Omaha

Pension Fund Fantasy: Omaha’s 8% Return Projection

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Omaha is not unique among municipalities across the country – deals cut with workers many years ago have left pension funds well short of money needed for retirement benefits. The shortage has cost Omaha it’s top municipal bond rating and has driven Chicago – the nation’s most egregious offender – to the brink of bankruptcy.

It’s time for the City of Omaha to level with unions and citizens and admit that it’s 8% return projection for the future is a mathematical impossibility.

Today’s World-Herald:

The city expects a return of about 8 percent each year. In 2014, the fire and police pension fund returned 4.9 percent and the civilian fund 5.5 percent, according to annual performance appraisal reports for the funds.

pensionsgraphic

Let’s start out with how the pension fund managers performed over the past two years, because frankly, its hard to fathom. If you try to “back in” to the portfolio allocation, some weird numbers emerge:

First of all, let’s assume that the City of Omaha is smart enough to follow John Bogle’s advice and put its money in low-cost funds that track the indexes. If the City is paying anything more than 1% to have someone manage the portfolio, it is an outlandish fee and further detracts from the struggling performance. That’s an argument for another day. Let’s stick with the passive formula assumption for now…

In order to have generated a 16.2% return in 2013, the fund would have allocated roughly 33.7% of its money in bonds. Let’s say they went with the biggest option and chose the PIMCO total return bond fund. It was a bad year for Bill Gross and prompted his departure to Janus as the fund returned -1.92%. But don’t fret Omahans, the remaining 66.3% of the portfolio invested in the S&P 500 index would have returned 26.39% in 2013. Thus, for the year, the fund still generated an outstanding 16.2% return in 2013.

But if you apply the same asset allocation assumption to 2014’s numbers, the performance breaks down. PIMCO’s broad based bond fund bounced back and delivered a 4.69% return. Meanwhile, the S&P 500 continued its bull run and advanced by 12.39%. Based on the same allocation weighting at 34/66, the pension fund should have easily turned in a gain of 9.8%, not 5.5%. The only way this 5.5% performance could have occurred is if the managers shifted almost 90% to bonds or made the even-worse decision of holding straight cash in a large portion of the portfolio. The pension manager should be called on the carpet.

The questionable 2014 results notwithstanding, reaching an 8% return assumption will be a virtual impossibility going forward:

First, you have the problem of rolling bond maturities. Assuming the pension fund bought some 30 year treasuries back when rates were north of 10% means that as those bonds reach maturity, those funds have no place to go but lowly 2-4% yields.

Second, if bonds are 34% of the portfolio and a PIMCO-esque fund runs at a typical 100 basis points over treasuries, 3.5% is a good year. What would the 66% of the stocck portfolio have to generate to reach an overall return of 8%?

10.35%

Nobel Laureate Robert Shiller has tracked stock market data from 1871 to the present and has shown an average return of about 8.2%.

Aswath Damoradan at NYU has a data series leading back to the late 1800’s showing that stocks have returned approximately 5.74% over the treasury bond. Based on these data points, one will do well to expect a stock return of more than 8% going forward with a Ten Year Treasury yield of 2.15%.

Using the same portfolio weighting noted above, the Omaha’s pension fund expected return should be adjusted to 7% (if not 6.5%!). Denial and compound interest don’t mix well.

If Omaha is looking for a dose of reality, it should look to California where unfunded liabilities are at 50%.  Calpers, the largest pension fund in the US, reduced it’s target rate to 7.5% in 2012. Its own actuary argued for 7.25%. 

The Discipline to Say NO

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You want to follow the herd. It’s natural. Do you remember the 1999 internet bubble? I got so frustrated hearing about my neighbors investing in Level 3 Communications, I thought I was the dumbest person on the block. I bought some Level 3. I made a little money, but I was too chicken to ride it out. I’m glad I didn’t.

Yes, some people escaped that bubble with fortunes intact, but most were swept away. The same can be said of house flippers and land developers in Las Vegas during the middle of the 2000’s. I remember feeling so envious of all these people making quick bucks left and right. What did I do? I went to Baltimore. I flipped a house and lost my ass. Thankfully I got out before the meltdown and I didn’t lose my entire net worth.

So, now, I look at my industry: apartments. Everybody loves apartments as an investment right now. The yield, the safety, the myth that people can’t afford houses anymore. I remember fretting about Omaha surpassing $1.00 per square foot rents in the late 2000’s. We’ve blown through that number.

Downtown is hot. Midtown is hot. But someone is going to be the last one in and they’re going to be late to the party. They will overpay for land, underestimate costs, and underestimate the depth of the market at an affluent level of rent.

It’s frustrating. You know people are making a lot of money right now. But you also have a sick feeling in your gut that everything is being propped up with artificially low interest rates. I went to a conference and heard they are paying 4.82% cap rates in Dallas.

Are we there? Is this Japan with a perpetual zero interest rate policy?

Everybody repeats the same cliche that real estate is about location, location, location. Here’s what they don’t say: real estate is also about price. You can have the best corner in the world, but if you pay too much for it you will dig yourself a hole that will take a generation to extricate yourself from.

We have to take risks as developers. You can’t make money without taking a risk. But you can’t follow the herd. Sheep get slaughtered as the saying goes. Lemmings head blindly over the cliff.

Farnam Street blog has an outstanding transcript of a television interview in India featuring Warren Buffett and Ajit Jain. Everyone needs to read it and watch the interview. It is pure gold.

