Upload
others
View
1
Download
0
Embed Size (px)
Citation preview
Investment Division Education Program
October 19, 2017: Real Estate
Steve Sexauer, CIO SDCERA Continuing Education Program
October 19, 2017, Real Estate
Trustee Education Curriculum
1. Measuring Performance 2. All About Risk 3. Real Estate A. Market Terms and Structures
B. Real Estate Fundamentals and Return Drivers C. Real Estate in a Pension Portfolio D. Discussion and Questions
2 Steve Sexauer, CIO
SDCERA Continuing Education Program October 19, 2017, Real Estate
Part A. Market Terms and Structures
Mike Comstock, Aon Hewitt
3 Mike Comstock, Aon Hewitt
SDCERA Continuing Education Program October 19, 2017, Part A, Real Estate
Real Estate Risk Spectrum Defined
Core – Most conservative real estate investment strategy focused on owning high-quality, stabilized properties in the most liquid and economically diverse/vibrant markets. Low use of leverage, and significant focus on current income yield. Often referred to as the “Beta” of the asset class. REITs – Access to real estate through securities traded in the public markets. Similar qualities as Core but slightly higher leverage. The liquidity benefit that comes from being traded daily has a trade-off in the form of higher volatility than private Core and thus is elevated on the risk spectrum. Value-Added – Focused on a balance of increasing property-level income and enhancing underlying asset appreciation to create value. Moderate use of leverage expected. Strategies generally focus on leasing, repositioning, and redevelopment. Opportunistic – Most tactical style of real estate investment, usually focused on enhancing/creating significant value appreciation. Significant use of leverage is common; limited focus on current income. Opportunistic investing is most successful when there is an imbalance in the real estate or capital markets. Strategies include: development, capital stack restructuring, change of property use, distressed asset/ownership/market conditions, public-to-private transactions, and emerging sectors.
4 Mike Comstock, Aon Hewitt
SDCERA Continuing Education Program October 19, 2017, Part A, Real Estate
Property Types
5 Mike Comstock, Aon Hewitt
SDCERA Continuing Education Program October 19, 2017, Part A, Real Estate
• The term “Real Estate” commonly refers to investments in commercial property • Institutional quality real estate refers to the subset of higher quality properties in medium to large markets, and largely focuses on the following property types:
• “Niche” properties can also be found in institutional portfolios: - Hotels, senior housing, student housing, self storage, medical office and land - Timber and farmland
Real Estate by Style
6 Mike Comstock, Aon Hewitt
SDCERA Continuing Education Program October 19, 2017, Part A, Real Estate
Capital Stack Defined
7 Mike Comstock, Aon Hewitt
SDCERA Continuing Education Program October 19, 2017, Part A, Real Estate
• Equity represents the highest risk in the capital stack • Debt can be further broken into multiple pieces
Source: Albourne
Real Estate Risk-Return Falls Between Stocks and Bonds
Core Real Estate’s risk-return profile normally falls between fixed income and equities
Equities experience a larger growth rate but are also more volatile, while Fixed Income provides less volatility but has limited growth potential
8 Mike Comstock, Aon Hewitt
SDCERA Continuing Education Program October 19, 2017, Part A, Real Estate
$-
$100
$200
$300
$400
$500
$600
$700
03/3
1/19
9203
/31/
1993
03/3
1/19
9403
/31/
1995
03/3
1/19
9603
/31/
1997
03/3
1/19
9803
/31/
1999
03/3
1/20
0003
/31/
2001
03/3
1/20
0203
/31/
2003
03/3
1/20
0403
/31/
2005
03/3
1/20
0603
/31/
2007
03/3
1/20
0803
/31/
2009
03/3
1/20
1003
/31/
2011
03/3
1/20
1203
/31/
2013
03/3
1/20
1403
/31/
2015
Growth of $100 (25 years ended Q2 2017)
Core RE Global Equity Broad FI
Risk-adjusted returns – Trailing 25 Years Ending 6/30/2017
Source Data: Core Real Estate - NCREIF NFI-ODCE, Global Equities - MSCI ACWI, Broad Fixed Income - Barclays US Aggregate
Real Estate Indices/Benchmarks
