BPOA Article Library
Real Estate Economics • November 16, 2009
CalPERS realty deals and image take a beating
CalPERS realty deals and image take a beating
Published Monday, Nov. 16, 2009
EAST PALO ALTO – At the top of the real estate bubble, CalPERS invested $600 million in two deals that were 3,000 miles apart but linked by a common vision: Buy apartments governed by rent-control laws and turn them into cash cows.
The plan failed in a flurry of litigation and bad debt. A project in East Palo Alto is in default. The second deal, in New York, is likely headed that way. CalPERS could lose most or all of its money.
What's more, critics say the deals might sully CalPERS' reputation as a champion of socially responsible investing, a concept to which the fund says it remains firmly committed.
Advocates for tenants' rights say the California Public Employees' Retirement System didn't merely blunder into a couple of bad deals.
Rather, they say the $200 billion investment fund was party to a pair of schemes to jack up rents at the expense of thousands of working-class and middle-class tenants.
"There's absolutely no reason a public employee pension fund ... should choose to invest in that," said Dean Preston, executive director of San Francisco advocacy group Tenants Together.
The controversy could become another public-relations headache for CalPERS, which is struggling with heavy investment losses and a possible influence-peddling scandal. The system manages retirement benefits for more than 1.6 million California public employees, retirees, and their families.
A delegation from East Palo Alto, including the mayor, spoke at a CalPERS investment committee meeting last December, saying tenants were being driven out. "Some of your money from public employees is being used to really hurt our people," Mayor Ruben Abrica said he told the committee.
Committee members pledged to look into the matter, according to minutes of the meeting.
The developer in East Palo Alto, Page Mill Properties, says it only banished drug dealers and gang members, not law-abiding tenants.
CalPERS spokesman Clark McKinley wouldn't respond last week to criticism that the fund had strayed from socially responsible investing. He said CalPERS remains committed to investing ethically while still looking out for the highest returns.
'Do well and do good'
CalPERS has endorsed a string of United Nations guidelines encouraging institutions to invest with the environment and social issues in mind.
"If we can do well and do good at the same time, we sure try to do that," McKinley said. "This seemed like a win-win."
Instead, both deals are teetering.
In East Palo Alto, where CalPERS invested $100 million in a cluster of rental units, the project was hit with a default notice from Wells Fargo & Co. That's the first step toward foreclosure.
In New York, CalPERS poured $500 million into a massive apartment deal that's turning into one of Manhattan's largest real estate debacles ever. The investment partnership could run out of cash by year's end, likely triggering a default. In another big setback for investors, the state's highest court recently ruled that the partnership was raising rents illegally.
The California State Teachers' Retirement System has written off the $100 million it invested in the New York deal. CalSTRS and CalPERS lost a combined $100 billion in the fiscal year ending June 30 and say taxpayers might have to put more money into the pension funds.
Under guidelines then in force, CalPERS' staff was able to make the New York and East Palo Alto deals without board approval, McKinley said. The guidelines have been tightened to give the board greater oversight.
McKinley said CalPERS was simply blindsided by the collapse in the market.
"In 2005, 2006, that's when the market was peaking," he said. "Many of those real estate commitments were made at that time."
Yet others say CalPERS may have had unrealistic expectations. Investors in the New York deal were told income could double in just four years, said Ben Thypin of research firm Real Capital Analytics.
"It was fanciful," he said.
In that deal, Tishman Speyer Properties and investment manager BlackRock Inc. in 2006 paid $5.4 billion for an 11,000-unit complex called Peter Cooper Village and Stuyvesant Town, a middle-class enclave built in the 1940s. The partners then sold the complex to investors such as the California funds, the Church of England and the government of Singapore.
'Prime real estate'
In East Palo Alto, CalPERS teamed with Page Mill Properties, which bought 1,800 rental units in a working-class district that was "ripe for gentrification," said Juliet Brodie of the Stanford Community Law Clinic, which has represented some tenants.
The units – apartments, duplexes, etc. – account for half the hardscrabble city's rental properties. They're clustered around a redevelopment site anchored by a Four Seasons Hotel, and wedged between Highway 101 and the border with wealthy Palo Alto.
"It's people working multiple jobs to put food on the table, to afford health care and to pay rent," said tenant Christopher Lund, who has led opposition to Page Mill. "But it's prime real estate in terms of its location with respect to Palo Alto."
Despite the rent-control laws, it's possible under certain circumstances to increase rents – sometimes substantially. That's especially true when a new tenant moves in.
But the process can be long and messy. Tenants sue. Elected officials step in. The landlords in both CalPERS deals were able to raise rents on hundreds of units, but they couldn't move quickly enough. Then the market collapsed.
In New York, the $3 billion loan was just turned over to a "special servicer," a firm that deals with troubled debts.
Tishman Speyer, the New York landlord, said it hopes the move can "facilitate negotiations on a restructuring of the debt load." But default appears more likely. Fitch Ratings, the Wall Street credit analyst, said the partnership will run out of money by Dec. 31.
Rents raised 30% or more
In East Palo Alto, the business model rested on a wrinkle in the rent-control law.
After the 2001 recession, actual rents fell considerably in the city and never recovered. That left a yawning gap between what tenants were paying and what CalPERS' partner, Page Mill, believed it could legally charge under the rent-control ceiling.
All at once, rents on many units jumped 30 percent or more, said Lund, an organizer for the East Palo Alto Fair Rent Coalition. The average unit went from about $900 a month to $1,200, he said.
Lund, 41, who rents a unit in a fourplex, said his payments doubled to about $1,400.
Tenant advocates said Page Mill was using a questionable reading of the law. The city passed an emergency ordinance halting the rent hikes. Page Mill sued, and got the law overturned.
More litigation followed. A few tenants, including Lund, were able to get their rent increases rolled back.
Lund said Page Mill began a campaign to drive tenants out. Tenants who were a day late with their rent, or who posted fliers in their windows supporting the Fair Rent Coalition, were threatened with eviction, he said.
The motivation, he said, was money. When an apartment in East Palo Alto becomes vacant, rent controls are temporarily lifted and the landlord can start the new tenant off at a market rate.
Page Mill disputes Lund's charges. It improved the units and only drove away "the drug dealers, the gang members and the troublemakers," said spokesman Sam Singer.
He said tenant opposition had nothing to do with Page Mill's woes. "This is strictly a market-driven issue."
Page Mill missed a $50 million payment to Wells Fargo, and the bank filed a default notice last month. Singer said "there's certainly the hope that Page Mill can pull this out."
But CalPERS appears to have less confidence.
"We decided we weren't going to put any more money into that," said McKinley.