assumptions are unique to the individual client, general trends worth noting are below.
Reduced Inflation Expectations
o For one California Limited Partner, in a May 2020 review of economic and non-economic actuarial assumptions, Segal Consulting recommended a decrease from the current 3.0% annual inflation to 2.8% for the June 30, 2020 actuarial valuation. This reduction reflects a general recommended adjustment downward. Segal referenced an average inflation assumption of 2.3%, as measured across six different investment advisory firms.
Reduced Confidence Levels
o Confidence levels describe the probability of achieving a funded ratio based on underlying assumptions. Post-COVID-19, it is realistic that confidence levels will decline to reflect increased uncertainty in economic outcomes.
The economic impact of COVID-19, if severe and prolonged, may affect other long-term assumptions.
o Note one positive impact is the considerable savings on travel budgets.
The CIO Perspective
The CIO perspective is one of caution and skepticism, with most questioning the notion of a V-shaped recovery. Most CIOs noted a disconnect between the “real world” and the “financial world.”
Total plan asset declines referenced in the press do not necessarily reflect changes that have yet to occur in the private markets. Private markets will also be impacted, resulting in further total plan asset declines.
In May, the financial markets rebounded from a mid-March low due to trillion-dollar fiscal stimulus packages (which may surpass $10 trillion).
Monetary policy has kept interest rates historically low, and equity markets appear disconnected from corporate earnings.
National unemployment is 15.0% and likely increasing. Unemployment in Los Angeles reached 20.3% post-COVID-19.
Pension budget deficits are growing. CIO’s continue to think about intergenerational transfers as debt reaches unimaginable levels.
Real Estate Due Diligence Activities
Most pension real estate portfolios appear "well-positioned" to both absorb valuation declines and invest across the 2020 and 2021 vintage years. Following the global financial crisis, many Investors re-oriented real estate portfolios to include a higher percentage of Core and Core Plus assets and limit overweight positions in troubled property types. Often at the request of the CIO, Real estate investment officers are focused on running sensitivity analyses on their existing portfolios. Investors are interested in hearing from their General Partners, preferably in an “executive summary” format. General Partners are not to blame for a global pandemic. Make sure to include details on where the trouble lies and potential impacts to come.
Ten Important Facts for Existing General Partners to Communicate
1. Organizational Changes (layoffs, furloughs, compensation structure)
2. Return-to-Work Plans
3. Research related to COVID-19 and its impact on the Real Estate Market
4. Fund Liquidity Status
5. Fund Debt Maturity Schedule
6. Communications with Asset and Fund Lenders
7. Monthly Rent Collection Rates/Impact of Short-Term Rent Deferral Agreements
8. Valuation Expectations/Re-forecasted Fund Returns
9. Amount of Dry Powder/Investment Opportunities/Acquisition & Disposition Activity
10. Anticipated Changes to the LPA, such as Extensions or Strategy Shift
Emphasis on Existing Partnerships
Many investors remain active but are focused on existing relationships.
Investors are willing to re-up and commit to existing partners when opportunities align with dislocation in the market. When asked about which groups they will physically meet with through the remainder of 2020, one investor simply said, "nobody new."
A philosophical shift may be taking place from single sharpshooters to allocators who perform well in times of distress.
Invest with operators with "boots on the ground" in specific geographic markets.
Investors will conduct due diligence on-site for new development deals.
Most Limited Partners said they are "pencils down" on new manager relationships for the time being. However, all agreed they will soon resume due diligence and are interested in hiring new managers. They believe that to take advantage of the opportunity in the markets, you must hire the best manager with boots on the ground expertise.
Focus on Being “Transaction-Ready”
Despite a limited number of transactions, Investors and Consultants are deliberately using this time to become “transaction-ready.”
Many open-end commingled funds are now "gated" for entry and exit. Limited Partners with unpaid redemption requests have rescinded some outstanding redemption requests, particularly in funds with multifamily and industrial overweight’s that may be positioned to outperform. Some concern remains that managers will pay redemptions after a significant valuation reset, and Limited Partners are not inclined to "sell low." Limited Partners with outstanding uncalled commitments to open-end funds have asked the managers to postpone capital calls.
