Real Estate

Real estate portfolio markdowns are coming, but by how much?

Some private capital fund managers are marking down portfolios more in line with public market prices, while others have yet to do so.

Institutional investors are waiting with trepidation and a little hope for markdowns, and seeing a wide dispersion of performance in their private market assets, particularly real estate, because managers differ in their approach to pricing. A wide range of returns can be seen within the same asset class and similar investment strategy.

While most expect investors’ private capital portfolios in real estate and private equity to eventually be written down between 10% to 15%, investors won’t know for sure for a year, or maybe longer.

“I don’t think I’ve seen a year where we’ve seen such a dispersion of returns within asset classes,” said Molly Murphy, CIO of the $20 billion Orange County Employees Retirement System, Santa Ana, Calif., at the Feb. 22 investment committee meeting.

Ms. Murphy said all of their private market managers will get audited “and that is what we are waiting for. … Auditors will hold them to legitimate valuations as opposed to optimistic valuations.”

The differences have less to do with how assets and properties are performing and more to do with how managers value those assets and price them, said Stephen P. McCourt, San Diego-based managing principal and co-CEO of consultant Meketa Investment Group Inc., speaking at the same meeting.

“There’s some realization of reality that hasn’t happened yet,” Mr. McCourt said. “The most significant departure from reality is real estate and different sectors experienced that in different ways.”

OCERS is not alone.

The $42.4 billion New Mexico State Investment Council, Santa Fe, should expect its real estate portfolio returns to fall over the next few quarters, said Seth Marcus, a partner at real estate consultant Townsend Group, at the council’s Feb. 28 meeting.

The council’s $4 billion real estate portfolio earned a net internal rate of return of 19.2% for the year ended Sept. 30, which Mr. Marcus said was “significantly above expectations and historical norms” of 7% to 9%.

Real estate lags the broader markets, which have already declined, by 12 to 18 months, he said.

Townsend expects write-downs in the fourth quarter and into 2023, Mr. Marcus said. He said that the council’s real estate investments could experience a -5% IRR in the fourth quarter.

Townsend expects real estate returns to continue to be negative and its outperformance to narrow into 2023 as private market assets are revalued.

Across property types, office and industrial were the lowest performers in the fourth quarter, Mr. Marcus told the council. There were also write-downs in stronger sectors such as medical office and life sciences.

Retail was down only slightly due to write-downs that were already taken starting before the pandemic, he said.