9 Mike Comstock, Aon Hewitt
SDCERA Continuing Education Program October 19, 2017, Part A, Real Estate
For programs investing through funds on the private side, we recommend using the NFI-ODCE:
• The index takes into account leverage, cash drag, and other portfolio management items; • Captures quarterly mark-to-market valuations on debt and equity; • Available on net-of-fees basis; and • Meets the formal definition of a benchmark
REIT Benchmarking: • REITs have grown tremendously in size over the last 25 years • Efficient exposure to the asset class - market cap and total assets greater than the tracked in the
private Core market
NCREIF – The National Council of Real Estate Fiduciaries NFI-ODCE – The NCREIF Fund Index-Open Ended Diversified Core Equity US REITs – United States Real Estate Investment Trusts
Part B. Real Estate Fundamentals and Return Drivers
Heather Christopher, Albourne
10 Heather Christopher, Albourne
SDCERA Continuing Education Program October 19, 2017, Part B, Real Estate
Performance
11
• The 2007 recession negatively impacted current 10-year trailing returns of the recovery from the 2009 lows, but also boosted the 3-year and 5-year trailing returns
Heather Christopher, Albourne SDCERA Continuing Education Program
October 19, 2017, Part B, Real Estate
Fundamentals: What Drives Returns, Part 1
12 Heather Christopher, Albourne
SDCERA Continuing Education Program October 19, 2017, Part B, Real Estate
Source: NCREIF
Source: NCREIF
Capital: What Drives Returns, Part 2
13 Heather Christopher, Albourne
SDCERA Continuing Education Program October 19, 2017, Part B, Real Estate
Note: Dry powder is an industry term meaning undeployed capital commitments available to buy investments; the charts estimate the aggregated capital seeking deals at each point over the above timeframe
Real Estate Valuations
14 Heather Christopher, Albourne
SDCERA Continuing Education Program October 19, 2017, Part B, Real Estate
Source: NCREIF
Source: NCREIF
Core Transaction Volume
15 Heather Christopher, Albourne
SDCERA Continuing Education Program October 19, 2017, Part B, Real Estate
Source: NCREIF
• No one wants to lock in a loss at the bottom of a cycle • Following the 2007 recession, a global pursuit of yield resulted in cash flows pursuing real
estate that would normally be allocated to fixed income
Part C. Real Estate in a Pension Portfolio
David Rose, Aon Hewitt
16 David Rose, Aon Hewitt
SDCERA Continuing Education Program October 19, 2017, Part C, Real Estate
Sizing up the Market
17 David Rose, Aon Hewitt
SDCERA Continuing Education Program October 19, 2017, Part C, Real Estate
Four Quadrants of Real Estate U.S. Institutional Real Estate Universe
Private Equity is the most common method of accessing real estate and refers to the direct ownership of real estate through pooled funds or separate accounts
Private Debt comprises a more indirect method of investing and is accomplished through the issuance or purchase of mortgages that are collateralized by real estate
Public Equity investing involves buying publicly traded shares of real estate companies such as Real Estate Investment Trusts (REITs) and Real Estate Operating Companies (REOCs)
Public Debt investing involves buying publicly traded shares of real estate companies such as Mortgage Real Estate Investment Trusts (REITs), mortgage-backed securities (MBS) or Commercial Mortgage-Backed Securities (CMBS)
$5.1 trillion $1.0 trillion
$6.0 trillion $1.5 trillion
The Role of Real Estate in a Pension Portfolio
18 David Rose, Aon Hewitt
SDCERA Continuing Education Program October 19, 2017, Part C, Real Estate
Investment Objectives
Real Estate can play a variety of roles within a multi-asset class investment portfolio including: − Diversification − Yield − Potential to Hedge Inflation − Enhanced Returns
Sector Drivers
Real Estate is a cyclical asset class impacted by: Economic Growth (Jobs) Construction (New
Supply) Capital Markets (Interest
Rates)
Program Benefits & Challenges
Diversification benefits to total plan
Opportunity for both beta and alpha exposures
