Commercial real estate crisis hits pension funds

Sat Jun 01 2024
Eric Whitman (323 articles)
Commercial real estate crisis hits pension funds

Government pension plans are being severely impacted by the commercial real estate downturn, causing widespread concern about the ongoing financial losses.

Canada’s national pension plan announced in May that it is divesting its stakes in office towers located in Manhattan and San Francisco. The plan will be selling these properties for $225 million less than the original purchase price. In April, the government worker pension fund in California announced the successful sale of a long-standing property development project in Sacramento. The fund had been working on this venture for nearly twenty years. In March, consultants delivered a cautionary message to California’s teacher pension regarding the persistent negative impact of office holdings on returns, following a significant 9% loss in real estate in 2023.

The recent developments provide a fresh perspective on the extensive and gradual decline in the commercial real estate market. Since these investments typically do not trade on public markets like stocks, there is no universally accepted price. Managers often find themselves grappling with the challenge of adjusting the value of their holdings when the market undergoes a significant shift. This process can be time-consuming, sometimes spanning several months or even years.

Now, with rates on the rise for the past two years and the lingering effects of Covid-19 for the past four years, the consequences of these events are extending beyond U.S. banks, which hold trillions of dollars in property loans and investments, to the retirement savings of teachers and firefighters.

Canada’s pension plan reported that real estate returns over the past five years have been less than 1% annually, according to its fiscal year ending in March. In a surprising turn of events, major U.S. public pension funds have reported their first annual real estate loss since the Covid-19 pandemic. The funds returned a negative 6% for the 12 months ended Dec. 31, as revealed by the Wilshire Trust Universe Comparison Service.

According to Shawn Quinn, managing director at Wilshire, many pension-fund managers are still concerned that the storm is far from over.

“People are spending less money, attempting to comprehend the contents of their investment portfolio,” Quinn explained. Some institutional investors remain uncertain about whether or not we have reached the lowest point.

According to Taylor Mammen of RCLCO Fund Advisors, the real-estate portfolio of the California State Teachers’ Retirement System is being hindered by underperforming offices. This was discussed during a board meeting in March. Around 18% of Calstrs’s property holdings consist of traditional office space.

RCLCO attributed Calstrs’s 9% real estate loss for the 12 months ending in December primarily to the impact of higher interest rates on property values. Mammen highlighted the potential for reset to provide pension managers with appealing real-estate investment opportunities beyond traditional office spaces.

“Over the past 12 months, many in the industry, including Calstrs, have focused primarily on playing defense,” he stated.

Pensions, sovereign-wealth funds, university endowments, and family offices typically acquire properties directly or invest through private fund managers. There are suspicions among analysts and pension advisers that these managers may be hesitant to promptly report any losses. The share prices of publicly traded real-estate investment trusts have experienced a more significant decline compared to private marks.

However, pension funds have so far reported even lower levels of strain compared to private managers. In 2023, the privately managed funds tracked by the National Council of Real Estate Investment Fiduciaries reported a significant negative return of 12%. This was twice the loss that pension funds experienced. The tracked funds contain a diverse range of apartment, industrial, retail, and office properties. Pension officials typically consider private fund marks on a one-quarter lag due to their longer arrival time compared to stock and bond valuations.

According to its annual report published in May, the board overseeing Canada’s $461 billion national pension plan is redirecting its attention from traditional real-estate investments to infrastructure projects like highways and energy.

In its report, the Canada Pension Plan Investment Board announced the successful sale of its stake in a prominent downtown San Francisco office tower. This particular building, which was previously home to Uber’s offices, fetched an impressive $44 million. CPPIB acquired the stake in 2014 for a sum of $219 million. The fund announced that it has recently reached an agreement to sell its stake in a building located at 10 East 53rd Street in Manhattan. The sale price is set at $7 million, which is significantly lower than the initial purchase price of $57 million back in 2012.

California Public Employees’ Retirement System, with its $493 billion in assets, continues to retain ownership of the AXA Equitable Center, a prominent office tower located at 787 Seventh Avenue in Manhattan. In February, KBRA conducted an analysis that revealed a decrease in the building’s value to $917 million, which is 12% lower than Calpers’ initial estimate when they acquired it in 2016.

Several properties have remained in pension-fund portfolios for ten years or longer. During the years preceding the Covid-19 pandemic, U.S. retirement funds embraced more daring real estate investments in an effort to compensate for funding gaps in a time of low interest rates.

Prior to the 2008-09 financial crisis, numerous property acquisitions were made as pension funds were in a strong position and pension boards were enthusiastic supporters of local economic development initiatives. In June 2023, Calpers allocated a significant portion of its $69 billion real assets portfolio to investments in California, surpassing all other types of investments.

A certain property has been the cause of much concern and worry for quite some time. In the early 2000s, Calpers set out on a mission to construct two magnificent 53-story condominium towers on a prime block in its beloved hometown of Sacramento. The financing was unsuccessful in 2007.

After ten years, the board of Calpers gave the green light to a fresh vision for the site: a cutting-edge complex featuring offices, condominiums, and retail spaces, set to become the tallest tower in Sacramento. However, the search for office tenants proved to be unsuccessful, leading to the abandonment of the plan by a new investment chief just before the onset of the pandemic.

According to a spokesperson, Calpers invested a total of $87 million in the parcel. In April, the pension fund announced the sale of the land for $17 million to the Shingle Springs Band of Miwok Indians of Placerville, Calif., a federally recognized tribe. According to a press release from Shingle Springs Band Chairwoman Regina Cuellar, the parcel holds significant historical value as it is part of the group’s ancestral homeland.

Calpers announced a change in its real estate strategy, opting for established projects that offer a reliable cash yield instead of speculative, undeveloped properties.

Eric Whitman

Eric Whitman

Eric Whitman is our Senior Correspondent who has been reporting on Stock Market for last 5+ years. He handles news for UK and Europe. He is based in London