Archive for April, 2010

How CalPERS bet big on real estate and lost

April 30, 2010

In a “lessons learned” report, the CalPERS staff analyzes how real estate investments, once a leading profit center, had lost nearly half their value by early this year, a performance ranking at the bottom among large public pension funds.

CalPERS has had well-publicized real estate losses — among them nearly $1 billion in a Los Angeles area residential development, $500 million in New York rental units, and $91 million on a stalled commercial development in Boston.

The report said CalPERS made policy changes allowing more risk and debt, followed by large ill-timed investments at the height of the real estate boom, resulting in a real estate portfolio worth $13.7 billion in January, down 47.5 percent for the year.

CalPERS sold $16 billion worth of income-producing and other low risk real estate, said the report, and then spent the money while buying $30 billion worth of higher risk real estate as the market peaked in 2005 and 2006.

Adding to the risk, CalPERS used a form of debt backed by CalPERS itself rather than the property. And as the real estate holdings became larger and more complex, CalPERS management was hampered by an inadequate data system.

Ted Eliopoulos, the CalPERS senior real estate officer, who has been working on reforms since taking the post three years ago, told the investment committee last week the report was a chance to “reflect” on experience and “provide hopefully some insight.”

A memo from Pension Consulting Alliance presented with the staff report said CalPERS real estate investments, which began in 1983, followed a “lower risk strategy” for nearly two decades.

But in 2002, CalPERS began a shift to a “higher risk strategy” with more debt, looser guidelines for partners, fewer stable income-producing investments, and a “dramatic” investment increase making the management and sale of assets difficult.

Another riskier change mentioned in the memo: “Large concentrated investments such as LandSource, Peter Cooper Village, and Centerpoint increased exposure to specific submarkets and strategies.”

Here are brief descriptions from various news sources of some well-publicized CalPERS real estate losses.

–LandSource: CalPERS paid $970 million in January 2007 for a majority stake in a Lennar Corp. development on the 15,000-acre Newhall Ranch north of Los Angeles. The project declared bankruptcy 15 months later. CalPERS severed ties with the advisor that recommended the investment, MacFarlane Partners of San Francisco.

–Stuyvesant Town and Peter Cooper Village: CalPERS invested $500 million in the $5.4 billion purchase by Tishman Speyer and BlackRock of 11,227 apartments on 80 acres in New York City. The plan was to replace rent-controlled tenants with market rents. But the courts objected, and the owners defaulted on a loan.

–Centerpoint: A CalPERS operative, CalEast, paid $3.4 billion in January 2005 for the largest industrial landlord in the Chicago area. An analyst told Forbes he thought CalPERS paid $900 million more than the value of the property, apparently to get the Centerpoint management team. CalEast value plunged in the economic downturn.

–East Palo Alto: CalPERS invested $100 million in a Page Mill Properties plan to upgrade 1,700 rent-controlled units and charge market rents. Critics said 1,500 low-income tenants were displaced. After a complex legal battle, the lender foreclosed.

–Columbus Center: CalPERS invested $91 million in a plan to build condos, hotel rooms and stores over a section of the Massachusetts turnpike in Boston, triggering a 13-year battle with neighborhood opponents and 130 community meetings. Opponents want CalPERS to pay $4 million to $5 million to clean up the partially excavated site.

–Capitol Mall Towers: CalPERS invested $100 million in April 2006 in a proposal for twin 53-story condo towers and a hotel in Sacramento, not far from CalPERS headquarters. As the real estate bubble burst, CalPERS bought out the developer 14 months later for an undisclosed sum and still owns the undeveloped block.

–Koin Center: CalPERS and a partner paid $109 million in 2007 to buy the bottom 19 floors of a landmark building in Portland, known as the “mechanical pencil” because of its shape. Last July they defaulted on a $70 million mortgage and gave up ownership.

CalPERS was riding high during the height of the real estate boom. In June 2006, the investment committee was told last week, annual real estate returns averaged 22 percent during the five previous years.

The CalPERS senior investment officer during the real estate boom, Mike McCook, was listed as one of the “30 most influential people in private equity real estate” in a November 2006 issue of Private Equity Real Estate.

“Our performance has exceeded every benchmark that we had,” McCook told the publication. “When you do that and there aren’t a lot of complaints from either partners or union sources, then you must be doing your job right.”

(The publication said McCook had left CalPERS after nearly five years in the post and would be going to work for Kenwood Investments, a private equity real estate firm in San Francisco founded in 1999 by Darius Anderson.

(Anderson agreed this month to pay a $500,000 settlement in a New York probe of kickbacks for obtaining pension fund investments. Anderson, who received “placement agent” fees for a CalPERS investment, was not charged in New York.

(McCook now works with Resmark Equity Partners in Los Angeles. He did not return a phone call asking for comment on the CalPERS staff report last week.)

Most real estate investors have had big losses in recent years. But CalPERS, using “leverage” or debt to make major higher-risk investments at the height of the boom, is one of the hardest hit.

The staff report said CalPERS, in percentage terms, had the biggest losses among a half dozen large pension funds in the last three years. A Wilshire report last month puts CalPERS 10-year real estate returns in the bottom 1 percent of large funds.

“If you look at CalPERS since the inception it’s just under seven percent positive,” Eliopoulos said of the real estate returns over the last three decades. “But this has been a very difficult stretch with the mistakes we have outlined here.”

Another perspective is that real estate is about 7 percent of a CalPERS investment portfolio currently valued at $210 billion. That’s less than the 10 percent target allocation for real estate.

Among the real estate reforms made during the last three years are policies to control debt and contracts, require reviews of some investment decisions by a staff committee and consultant, new databases and a performance review of investment partners.

The Pension Consulting Alliance is suggesting that CalPERS return to the “less aggressive” investment real estate strategies used before 2002, many generating stable income. CalPERS is doing a year-long look at overall investment strategies.

Board member Priya Mathur said CalPERS did not “hide our heads” and has dealt with the difficult issue of real estate losses. She and other board members congratulated the staff for years of hard work to restructure the program.

“I hope we can stop having these discussions where we continue to berate ourselves for past misactions,” Mathur said. “But I think this really is a great way for us to move forward.”

Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at Posted 30 Apr 10

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