Pensions Are Paying Billions in ‘Unnecessary’ Private Real Estate Fees

Researchers from the University of Chicago have a cheaper idea: leverage.

Sam Hall/Bloomberg

Sam Hall/Bloomberg

Investors would be better off adding leverage to their core real estate portfolios than paying billions of dollars in fees each year for alternative assets in the sector, a new study has found.

Underfunded public pensions have shifted to riskier assets in hopes of high returns, but their reach for yield in non-core real estate funds is not paying off, according to real estate professor Joseph Pagliari of the University of Chicago Booth School of Business and Mitchell Bollinger, an industry advisor, investor, and analyst.

Investors could have collectively saved an average $7.5 billion a year in “unnecessary investment-management fees” from 2000 through 2017 by adding more leverage to less risky, core assets rather than investing in non-core funds, the researchers found. Bollinger and Pagliari published their findings in the Journal of Portfolio Management last month.

Many chief investment officers at public pensions are “swinging for the fences,” seeking to repair their funding shortfalls with outsized returns from alternative investments such as non-core real estate, Pagliari said Friday in a phone interview. “If you adjust for fees and risk, then on average, investors have overpaid by approximately 300 basis points per year for their non-core real estate funds.”

[II Deep Dive: Pensions Are Making Riskier Real Estate Bets]


Core real estate funds typically hold fully-leased buildings that are considered investment-grade, according to Pagliari. Non-core funds in private real estate, including value-added and opportunistic, are riskier and involve more leverage.

He and Bollinger found that value-added funds underperformed levered core funds by 3.26 percentage points annually, while the opportunistic funds lagged by 2.85 percentage points.

“Consider the implications,” Pagliari and Bollinger wrote in their paper. “Investors could have increased the leverage on their core portfolios from approximately 22 percent to somewhere between 55 percent and 65 percent, and they would have outperformed the net returns of the value-added and opportunistic funds by approximately 300 bps per year while incurring the same level of volatility.”

Value-added funds charge investors about three times more in fees than core real estate funds, according to their research. Opportunistic funds are even more expensive, raking in about four times more in fees than core real-estate funds.

Joseph Azelby, head of real estate and private markets at UBS Group’s asset management unit, noted at a media briefing in June that pensions have been shifting a portion of their core real estate holdings to properties under development or renovation. He flagged these riskier bets as a potential concern because pension managers had similarly stretched for yield in the runup to the 2008 financial crisis.

During the phone interview, Bollinger said it’s not easy to change the behavior of pensions despite “overwhelming” data showing it would make “economic sense” to add leverage to core funds instead of paying for riskier, private real estate. Having approached risk-taking in the sector in the same way for years, pension fund managers may be reluctant to venture outside their “comfort zone,” he suggested.

Pagliari also finds it puzzling that investors wouldn’t want more leverage on core assets and less on riskier properties that aren’t fully leased or require development.

“That’s a bit of a mystery,” he said by phone. “It’s backwards.”