Ajit: The discipline to say no, if you have that and you’re not willing to let people steamroll you into saying yes. If you have that discipline, that’s more than 50 percent of the battle.

Warren: Don’t do anything in life where, if somebody asks you the reason why you are doing it, the answer is “Everybody else is doing it.” I mean, if you cancel that as a rationale for doing an activity in life, you’ll live a better life whether it’s in the stock market or any place else.

I’ve seen more dumb things, and sometimes even illegal things, justified (rationalized) on the basis of “Everybody else is doing it.” You don’t need to do what everybody else is doing. It’s maddening, during the Internet craze when the bubble was going on.

You have to forget about all those things. You have to do what works, what you understand, and if you don’t understand it and somebody else is doing it, don’t get envious or anything of the sort. Just go on and wait until you find something you understand.”

OWH: Aksarben Village has another $82 million in development planned

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By Cindy Gonzalez / World-Herald staff writer

An additional $82 million in new construction projects headed to Aksarben Village — more office, retail, apartment and parking structures — will close up a couple of the biggest gaps left at the 70-acre midtown Omaha campus.

Not all of the tenants have been secured for those proposed properties, but developers say the village’s history suggests that won’t take long.

And except for a few hitches, such as the scrapping of a plan for owner-occupied town houses, the ongoing transformation of the old Thoroughbred racetrack grounds near 67th and Center Streets continues better than expected, said lead developer Jay Noddle of Noddle Cos.

So far, he said, the investment on projects built, under construction or planned at the village totals about $500 million. Original estimates a decade ago were about $150 million. That is just the village portion, not First Data Corp. or university-related buildings on the larger former Aksarben site.

City Planner Bridget Hadley said spinoff activity and property improvements in and around the village are what the city had hoped for: “Not only bringing forth more density, but a vibrant mixed use of work, play, entertainment and living options,” she said.

The latest changes, according to documents submitted to Omaha planners, total more than $82 million and seek $9.75 million in tax increment financing. The plans call for:

» An 80,000-square-foot office, retail and restaurant building on the corner of 67th Street and Mercy Road. A large corporate user reportedly has committed to occupying the top level of what would be a three- or four-story structure.

» A four-story retail and residential building fronting Frances Street that would have 10,000 square feet of retail and apartment lobby space on the ground floor; upper floors would contain 21 apartments.

» Another four-story building with 40 apartment lofts, facing west with a view of College of St. Mary softball fields and campus.

» As announced six weeks ago, a five-story building with Pacific Life Insurance Co. as anchor on the northeast corner of Mercy Road and Aksarben Drive. Restaurants, other retail shops and offices would occupy the rest.

» An 880-stall, four-story parking garage, replacing an existing surface parking lot and connecting by sky bridge to the Pacific Life building.

» About two blocks to the east, southwest of 64th Avenue and Frances Street, two apartment buildings. The largest would have four levels, 45 units and 31 parking stalls. A three-story eight-plex is designed in a “walk-up” style. Parking for both would be available in an existing garage servicing nearby businesses.

Construction on the Pacific Life building and connected parking garage are to begin soon, with opening of the office structure expected late next year, planning documents said. The other office and housing structures in the entertainment zone are to be done either next year or in 2016.

The other apartments are to be completed by fall 2016.

The TIF funding, a tool that allows property tax revenue from new construction to pay some redevelopment costs, is to be a topic at today’s City Planning Board meeting.

Alchemy Development, which is planning the new apartments at 64th Avenue and Frances Street, already has developed 183 other units at Aksarben Village. The next group would resemble the existing Pinhook Flats buildings, said Alchemy owner Bert Hancock, but have a distinct name and feature red and bold color elements to complement the neighboring DLR Group.

“We want to have an impressive corner element so when you’re looking from the new arena it will really attract people’s attention,” Hancock said, referring to the $88 million sports arena that the University of Nebraska at Omaha is to open next year at 67th and Center Streets.

Earlier plans by Noddle Cos. had called for the Alchemy site to be 21 upscale “live and work” town houses, the first owner-occupied residences in the village. But Hancock said people who could afford the homes typically are older and don’t like all the stair-climbing.

“If everything had gone as planned, there would have been more town homes, but that market really evaporated in the recession,” Hancock said. “We adjusted course, added apartments and everybody is happy. It has added to the amount of people that live and work in the area.”

The other proposed apartments and office/retail structures are projects primarily of Magnum Development and McNeil Co., which previously partnered on Aksarben Cinema.

John Hughes of Magnum said that new chunk would, for the most part, finish off the 8-acre entertainment “Zone 5” bordered by Stinson Park, Aksarben Drive (parallel to the Keystone Trail), 67th Street and Frances Street. (Also in that zone is the theater and businesses including DJ’s Dugout and Aspen Athletic Club.)

Securing TIF funds is an important part of making the proposed parts fall into place, Hughes said. He said he is in negotiations with various tenants to fill the space.

The land remaining lies mostly in Zone 6, the vacant block where the $50 million Waitt Plaza is to rise. Announced six months ago, the eight-story office and retail building with a parking garage is scheduled to be completed at the northeast corner of 67th and Frances Streets by early 2016.

Plans for that block call for two other office/retail buildings. Noddle said marketing and tenant recruitment for all three has ramped up.

A few property patches “here and there” remain and could become homes to various users as the village further matures, said Noddle. “It’s those little eclectic pieces that get filled in and really round out the mix in the village.”