Real estate dragged down returns for public pensions, just as venture capital pressured the performance of endowments and foundations.
Many state plans with large real estate holdings — including those for Connecticut, New Jersey, Washington, and Arizona — fell short of their benchmarks for their most recent fiscal years.
In analyzing pensions with more than $20 billion in assets, Markov Processes International observed through its MPI Transparency Lab a “negative correlation” of 0.5 “between the size of pensions’ estimated real estate exposure and their returns for fiscal 2024,” according to CEO Michael Markov. He added that “pensions’ exposure to real estate has functioned similarly to venture capital in the endowment world, pulling down returns in the recent two fiscal years.”
Markov argues that real estate and equities — particularly U.S. stocks — have been the biggest drivers of recent pension returns. “The more real estate they had the worse they did, and the inverse was true for equities,” the MPI founder said. “For some pensions, the two balanced out; for others, an imbalance with lower exposure to public equities hurt.”
The Cambridge Associates Real Estate Index fell 4.2 percent for FY24, deepening the prior year’s 1.9 percent decline.
Data from MPI illustrates this point with examples such as the $55 billion Arizona State Retirement System, which had an estimated 18.7 percent exposure to real estate and returned 9 percent in FY24 (below its benchmark return of 11.9 percent). In contrast, the $110 billion Georgia Teachers Retirement System, which had a much smaller allocation and posted a 14.5 percent return (below its custom benchmark of 15.26 percent but above its 13.38 percent policy benchmark). According to MPI, Georgia’s strategy of allocating 70 percent of its portfolio to stocks and 30 percent to bonds, insulated it from private market volatility; Arizona’s heavy real estate exposure pressured returns, but private credit holdings offset some of the damage.
Real estate has become less predictable since the pandemic. Tim Atwill, CIO of the $2.25 billion Tacoma Employees’ Retirement System, told Institutional Investor: “Prior to 2020, private real estate was relatively boring. Your sector allocation was relatively unimportant, and your individual project selection drove the majority of relative returns. Since COVID, this is 100 percent reversed, where your sector allocation is driving relative returns.”
Private real estate has experienced a prolonged downturn, recording negative returns in every quarter from the last quarter of 2022 to the second of 2024. “In a larger sense, private real estate has been the one asset class consistently dropping over the past couple of years,” Atwill added, making the asset class “a sore point” for investors.
Public pension plans, which have typically allocated 5 percent to 10 percent to the sector, are now reevaluating their strategies, with many divesting from current managers and reconsidering allocation sizes. Atwill said this makes sense, as it’s hard to overstate “just how different the asset class is behaving now,” with it “still not clear what post-COVID looks like, as return-to-work plans are relatively unsettled.”
Tacoma ERS, which has a target allocation of 10 percent to real estate, returned 7.68 percent for the calendar year ended December 31, compared to its actuarial assumed rate of 6.75 percent.
Real estate’s underperformance has also pressured state pensions’ long-term funding metrics, though not to a critical extent. “Generally, lower asset returns relative to the rate used to discount liabilities pressure plans’ funded status,” said Fitch Ratings’ Dafina Dunmore. “While declining real estate valuations pressured overall returns, plans are diversified across several asset classes, with strong public equity returns in 2023 and 2024.”
Still, many public plans are adapting their approaches to real estate allocations. “Plans have been rotating portfolios to properties with stronger underlying fundamentals like industrial and multifamily properties and are pivoting away from more distressed traditional office and retail properties over the past several years,” Dunmore said. “Valuations remain pressured across the board given higher borrowing costs, although we may be nearing an inflection point.”