Characteristics include: low correlations, strong cash flow, capital preservation and attractive risk-adjusted returns
Challenges include cyclical asset class, limited liquidity, extended time to realization, control, and transparency
Diversification
19 David Rose, Aon Hewitt
SDCERA Continuing Education Program October 19, 2017, Part C, Real Estate
Private core real estate has had a low correlation to the traditional asset classes historically due to: Income yields that provide stability but aren’t fixed and respond to inflationary pressures and
economic growth Valuation process that is independent from public market sentiment
(0.80)
(0.60)
(0.40)
(0.20)
0.00
0.20
0.40
0.60
0.80
1.00
Dec-
84
Dec-
86
Dec-
88
Dec-
90
Dec-
92
Dec-
94
Dec-
96
Dec-
98
Dec-
00
Dec-
02
Dec-
04
Dec-
06
Dec-
08
Dec-
10
Dec-
12
Dec-
14
Dec-
16
Five Year Rolling Correlations (Q4 1984 - Q4 2016)
Core RE/Global Equity Core RE/US FI
Source Data: Core Real Estate - NCREIF NFI-ODCE, Global Equities - MSCI ACWI, Broad Fixed Income - Barclays US Aggregate
Downside Protection Over the last 35 years, core real estate has only had two drawdown events where the benchmark has
fallen over 10%; this compares to six such events for global equities Real estate drawdown events:
Early 1990s – Oversupply from loose construction lending in the 80s 2008-2009 – All return-seeking asset classes experienced re-pricing
20 David Rose, Aon Hewitt
SDCERA Continuing Education Program October 19, 2017, Part C, Real Estate
-
0.10
0.20
0.30
0.40
0.50
0.60
0.70
0.80
0.90
1.00
1.10
Mar
ch-7
8
Mar
ch-8
0
Mar
ch-8
2
Mar
ch-8
4
Mar
ch-8
6
Mar
ch-8
8
Mar
ch-9
0
Mar
ch-9
2
Mar
ch-9
4
Mar
ch-9
6
Mar
ch-9
8
Mar
ch-0
0
Mar
ch-0
2
Mar
ch-0
4
Mar
ch-0
6
Mar
ch-0
8
Mar
ch-1
0
Mar
ch-1
2
Mar
ch-1
4
Mar
ch-1
6
Drawdown Analysis - Global Equities vs Core Real Estate
Global Equities Core RE
Source Data: Core Real Estate - NCREIF NFI-ODCE, Global Equities - MSCI ACWI
Forward Looking Expectation for Portfolio Returns and Volatility
21 David Rose, Aon Hewitt
SDCERA Continuing Education Program October 19, 2017, Part C, Real Estate
Incorporating Core Real Estate within a multi-asset portfolio helps investors achieve a similar total return with less volatility
The below graph illustrates this concept using two efficient frontiers: The blue curve shows a portfolio with only fixed income and equity allocations The red curve depicts a portfolio that includes a 15% allocation to core real estate within the
return-seeking assets (equity) allocation
Example: If targeting a 60/40 RS/RR Portfolio, adding Core RE reduces the expected total portfolio volatility by approximately 100 bps for the same expected total return
Fundamentals Remain Relatively Healthy
22 David Rose, Aon Hewitt
SDCERA Continuing Education Program October 19, 2017, Part C, Real Estate
All property types moving in positive direction on occupancies and rental rates, Hotel and Apartment sectors showing some signs of slowing
Muted new supply has been a major tailwind to date; pace of new completion differs by sector; Apartment sector actually forecast for drop in new deliveries after 2017
70
80
90
100
110
120
130
140
150
160
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
Economic Occupancy Index By Property Type (Jan 2006 = 100)
Apartment Industrial Office Retail Hotel
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
3.5%
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
New Supply as a % of Existing Stock
Retail Office Industrial ApartmentSource: CBRE-EA 3/31/17 Source: CBRE-EA, 3/31/17
Pricing, Yields & Spreads
23 David Rose, Aon Hewitt
SDCERA Continuing Education Program October 19, 2017, Part C, Real Estate
Sources: RCA, 6/30/2017 Sources: NCREIF, US Treasury 6/30/17
While the trend for pricing continues to move upward, the last 18 months has witnessed some capitulation in all property types at various points
Risk premiums for stabilized real estate showing signs of slimming with uptick in long duration risk free rates that began in late 2016, expectations are for thinner premiums in 2017 and this cycle of cap rate compression coming to an end
