Question

Please summarize this article in a summary.

For Pensions, Valuing Real Estate Is Tough. Covid-19 Brings New Hurdles

With Covid-19 and the dramatic slowdown in deal making, investors are finding it more difficult to calculate the value of real-estate holdings

Public pension funds invested in malls, apartments and offices over the last decade in search of higher returns. Now they are grappling with how much those real-estate investments are worth in a world transformed by Covid-19.

Pension giant California Public Employees’ Retirement System is projecting malls will lose some of their value in the second quarter, according to an internal estimate. The Arizona State Retirement System predicts the value of distribution centers for e-commerce will rise as more people shop online.

The investment chief of the Chicago Teachers’ Pension Fund is expecting the worth of student housing to drop.

“If you talk to anyone who says that they know exactly where the market is going and that they have all of the answers, they really don’t know,” said Chicago Teachers’ investment chief Angela Miller-May.

Since April, she has been speaking with managers of the fund’s more than $900 million in real-estate investments monthly instead of her usual quarterly check-ins.

How assets are valued has major consequences for the nation’s pensions. Any reduction could lower returns and add to funding shortfalls, increasing retirement costs for states and cities while the pandemic is draining pension funds and crushing municipal budgets.

U.S. pensions were already facing major funding gaps. Pensions are $4.9 trillion short of what they have promised retirees as of the first quarter, according to the Federal Reserve. The shortfall stems from years of over-optimistic investment assumptions and government decisions to skimp on annual retirement fund contributions.

Over the last two decades, pension funds poured state and local government workers’ retirement money into real estate and other private assets in an effort to cover shortfalls and meet return targets.

Real-estate holdings have climbed to 6.1% of U.S. public-pension portfolios in the first quarter from 3.8% in 2007, according to Wilshire Trust Universe Comparison Service. That share equates to more than $240 billion of the total $4 trillion in state and local government pension holdings reported by the Federal Reserve.

Figuring out what privately held assets are worth has always been harder than with publicly traded stocks and bonds. Specialists come up with opinions on value by looking at how similar assets trade and forecasting how much cash these investments can generate.

The pandemic has made that process a lot more complicated. Deal making has slowed dramatically, giving investors fewer templates to price assets. Widespread uncertainty about how people will work, travel and shop has made it more difficult to calculate how much cash properties will generate.

Predicting how much rent a landlord might collect is difficult when you don’t know when a commercial building will be allowed to reopen or when a residential landlord will be allowed to evict a nonpaying resident. Appraisers have sometimes resorted to researching different government’s social-distancing policies and the proposed terms of failed deals, pension advisers said.

It is unclear how certain real-estate markets will be affected by people moving during the pandemic.

“Some who work in cities may have moved to the suburbs, and people in the suburbs may relocate to the exurbs. And that’s something we need to understand,” said Jonathan Grabel, chief investment officer of the Los Angeles County Employees Retirement Association, which owns more than 100 properties across the U.S.

The pension fund plans to re-examine those holdings in September as part of a special Covid-19-prompted review of all its assets.

The scarcity of traditional data points means estimated values may not price in the true impact of the pandemic, said Christy Fields, a managing principal with consultant Meketa Investment Group.

“It is a real guessing game,” said Ms. Fields.

Investors are debating the right way to price in risk when central bank interventions have propped up a swath of markets and shielded investors from losses—even as the economy faces significant threats. Appraisers are also having to make tough choices about whether to mark assets against the distressed prices some investments are trading at or use theoretical models.

“In normal times, appraisers fall into a pretty narrow band,” said Karl Polen, chief investment officer of the roughly $40 billion Arizona State Retirement System, which owns stakes in over 100 U.S. real-estate properties through managed accounts.

“Because there’s so much uncertainty about how the recovery is going to happen, you see a wider band of how individual appraisers are looking at valuations.”

At Calpers, the nation’s largest pension fund, staffers are thinking about both the short- and long-term impact of Covid-19 on asset values. They have questioned investment managers on how they are pricing investments in the wake of the pandemic. When looking at how one fund was valuing holdings, Calpers expressed a more bearish view on Brazil’s ability to weather the pandemic than that of an appraiser, a person familiar with the matter said.

Last year, Calpers’ pension staff also scrutinized the valuations of billions of dollars in property, infrastructure and timberland investments after a new investment boss took charge. The new chief, Ben Meng, encouraged staff to take a closer look at how investments were valued.

The pension fund asked for more information on some managers’ methodologies and pressed some to rein in overly-optimistic assumptions, said people familiar with the matter. Amid the intensifying scrutiny, one of Calpers’s managers reduced the valuation of an investment in a developer of solar- energy projects in Africa and Asia by about 30% in 2019, the people said.

In hindsight, staffers are relieved they dealt with such valuation issues across the portfolio before the pandemic hit, one of the people said.

Answer 1

With reduction in the value of real estate holdings because of the pandemic, it is proving extremely difficult to value real estate assets and gauge the extent of returns which have been hit as major pension funds have invested in such holdings. While some other assets will start to appreciate in value such as distribution centers. However, with chances of overall lower returns, the states and cities will have to compensate for the costs as the share of real estate holdings in public pension portfolios have climbed to 6% now from 4% in 2007. Plus the pandemic has made valuing the assets accurately a lot more difficult as the future is uncertain and investors no longer have set templates to value assets. Some funds plan to reassess the valuations of the holdings in September 2020 to review assets, but there are chances that the estimates would not be necessarily in line as traditional data points of valuation are no longer relevant. Still some are trying to assess the short term and long term impact of the pandemic on asset values, but there are variations between the reviews of several appraisers which is making it hard to decide which one is more accurate.