Downtown San Francisco

SAN FRANCISCO-The City and County of San Francisco Employees’ Retirement System has signed off on an expected 73% reduction in its new capital investment in real estate for the next fiscal year. SFER’s real estate consultant, the Townsend Group, recommended the pension fund allocate no more than $200 million toward real estate, down from $750 million in the previous fiscal year, and invest all of it in Non-Core assets as opposed to Core assets.

“The broad real estate markets are in transition,” says Townsend Group principal Micolyn Yalonis in an executive summary of the revised investment strategy, a five-year planning document that is reviewed annually. “Re-pricing is expected but has not begun to clear within market transactions or asset valuations.”

Given that the Core portfolio is projected to be 49% at the end of 2010 and the longer-term goal is 30%, “Townsend does not recommend new Core allocations and will instead continue to focus new allocations in the non-core strategies,” states an executive summary of its real estate investment recently approved by the SFERS’ Board of Retirement. Specific strategies will be reviewed by the Board later this year.

In the Non-Core sector, Townsend says it will focus its due diligence efforts and resulting recommendations on niche strategies (e.g. non-traditional property types, unique market opportunities) and international opportunities for excess returns. More specifically, Townsend says it will look for “Value and High Return pooled funds capable of providing unique access to opportunities (property type, platform, property life cycle) and advantageous funding capabilities (pre-specified pools and/or short investment windows) to facilitate maintaining the funded status of the program.”

As part of that effort, Townsend is recommending two new commitments to Capmark Investments—a $25-million allocation to Capmark Apartment Income and Growth Fund and a $37.5-million investment in Capmark High Return Fund. In late 2006, SFERS committed $25 million and $75 million to the two funds, respectively.

Capmark and SFERS are 50-50 owners of the Apartment Income and Growth Fund, which focuses on value-add and higher-return strategies in the US apartment market, including niche products like student housing. The High Return Fund will invest in all property types and credit enhancement opportunities with a return goal of net 15% IRR to the investor.

As for the rest of this fiscal year, SFERS likely will invest $100 million less than projected ($1.27 billion) in Core investments and approximately $100 million more than projected ($486 million) in Non-Core investments, according to Townsend.

The Board also made moves earlier this year to balance its portfolio, which became overweight in Core last year after its 80% interest in AMB Partners II was transferred from the Value sector to the Core sector after that fund’s development piece had matured and the other fund assets had stabilized to the point where their returns would be lower.

To shift some of the funds back to the Value sector, SFERS decided in March to transfer its interest in AMB Partners II to AMB Institutional Alliance Fund III. The move also will give it more flexibility to liquidate its interest and shift some of its interest away from Industrial, giving the portfolio more balance in that respect as well.

Also that month the Board committed $25 million to the Fidelity Real Estate Opportunistic Income Fund LP, a new funds that will invest primarily in high yield real estate debt securities and instruments backed (directly and indirectly) by commercial property. Some of the capital will be invested in residential mortgage-backed securities and subordinated securities of real estate CDOs, according to staff and advisor memos.