Investor Flows into Core
24 David Rose, Aon Hewitt
SDCERA Continuing Education Program October 19, 2017, Part C, Real Estate
Investors have heavily poured capital into US Core real estate since the Global Financial Crisis, however 2016 was a year of moderation with redemptions nearly matching contributions and 2017 is flat through mid-year
Select funds have formed exit queues as investor sentiment has cooled a bit on the asset class
Source: NCREIF NFI-ODCE, AHIC: 6/30/2017
Return History & Near Term Expectations
25 David Rose, Aon Hewitt
SDCERA Continuing Education Program October 19, 2017, Part C, Real Estate
The NFI-ODCE returned 8.3% over the trailing one-year; moderating toward the long run average Momentum is slowly waning as the cycle matures from recovery to expansion, yield compression is
largely complete, total returns will be more dependent on increasing income (cash flow growth) at this point
Consensus expectations for 2017 total unlevered property level return is 6.4% (Source: PREA Q3 2017 Survey)
Source: NCREIF NFI-ODCE, AHIC: 6/30/2017, *Long Term return is 30 year annualized ending 6/30/2017
Glossary • Alpha: The amount by which an investment outperforms its benchmark on a risk-adjusted basis; alpha can
be positive or negative • Beta: The sensitivity of an investment to the market • Brownfield (real estate): Land previously used for industrial or commercial use that may have let to
contamination by low concentrations of hazardous waste or pollution, and has the potential to be reused once it is cleaned up
• Cap Rate: The ratio between the net operating income produced by an asset and its capital cost (the original price paid to buy the asset) or alternatively its current market value
• Co-Investment: The syndication of capital for an investment, usually alongside a commingled fund • Core Real Estate: Core is the most conservative institutional real estate investing style • Core-Plus Real Estate: Core-Plus is a style whereby investments have a slightly higher level risk and
expected return relative to Core, primarily through the use of increased leverage • Correlation: The extent to which the return patterns of two assets are similar • Current Value Cap Rate: Cap rate based on the estimated value of a property (aka market value) • Development: The construction of buildings from breaking the ground through building completion; this
may also include entitlement of the land and the pursuit of permits prior to construction • Derivative: A financial instrument which derives its value from the price of underlying assets, such as
stocks, bonds, oil prices, or pork bellies • Distressed Debt: A strategy involving investment in equity or debt in investments that are unable to service
existing debt; often such investments have defaulted and are facing foreclosure
26 Heather Christopher, Albourne
SDCERA Continuing Education Program October 19, 2017, Real Estate
Glossary (cont’d) • Dry Powder: Industry term meaning undeployed capital commitments available to buy investments • Fund of Funds: A fund which invests in a portfolio of underlying funds, which then invest capital directly;
despite the extra layer of fees, they provide a route to investing in primary funds that would otherwise be closed to them
• Greenfield (real estate): Undeveloped land in a city or rural area either used for agriculture, landscape design, or left to naturally evolve and may be considered for urban development; such land does not have hazardous waste or pollution contamination
• Highest and Best Use (“HBU”): The possible or probable use of a given property that produces the highest value; this may differ from the current use of the property
• Internal Rate of Return (“IRR”): The measurement of a portfolio’s actual performance between two dates, where greater weighting is given to those time periods when more money is invested; also known as dollar weighted return
• Investment Grade Bonds: High quality debt securities that are unlikely to default on their obligations • J-Curve: The curve realized by plotting the returns generated by a fund against time (from inception to
