What are Institutional Investors?

[Joe Latson]

Institutional investors are a professional class of organizations that manage large sums of “institutional capital” (money), such as pension funds, university endowments, insurance companies, sovereign wealth funds, or family offices.

For example, CalSTRS is a pension fund that provides retirement benefits for California’s public school teachers. They are also an institutional investor. As of May 31, 2021, they are responsible for investing $307 Billion of assets under management (AUM) on behalf of their pension.

All pensions, CalSTRS included, do more than just working with their members to provide pension benefits. CalSTRS is also an investment manager of all of the money that they are responsible for, and their investing employees’ primary role is to perform a function called Asset Allocation.

Asset Allocation means to deploy capital using a diversified investment strategy. To do this, they set targets for how much capital is dedicated to each asset class. They base their allocation targets on historical risk and return profiles, as well as high-level macroeconomic trends and forecasts.

CalSTRS target Asset Allocation is reflected below:

Within each asset class, there is further diversification. For instance, within real estate you can diversify across geographies (domestic vs. international), product types (office vs. residential) and strategy (acquisitions vs. development).

Institutional capital is by no means an expert in all of these various domains, so they partner with professional investment managers who specialize in specific sectors and strategies. CalSTRS real estate allocation is managed by over a dozen firms, including Blackstone, Invesco (partnered with Mynd), Divco (partnered with Atlas), Blackrock, Fortress and JP Morgan.

Effects on the Real Estate Market

Institutional capital flows are noteworthy because when investors adjust their target Asset Allocations, it can result in huge sums of money flooding into a sector simultaneously.

For example, CalSTRS decided 14% of their capital should be invested in real estate. As of May 31, 2021, their actual real estate allocation was only ~12%. To bridge the 2% gap, CalSTRS needs to increase its real estate exposure by $6.1B!

This is an example of just one pension fund. There are hundreds of investment managers making allocation decisions, and Institutional investors are known for operating with a “herd mentality” – they tend to copy their peers’ strategies.

Think about this: the 100 largest pension funds collectively manage ~$18T. If they decide to increase their exposure to real estate, or specifically residential housing, by just 1%, they would be mandated to acquire $186B worth of housing units.

Using an average home price of ~$285K, they would need to acquire over 650K homes to hit their allocation targets! These are huge numbers – to put it in perspective, according to the US Census, the City of Austin, TX has ~400K households.

Takeaway

This phenomenon of capital flooding into a sector is especially notable if it is happening for the first time – which is what we are seeing in single family housing, particularly rentals.

To effectively deploy billions of dollars into a sector for the first time, especially one as nuanced and fragmented as housing, new technologies and operating models must be invented and executed with expert precision. These innovations create opportunities for those paying attention.