Since 2016, Oregon State Treasury has gradually de-risked its $12 billion real estate allocation, liquidating opportunistic investments in favour of high-quality, cash-flow generating assets to fashion a more sustainable, long-term portfolio.
The new look is the culmination of a portfolio-wide strategy that began in 2015 to reduce embedded equity risk across the $100 billion fund, described by CIO John Skjervem at the time as “lead guitar” in every part of the portfolio. Three years later, in a supportive, more side-of-stage role, real estate plays bass.
“It makes sense; it is the driving force of what we are trying to achieve in this portfolio,” says Anthony Breault, a former US Naval officer who leads Oregon’s recently boosted five-strong real estate team.
The new approach moves away from closed end, private equity-style investment and its associated inherent cyclical risk and total return focus. Now the portfolio has built in more liquidity and transparency, reduced volatility and lowered fees via evergreen manager partnerships in separate account and open-end fund structures.
The lion’s share of Oregon’s real estate portfolio (60-70 per cent) is now in separate accounts with general partners. Ranging from core through to value-add investments, this structure allows the fund more alignment and say over strategies, Breault says.
Between 10-20 per cent of the allocation is in open- end funds, with the benefits of liquidity, transparent cash flows and relatively lower fees, and between 20-40 per cent of the portfolio remains in closed end funds in value add and opportunistic investments designed to provide alpha relative to the core benchmark. The fund doesn’t have any direct real estate investments because of the governance and internal resources it would demand. “This is not something we can do,” he says.
The allocation to closed-end funds, which Breault wants to be less than 30 per cent of the portfolio, means less capital repatriation that comes with these structures: instead portfolio yield will account for more of the overall return.
Today Oregon’s top 10 managers account for 69 per cent of the portfolio, up from 62 per cent in 2013, and the emphasis on evergreen partnerships means that the frequency of new partnership underwriting will fall. The portfolio is divided between core (57 per cent) value add (15 per cent) opportunistic (21 per cent) and publicly traded RETIS (7 per cent).
This new structure offers Oregon a new level of control to allocate capital in line with its long-term diversification targets and short-term tactical opportunities, positioning for the opportunities and risks coming down the line. Like the disruptive forces which have already changed the way we buy things, now changing the way we work too. The predicted drop-off in the number of companies prepared to fit out an office space and lock in 10-year tenancies in the years ahead is putting a pressure on the office and causing “handwringing around the globe,” according to Mary Ludgin, head of global research at real estate manager Heitman in a presentation to the investment division.
She noted that suburban office blocs are also falling out of favour given millennials muted enthusiasm to drive to work and “sit in traffic jams.” Cue investment opportunities like converting suburban offices into workforce housing or micro units with communal spaces, she said.
Winners in the changed landscape include apartments, medical centres and self-storage. Self-storage isn’t “marble” or “granite,” but it has “durable cashflows” because of households’ tendency to “hold onto their stuff.” It is also recession proof because downturns force people to downsize, putting belongings into storage. In contrast logistics, the investor “darling” given its five years of consecutive above inflation rate growth isn’t, she warned.
And logistics won’t only feel the heat if recession bites. Other changes are also emerging. Amazon has led the growth in logistics with next day and 90-minute delivery promises, causing a ripple effect as other retailers scramble to respond. Now it is leading another trend too. Struggling to reduce their shipping costs, e-commerce giants are moving from click to brick and starting to invest in bricks and mortar stores to cost-effectively fulfil on-line orders. “Amazon is opening books and grocery stores for a reason,” said Ludgin.
Climate change offers other risks and opportunities to real estate investors. Investment needs to take account of a building’s ability to withstand changes in temperature, or rising sea levels. This could see vulnerable cities like Florida, Miami and New York “re-priced” in a new landscape that increasingly relies on data to score portfolio assets, she said.