termination) • Land Speculation: Purchasing land believing that the price will increase typically through HBU; such that
strategies are high risk vacant land is likely to have expenses, such as taxes and insurance, that exceed rental income (like farming); such momentum plays are usually dependent on the development of surrounding parcels making it scarce and in demand
• Loan-to-Value Ratio (“LTV”): A ratio of a loan relative to the value of the property collateral
27 Heather Christopher, Albourne
SDCERA Continuing Education Program October 19, 2017, Real Estate
Glossary (cont’d) • Leverage: Taking investment positions with borrowed money or derivative positions such that the total
investment exposures (long short plus) exceed the fund’s total assets • Liquidity: The extent to which a security can be purchased or sold quickly at a fair price • Lockup: The amount of time before an investment manager can be terminated and the assets withdrawn • Market Value: The price at which an asset would trade between a willing buyer and willing seller • Mezzanine: An investment strategy involving subordinated debt (the level of financing senior to equity and
below senior debt) • Multiple: The sum of the total proceeds (distributions and appreciation upon sale) returned to an investor
over a hold period divided by the investor’s initial investment • NCREIF: The National Council of Real Estate Fiduciaries is a not-for-profit organization established in
1982 to collect, validate, and disseminate real estate performance and benchmarking data • NFI-ODCE: The NCREIF Fund Index – Open-ended Diversified Core Equity is a quarterly time weighted
return measure of performance of a US open-ended Core real estate funds with properties acquired in the private market for investment; NFI-ODCE data begins in 4Q1978
• Non-Core: Styles that have risk greater than that of the Core real estate style • NOI: Net Operating Income • NPI: The NCREIF Property Index is a quarterly time weighted return measure of the performance of US
Core institutional real estate properties held by both funds and separate accounts acquired in the private market for investment; NPI data begins in 4Q1978
28 Heather Christopher, Albourne
SDCERA Continuing Education Program October 19, 2017, Real Estate
Glossary (cont’d)
29 Heather Christopher, Albourne
SDCERA Continuing Education Program October 19, 2017, Real Estate
• Opportunistic Real Estate: Style of real estate in which the investor is willing to take entrepreneurial risk to achieve outsized return; includes strategies such as ground-up development, adaptive re-use or change of use, distressed debt, and land speculation
• Preferred Equity: A direct equity investment with a fixed, preferential return that is paid prior to distributions to the “common” equity interest in the owner
• Redevelopment: New construction on an existing structure to typically change its use while leaving a portion of the original structure in tact
• Secondaries: Investment made in existing private equity assets usually through the sale of commingled fund interest or portfolios of direct investments the purchase of these investments from existing institutional investors
• Senior Debt: Debt that takes priority over other unsecured or otherwise more “junior” debt owed by the borrower
• Time-Weighted Return (“TWR”): Measurement of investment performance by eliminating all the effects of capital additions and withdrawals; essentially it is the return on the first dollar invested
• Transaction Cap Rate: Cap rate resulting from a sale of a property • Transitional Assets: Assets whose utilization moves from one use to another • Value-Added Real Estate: Style of real estate where investors seek to take moderate risk in improving
properties that tend to have high vacancy or some physical obsolescence • Vintage Year: The first year in which an investment, usually in a fund, is made • Volatility: The standard deviation or variability of security returns; this is the most common measure of
risk in investment portfolios