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WSJ Your Money Briefing
Pensions Taking on Riskiest Real Estate Bets
00:08:12
In an effort to close funding gaps often in the trillions, many U.S. pension funds have turned to some of the riskiest types of property investments. Wall Street Journal reporter Heather Gillers explains.
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- [00:01]
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This episode is brought to you by Charles Schwab. Decisions made in Washington can affect your portfolio every day, but what policy changes should investors be watching? Washington Wise is an original podcast from Charles Schwab that unpacks the stories making news in Washington right now and how they may affect your finances and portfolio. Listen@schwab.com WashingtonWise.
- [00:31]
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With your Money briefing. I'm J.R. whalen at the Wall Street Journal in New York. Some US Pension funds are taking on extra risky real estate bets to close funding gaps. In some cases, they're 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. The 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% in the year ending in September. That's down from the 5.7% 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 nonprofit 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%, or $15 billion, compared with what would have happened under the old tax law. Pension funds are making efforts to close funding gaps. 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.
- [02:32]
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Thanks for having me.
- [02:33]
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So many of the largest US 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.
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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 estate they invest in. This data showed that over the 10 year period from 2006 to 2016, investment in opportunistic real estate increased sixfold. 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 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.
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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.
- [04:13]
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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 gotta pave the roads, we gotta pay our police officers, but 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. So that leads them to contribute less. In fact, you might say they have an incentive to make overoptimistic assumptions because then they don't have to find as much money in the budget to put into the pension fund. So all these types of behaviors combined have left a lot of the pension funds in the US behind. And so now they're stretching for these high risk, high return types of investments to fill the gap.
- [05:04]
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The largest retirement funds have funding gaps in the trillions, and they're hoping for 7% growth every year to support current and future payouts. When I read that in your story, I thought that 7% annually seems like a big ask. That seems like a lot.
- [05:20]
A
That's right. Particularly in the low interest rate environments that we've been seeing over the past decade. And so often pension funds aren't making those, especially sort of in recent years. And there were huge losses during the crisis in 2009, 2010. So, yes, the 7% often is not met. And that causes the funds to drop level, to drop lower.
- [05:44]
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And there are some opportunistic real estate funds managed by Blackstone Group that are attracting investments from retirement systems nationwide.
- [05:52]
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I found that the South Dakota retirement system, the Virginia retirement system, the retirement system that Pennsylvania runs for its public school employees, are all invested in opportunistic real estate funds run by Blackstone. Some other types of pensions, like CalPERS, are actually building buildings in an even more direct way. CalPERS may go forward with the tallest tower in Sacramento. These are not sort of your mashed potatoes and gravy, bread and butter, meat and potatoes investments.
- [06:24]
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Yeah, I mean, you're talking about these pension funds. These are enormous amounts of people that are enlisted in these pension funds eventually looking for a payout.
- [06:33]
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And oftentimes they have taken these jobs because of the benefits that come with them. And there can be really dire consequences when pension funds sort of veer towards insolvency. So maybe most extreme example is the Dallas police and fire pension fund, which made all kinds of real estate bets prior to the crisis. They bought homes, they invested all over the world, and those investments just lost an incredible amount of value. And the pension fund sort of started hemorrhaging money. And. And the police and firefighters said to themselves, that's our retirement. That's our security. And what they did is they began cashing out their money. And so huge sums of money flowed out of this pension fund. And because part of the way the pension fund makes money is by earning income on its nut, on its nest egg, this shrinking nest egg really jeopardized the fund.
- [07:32]
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Now, Heather, these are very risky moves with a lot of people's money. Who's policing this? Is there some structure in place to sort of put the brakes on some runaway spending?
- [07:42]
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Well, the governance of pension funds varies from state to state. But often the people who are in charge of ultimately making decisions about how to invest this money are not finance professionals. They are teachers or retired teachers or public workers or local community leaders. And they're charged with making the best decision they can with the information they have, but they have tremendous amounts of information thrown at them. I mean, the packets that they see before board meetings are inches thick. And I mean, the California Public Employees Retirement System meeting goes for three days, all day. And often these people have full time jobs. So it can be a difficult burden for these folks.
- [08:29]
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All right. That's Wall Street Journal reporter Heather Gillers joining us here in our studio. Heather, thanks for being with us.
- [08:34]
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Thank you.
- [08:35]
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And that's your money briefing. I'm JR Whalen in New York for the Wall Street Journal.
- [08:40]
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This episode is brought to you by Charles Schwab. Decisions made in Washington can affect your portfolio every day, but what policy changes should investors be watching? Washington Wise is an original podcast from Charles Schwab that unpacks the stories making news in Washington right now and how they may affect your finances and portfolio. Listen@schwab.com WashingtonWise.