One Limited Partner elected to delay considerable 2020 commitments to Core open-end funds until 2021 when they expect valuations to reflect the current environment. The vast majority are waiting to see the magnitude of the write-downs before allocating capital to the Core segment.
To satisfy liquidity needs or avoid unwanted exposures, investors are turning to the real estate secondary market. The secondary market has emerged as a possible way to exit current positions or make new commitments at a discount to carrying value.
o Secondary Brokers have amassed pipelines of over $1 billion in selling interest in the US open-end funds. This pipeline compares to selling interest of $300 million in March that did not trade following a misalignment between Q1 2020 NAV pricing and the public markets. Bid-ask spreads exist.
Special Mentions
Blind pool diversified opportunity funds
Core open-end fund positions (post-valuation reset; “Don’t focus only on distress – lest we forget that the Core funds offered the best risk-adjusted return to investors following the GFC.”)
Favored Sectors
o Industrial
o Apartment
o Data Centers
o Public Securities
o Distressed Credit
Investors who were haphazardly allocating capital geographically are now beginning to think about the geographic exposures as urbanization desires change.
Return to Work
Most Limited Partners are planning a phased “return-to-work” with dates ranging from June 1, 2020 to September 1, 2020. At this point, all Limited Partners who initially anticipated a June 1, 2020 start date expect the target date to move.
Corporate re-stacking plans and staggered starts are being contemplated, as well as rotating shifts.
Several investment staff members have been deemed "non-essential" – not in terms of their essential function - but instead, their required physical presence in the office.
“Path-of-travel” for office employees (commute, elevators, multi-floor tenant use of stairwells) is a consideration. Interestingly, some office operators are restricting elevator use to two people per lift. Additional cap-ex proposals for elevator modernization and destination dispatch systems are in review.
Travel Restrictions
Travel will be optional for the remainder of 2020. While none of the Limited Partners have instituted a formal travel restriction to date, several stated that resuming post-COVID-19 travel will be a “personal choice,” as opposed to a mandated policy across organizations. Some Limited Partners are considering a stringent sign-off requirement for all future travel.
Limited Partners are not interested in attending large group gatherings before 2021. Despite this sentiment, industry conferences such as IREI, are moving forward with in-person Fall 2020 meetings.
A majority of the General Partner Annual Meetings scheduled for Fall 2020 are taking place via web format due to “informal” travel restrictions and investor sentiment regarding travel. Only a handful of General Partners are keeping their Fall meetings in place.
A majority of the Limited Partners suggested they will not see new investment managers in their offices for the remainder of 2020.
The consensus view is that Limited Partners do not miss traveling frequently. Many have realized that they can be more effective in meeting people through Zoom and video conference calls.
Allowing on-site meetings with new (and even a few existing) partners is now considered a liability.
Productivity in a Web World
Most CIO’s described their investment team’s work-from-home environment as productive.
While working from home, Limited Partners are spending most of the time on back-to-back conference calls and webinars.
General Partners should be respectful of the time commitment required when planning a virtual Limited Partner and Limited Partner Advisory Committee meeting.
Other responsibilities exist in the business day when working from home.
Limit calls/videos to a maximum of 4 hours to hold attention span.
Plan to deliver a condensed version of the material – executive summaries are always appreciated, backed by research.
Distribute all educational materials, or referenced material, in advance of the meeting.
Test audio with all participants and have an audio-only backup.
At the beginning of the call, acknowledge that the call will be recorded. Indicate that no press is permitted on the line (if this is the case) and note that a recording will be available for all registered participants following the session.
Include a chat function for participants' Q&A during the session – use "raise your hand function" and assign a responsible moderator to organize the conversation.
Distribute the Q&A to all participants following the event.
By: Alliance Co-Founders
Disclaimer: This blog was originally published on June 1, 2020 and will be updated periodically to reflect changes in the industry. The content may contain or cite personal and/or professional opinions that differ from the views of Alliance Global Advisors.