A negative return on commercial real estate has hampered annual performance of the nation’s largest public pension fund, one of the latest signs of weakness for U.S. properties.

The California Public Employees Retirement System, with $462.8 billion in assets, was still able to report a preliminary net return of 5.8% on all its investments for the 12 months ended June 30, compared with a negative net return of 6.1% a year ago.

The results benefited from a 14.1% return on U.S. stocks and bonds but were hurt by a 3.1% drop in real assets, a category that is 80% made up of commercial real estate, the pension fund said.

CalPERS historically is the first big public pension fund to report fiscal year returns. The expectations are that these funds will either miss their investment targets or show very little improvement, according to a recently released report from industry watcher Equitable Institute.

In the first half of 2023, market returns improved over 2022's bear market, Equitable Institute said. However, the performance of state and local pension funds' investments — 5.3% on average — have not met investment targets.

“In just the past fiscal year, asset values were shaken by rapidly changing interest rates, a crypto-economy crisis capped by the collapse of FTX, a community bank crisis marked by the failure of SVB Financial, an unexpected AI-driven market rebound, and more," Anthony Randazzo, Equable Institute executive director, said in a statement. "All of these trends complicate the long-term outlook for plans.”

Looking forward, Equable Institute included market uncertainty as a factor that will shape the long-term outlook for pension funds.

As of the end of 2022, pension funds held $460 billion in real estate investments, according to Equitable Institute.

CalPERS' preliminary 5.8% net investment return stands in contrast to the prior fiscal year, when global financial volatility led to the fund’s first negative net return since the Great Recession.

“The resiliency of the stock market — particularly since the start of the calendar year — has created a solid base for the investment team to implement innovative approaches in delivering added value for our members in the coming years,” CalPERS Chief Investment Officer Nicole Musicco said in a statement.

Two CalPERS asset classes — private equity and real estate — reported negative returns, the fund said. Private equity investments were down 2.3%.

CalPERS did not provide insight into what contributed to the full-year decline in either class. However, a report discussing first-quarter 2023 results posted last month from CalPERS consultant Meketa Investment Group gave a good indication of real estate returns for the three months ended in March.

The first-quarter return on commercial real estate investments was negative 5.2%, according to Meketa’s report.

“As anticipated, higher interest rates and slower economic growth are weighting heavily on the results for the current quarter across property types and geographies,” according to Meketa.

CalPERS’ real estate portfolio had a market value of $56.8 billion at the end of the first quarter.

The fund’s industrial and multifamily holdings, which together comprise roughly 50% of CalPERS’ total real estate investments, posted lower returns attributable to property type, for example choosing more profitable urban high-rise apartments over suburban garden-style apartments; market selection; and overall pricing adjustments due to increasing discount rates, according to Meketa.

CalPERS’ office portfolio, representing 14.1% of its real estate, generated negative returns for the first quarter, and for the one- and three-year time periods. The office sector is very challenged, and further deterioration is expected, Meketa noted.

“As commercial real estate assets reprice amid greatly reduced transaction volume, and some asset owners with maturing debt struggle to refinance or sell their asset(s), we anticipate some continued volatility,” Meketa said.