Efficient. Bare-bones. Cost-conscious. These words perhaps best describe the California State Teachers' Retirement System's approach to investing in real estate in general and multifamily properties in particular. After all, portfolio manager Jim Hurley is the only full-time staff member dedicated to the $1.5 billion multifamily fund. He runs a virtual corporation, relying on a team of operators, consultants, researchers, and auditors.

Entrepreneurial, though, may be an equally good way to characterize this operation. The $116 billion California State Teachers' Retirement System (CalSTRS), a Sacramento, Calif., pension fund, relies heavily on the expertise of joint-venture partners to buy and run properties. It gives those companies latitude to buy and sell buildings.

Broadening Horizons The seeds for CalSTRS' joint-venture system, unusual among conservative pension funds, were sown in the late 1990s. After the Dow Jones hit 11,000, the management team realized the equities market had become overheated and decided to diversify its portfolio. It decided to increase its real estate allocation from 2 percent to 5 percent.

Jim Hurley, Portfolio Manager, CalSTRS
Jim Hurley, Portfolio Manager, CalSTRS

Traditionally, CalSTRS, like other institutional investors, put most of its real estate money in industrial portfolios. To help better organize its expanded real estate investments, Mike DiRé, director of real estate, divided them into four product types – multifamily, office, industrial, and retail. In 2001, the real estate team saw that the pension fund needed to be more responsive to the market and more flexible in its approach to investing in it. In multifamily, for instance, the portfolio was almost entirely class A apartments in the Sun Belt region. "We needed to align ourselves with better operators, diversify the operators we used, and give them the flexibility to execute," Hurley says.

After evaluating different structures for multifamily, two years ago CalSTRS decided on joint ventures because it could invest in a variety of properties, without having to spend a great deal on staffing.

The joint ventures CalSTRS enters into are the key to its multifamily programs. So far, it has partnered with six developers – SSR Realty Advisors in Morristown, N.J.; General Investment and Development in Boston; Waterton Associates in Chicago; Fairfield Residential LLC in San Diego; Morgan Stanley's real estate group in Boston; and Apartment Investment Management Co. (AIMCO) in Denver – to invest in everything from class A development to student housing. Two more partnerships are in the works. Instead of purchasing properties itself and using an adviser to manage them, the pension fund partners with operators that buy properties. CalSTRS typically invests 90 percent; the partner contributes 10 percent. Partners receive management fees and a bonus if properties get returns above a prespecified amount. They also can buy and sell apartments at their discretion if they fall within agreed-upon parameters.

A Partnership While the pension fund is putting a lot of faith in its partners in these ventures, it knows that it has to if it wants to continue growing. "We realized that if we grew to 100 properties, it would be difficult to manage," Hurley says. "We wanted our partners to manage it instead."

Partner: Waterton Associates LLC - Property Name: Lake Fredrica - Location: Orlando, Fla. - Overall Cost: 360 units of a 1,000-unit, $58 million portfolio - Waterton Contribution: $19 million of the portfolio - Niche: Class B Rehab
Partner: Waterton Associates LLC - Property Name: Lake Fredrica - Location: Orlando, Fla. - Overall Cost: 360 units of a 1,000-unit, $58 million portfolio - Waterton Contribution: $19 million of the portfolio - Niche: Class B Rehab

The major drawback: CalSTRS would rely heavily on its partners to make the right decisions and not play fast and loose with the money. The pension fund and the partners set up parameters for the size, geography, and percent return expected for each property. These criteria differ by partner. If a property meets the specifications, the partner needs no further approval from CalSTRS to buy it. If, however, a partner finds an attractive property outside of the specifications, a board made up of representatives from both CalSTRS and the partner must review the proposal.

Each year, representatives of the pension fund and its partners sit down in late fall and develop a strategy for which projects to hold and which ones to sell. The partners generally make the buy-sell decision. "The strategy is determined by consensus, and tactics are determined by the operator," Hurley says. "We want operators to have flexibility without bringing every decision back to us."

CalSTRS' partners applaud this strategy. "The ability to have delegated underwriting authority based on meeting certain parameters is a great attribute of this program and a real responsibility," says Jerry Brand, senior vice president at Fairfield Residential.