Pension Funds Impacted by Drop in Real Estate Values
The ill-effect of aggressive mortgage lending on pension funds is still unfolding but actively monitored, given the sheer size of many plans. A February 5, 2008 news release, issued by the Massachusetts Institute of Technology (MIT), suggests that the sub-prime fallout is real. Citing a second straight drop in the quarterly Transaction-Based Index ("TBI"), a measure of commercial real estate trades by pension funds, MIT Center for Real Estate Director David Geltner blames the credit crunch. A 5 percent decline for the fourth quarter of 2007 follows a prior 2.5 percent three-month drop. These hits are in stark contrast to reported growth in the TBI of 64 percent from 2004 through 2006. Click here to read the MIT story. Also check out the February 6, 2008 CNBC broadcast.
In a related piece ("Risk of property defaults growing - February 6, 2008), Financial Times reporters Daniel Pimlott and Gillian Tett describe a disturbing (though not surprising) trend in commercial property loan defaults. They quote Sam Chandan, chief economist at research company Reis, as saying that "It will be very difficult to acquire refinancing." The article also references Wachovia Capital Markets by pointing out that $20+ billion of floating rate commercial mortgage-backed securities ("CMBS") come due this year, $2 billion of which "face the greatest risk of default" because they are final maturity loans "with no option to extend."
What remains to be seen is whether pensions' foray into real estate, direct or indirect, via an emerging real estate derivatives market, diminishes as values turn south. Shying away from this alternative investment class could have a dramatic impact on the strategic asset allocation of defined benefit plans, especially as relates to portfolio diversification. Certainly such a response will impact companies and individuals who want to sell property. A February 2007 Pension Real Estate Association (PREA) report estimates institutional real estate holdings for 2005 at $146.8 billion, an allocation of 6.92%.
Editor's Note: Click to read "Constructing the Real Estate Derivatives Market" (March 25, 2007 post) and "Are Pensions Ready for Property Derivatives?" (March 9, 2007 post).
