SDCERS considers opportunistic real estate

The $5.8bn retirement system would allocate 2-3% of its assets to opportunistic real estate. 

The San Diego City Employees’ Retirement System’s Investment Committee will consider adding a 2 percent to 3 percent sub-allocation to opportunistic real estate at its meeting Thursday, according to meeting materials.

The Investment Committee expressed an interest in investing in non-core real estate at its May meeting, according to a Hewitt EnnisKnupp report detailing the proposed allocation. The bulk of those opportunities appear to be in opportunistic real estate, which the retirement system defines as distressed debt or equity investments.

“There are still significant refinancing risks with over $1 trillion in commercial real estate loans coming due during the next several years – alternative sources of capital will be required to fill the gap,” according to advisor Hewitt EnnisKnupp’s report. “Compared to the $120 billion raised for private equity real estate in the last two calendar years (source: Preqin), there is a significant gap.”

The report estimates that only half of the $400 billion in overdue or default commercial mortgages that have been resolved or restructured. As such, several fund managers have entered the market with opportunistic strategies involving the acquisition or origination of real estate debt, as well as the recapitalisation of broken capital structures.

If SDCERS approves the new allocation, Hewitt EnnisKnupp’s global real estate team would work in conjunction with SDCERS’ staff to identify and monitor the investments, which would likely target larger commitments to fewer managers.

The typical fee structure SDCERS would target would include a 1-1.5 percent base asset management fee with 20 percent carried interest and an 8-9 percent preferred return. Fund structures would likely be close-ended with 8-10 year life spans.

SDCERS would set the allocation as a component of its Opportunity Fund, a portion of the retirement system’s assets dedicated to strategies that do not fit within one asset class. The immediate opportunities in opportunistic real estate do not warrant a permanent adjustment to San Diego’s 11 percent long-term allocation to real estate, Hewitt EnnisKnupp writes.  

The board approved an 8 percent allocation to the Opportunity Fund in 2010, according to Hewitt EnnisKnupp’s report. Since then, the fund has housed only one investment; a Term Asset-Backed Loan Facility (TALF) that was fully liquidated in 2013. TALF had generated a 13.3 percent internal rate of return.

A spokesperson for SDCERS could not be reached at press time. Hewitt EnnisKnupp did not respond to a request for comment.

In May, SDCERS approved a new asset allocation that increased its targets in both emerging market debt and private equity. The private equity portfolio’s composition included approximately 24 percent dedicated to distressed funds and 3 percent to mezzanine, according to documents from that meeting.