A reluctance to commit capital to new real estate investments today can be seen in the number of US pension funds delaying manager searches. Jon Peterson reports

"W e are recommending to our pension fund clients that no new manager searches should be conducted for the near term," says Rob Kochis, a principal with The Townsend Group, a leading real estate investment consultant for pension funds in the US.

In July 2008, the University of California Retirement Plan approved an increase to its targeted real estate allocation from 5% to 7%. The pension fund had planned to have a meeting with Townsend in November to discuss a possible investment strategy for the new capital. The meeting has been cancelled and no new date has been set. There is a possibility that the pension fund will look at this situation again some time during the first quarter of this year.

One of the factors that is leading some pension funds to delay commitments is the denominator effect. This is where a pension fund's investments in other asset classes lose value more quickly than the real estate investment, with the result that the pension fund becomes over-allocated to the asset class despite not making any new commitments.

Pension funds around the country are seeing their total assets drop from 10-30% with the poor performance in other asset classes such as equities and stocks and bonds.
One example of this is the California State Teachers Retirement System, whose allocation to real estate increased as a result of the denominator effect to 14.4% as of mid-November compared with a target allocation of 11%.

Pension funds are also reluctant to place any more capital in real estate until the existing commitments are 100% funded. Sacramento County Employees' Retirement System is an illustration of this situation. In August of 2006, the pension fund made $25m commitments to Hines US Office Value Added Fund II, AEW Value Investors II and Allegis Value Trust.

Jeff States is the chief investment officer for the pension fund. He says: "Around 60% of the capital that we committed has not been called by the managers. We want to make sure that this capital gets invested first before we do anything else."

This is why the pension fund has put on hold another $75m of capital that it was going to place with three value-added commingled fund managers. The original plan was to carry out a search sometime during the third or fourth quarter of 2008, but this has been delayed until at least the first quarter of 2009.

Mercer Investment Consulting also saw the number of real estate searches decline significantly during the fourth quarter of 2008.

Allison Yager, a principal with the company, said: "There has been very little new search activity. Most investors are very wary of putting out any new capital. Core values have dropped by 10% so far and there could be another 5-10% drop in the near future. Investors want to see a levelling-off period before committing any new capital."

Some Mercer clients are undertaking searches but delaying funding right away. One of these is the $300m Santa Clara Valley Transit Authority, which is carrying out a search early this year that it had originally planned to undertake in the fourth quarter of 2008. Funding will not be forthcoming immediately.

Real estate is not the only asset class being affected by a lack of search activity. Jeff Gabrione, head of the research group for Mercer in the Americas, said: "We have noticed that during the latter part of 2008 all of the major asset classes saw a lack of new search activity. We expect that the dust will not settle on this situation in early 2009. It might last a good while."

There are some real estate managers that will not cease the marketing of new commingled funds even though the current appetite from pension funds in the US is limited.

One of these is Cornerstone Real Estate Advisers. The real estate manager is well aware of what is happening in the marketplace. Despite little new search activity, the company is still marketing its new commingled fund, The Rotational Fund II.

Cornerstone believes the early marketing process needs to happen now. There is going to be a point that the financial markets will turn around and pension funds will have capital to invest.

The manager wants these investors to have information on its fund at their fingertips, and be ready to make a commitment right away.