The Chinese Pension System
February 12, 2025
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We are already aware that pension funds control a significant amount of investment funds across the world. The total amount of money controlled by pension funds runs into trillions of dollars. However, historically pension funds have shied away from investing in real estate.
Pension funds are generally invested in asset classes such as equity or debt. Real estate forms a very small portion of their overall portfolio and is considered to be an alternate asset. This has been rapidly changing in the recent past because of the red-hot real estate market, particularly in North America.
Pension funds have now started directly or indirectly acquiring all kinds of properties. These properties include single-family homes, multifamily homes, commercial and even retail real estate.
In this article, we will have a closer look at how pension funds typically invest in real estate and why they have now started in real estate in large amounts.
Pension funds have multiple ways of having exposure to real estate investments. The three most prominent ways are mentioned below:
Hence, pension funds have various ways in which they can invest in real estate. Each has its own advantages and disadvantages.
One of the main reasons that pension funds invest in real estate is diversification. The rate at which real estate prices rise has a very low correlation with the rate at which other asset classes grow.
Hence, the addition of real estate to an undiversified portfolio helps in increasing the diversification of such portfolios. Also, real estate values tend to be very stable.
Empirically, these values have never seen a significant downfall for an extended period of time. This is because a large percentage of household wealth is locked up in real estate investments.
Hence, if the housing market witnesses a downfall, it ends up creating political turmoil. The end result is that the government and the central bank are forced to prop up the real estate market. This is the reason that many pension funds perceive real estate investments as being a safe bet.
There are several advantages that accrue to pension funds once they invest in real estate. Some of these advantages are listed below:
Most pension funds do not invest in real estate for capital investments. Instead, they invest in real estate to take advantage of incremental cash flows.
Pension funds have traditionally shied away from making real estate investments. This is because real estate investments have several disadvantages as well.
Individual investors get tax breaks for making real estate investments whereas pension funds do not get any such tax breaks. Also, if pension funds invest via the real estate investment trust route, then too, they are taxed at a higher rate as compared to other investments.
Pension funds are forced to take the services of intermediaries which can add to the transaction costs and also makes the process more complicated for pension funds.
Hence, it can be said that even though traditionally pension funds have tried to steer clear of real estate investments, they are now keen to enter the sector. This is largely because of the macroeconomic factors which have made investing in real estate a compelling proposition.
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