Tuesday, June 18, 2013

Purging: New Jersey Sells Real Estate Partnerships

Purging:  New Jersey Sells Real Estate Partnerships

When public pension plans or endowments sell limited partnerships in their alternative portfolios, they generally don’t want to talk about it because something went wrong.  The most recent example comes from New Jersey where the public employee pension is selling $925 million worth of real estate partnerships to Northstar Realty Financial Group and Goldman Sachs Asset Management.  This transaction would have occurred without any fanfare, except that Northstar has to make public filings with the SEC.
Annuities (1999)
Despite making detailed asset allocation studies and trying to model alternative investments, institutional investors have a habit of overeating when it comes to alternatives.  Whether it’s private equity, real estate, or hedge funds, they often times make excessive commitments and then find themselves with a case of alternative indigestion.  So while one segment of the money management industry is eager to offer rich diets of alternative investments, another segment has sprung up to purge institutional investors of their excesses.

As CIO of North Carolina, I invested in several secondary funds specializing in buying unwanted limited partnerships from pensions, endowments, and banks.   The most successful managers in this area have to have a bit of vulture in their investment DNA.  Typically, the investor is desperate to and embarrassed about unloading a block of alternatives.  The secondary manager is keen to exploit these weaknesses.

According to The Wall Street Journal New Jersey’s CIO, Tim Walsh, is pleased with the bids they received, and noted that the pension will receive the full net asset value of the real estate partnerships.[1]  As far as I am concerned, Mr. Walsh is putting the best light on a bad situation.  It turns out that $925 million is a relatively big mistake, because the pension plan’s total exposure to real estate was about $3.2 billion.  In other words, they are selling 28% of their real estate exposure.[2] 

You have to do a bit of digging to find this out, because the details are only contained in the Treasurer’s Annual Report for 2012.  Moreover, the investment performance of real estate is rolled up into a category called the “alternative investments segments” and the allocation is categorized under something called “real returns.”[3]  The New Jersey Treasurer’s website obscures their asset allocation in categories such as global growth, income, risk mitigation, real return, and liquidity.[4]  These categories are part of trend among institutional investors to provide a level of transparency without making meaningful disclosure.  In any event, New Jersey’s real estate exposure is contained in the real return category.

In looking at Northstar’s SEC filing, we learn that New Jersey isn’t getting $925 million, at least not immediately.  Rather they’ll receive $510 million when the deal closes, and the remainder over the next four years.[5]  However, the structure of the deal allows New Jersey to claim that they got full value.  Even that claim is hollow, because the real estate assets will throw off much more cash flow than $925 million.  Northstar and Goldman Sachs will walk away with a tidy profit.  In fact, the SEC filing reveals that the Northstar/Goldman combination only expects to have to call $60 million from its investors to make this transaction work. 

We don’t know why New Jersey was forced to sell its real estate positions.  My guess is that they needed the cash to fund commitments in other areas.  New Jersey has been busy building up its hedge fund and private equity portfolios, and probably required the proceeds from the real estate partnerships to meet those new obligations.  It’s possible that New Jersey didn’t think the real estate investments were worth holding.  Unfortunately, New Jersey’s annual report doesn’t disclose the names of their real estate managers, so we can’t evaluate the holdings.  However, I suspect most of these partnerships were in descent shape given the level of interest in this transaction.

When institutional investors enter into secondary transactions in order to sell positions, they’re hoping that no one is paying attention.  If the news gets out, they’ll try to put a happy face on a bad situation.  I wish they’d just be honest and admit that they screwed up.

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